Page 46 - Bankruptcy and Reorganization Services

Step 5: Adjust the Calculated Multiples for Material Differences Between the Subject Company and the Se-
lected Guideline Companies

The analyst should further consider any adjustments to the multiples to reflect the differences in perfor-
mance and operating characteristics between the subject company and the guideline companies. For ex-
ample, the anticipated earnings growth for the guideline companies is typically different than the antici-
pated earnings growth for the subject company. Where possible, practitioners should adjust for such dif-
ferences.

In addition, revenue multiples are typically more sensitive to differences in profitability than earnings
multiples, all other factors being equal. This is because earnings levels are already taken into account
when calculating earnings multiples, but not when calculating revenue multiples. Another example re-
lates to differences in capital structures. Although long-term debt is traditionally considered part of the
capital structure, sometimes short-term debt may be part of the permanent long-term capital structure of
the guideline (or subject) companies, necessitating adjustment of the multiples. Some practitioners ad-
just for these differences as well.

In addition to the aforementioned factors, there are often risk factors specific to each company that need
to be considered when comparing the guideline companies to the subject company. These factors can be
both positive and negative. For instance, a common adjustment to guideline multiples relates to differ-
ences in size. In situations in which guideline companies are not of comparable size to the subject com-
pany, practitioners should adjust guideline multiples to reflect such differences.

Additional company-specific risk factors include key person dependence, key supplier dependence,
forecast uncertainty (achievability), customer concentration, litigation, and forecast bias. These factors
are often more pronounced when a company is in bankruptcy. Generally, these are the same factors con-
sidered when developing the company-specific risk component of the cost of capital under the income
approach. Some practitioners adjust guideline company multiples to reflect such differences. A more de-
tailed discussion of company-specific risk factors is presented later in this section under "Income Ap-
proach" and in chapter 11, "Cost of Capital,” of this practice aid.

Multiples for distressed businesses may also need to be adjusted for neglect, such as deferred capital ex-
penditures or diminished working capital accounts. When utilizing a set of healthy guideline companies,
it is often assumed that the resulting implied valuation reflects a business that has maintained its asset
base and has a normalized level of working capital. However, capital expenditures may have lagged be-
hind industry norms and working capital may become distorted in distressed situations. In addition to or
instead of adjusting multiples, practitioners may make adjustments to indicated values for the aforemen-
tioned factors.

Taxes are an important consideration and it may be the case that, in distressed situations, tax attributes
and treatment vary significantly between the guideline companies and the subject company. Cancella-
tion of debt income and net operating losses (NOLs) are two elements of differences that may exist be-
tween the subject and guideline companies. Such differences should be evaluated, and adjustments
should be made to the extent possible given the information available. Where a significant unutilized
NOL exists, the NOL should be valued separately and added to the implied value.

Step 6: Select and Apply Multiples to the Relevant Financial Metric of the Subject Company

After the practitioner has calculated the selected multiples for each guideline company, the analyst must
determine the appropriate multiples to apply to the subject company.

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