Pro Forma Multiples

Pro forma multiples are valuation or financial multiples that are usually adjusted in a comparable analysis to “pro forma” for major corporate events that could distort those multiples.

In any multiple, it is imperative that the numerator and denominator reflect the same collection of assets.  So, if the numerator (i.e. enterprise value) reflects all the new capital to fund an acquisition because the acquisition has closed, the denominator (i.e. EBITDA) needs to include the contribution of the acquired assets for the full 12-month period being analyzed in the multiple.

The term “pro forma” essentially means to “pretend” that the transaction occurred at the beginning of the financial period used in the denominator.

Situations Requiring Pro Forma Multiples

It is most common to make “pro forma” adjustments to multiples to reflect an acquisition by the subject company.  However, these types of adjustments are not limited to acquisitions.  Multiples can be adjusted for any of these events:

• Recent acquisitions or divestitures
• Recent debt or equity offerings
• Conversion of debt to equity, or repayment of debt
• Stock repurchases
• Significant investment in new assets
• Payment of legal settlements

Whether to adjust will be a subjective decision as to the materiality of the event.

Valuation or financial multiples are usually adjusted in a comparable analysis due to recent acquisitions or other subsequent events happening after the period end of the latest filed financials.  For example, EV / EBITDA multiples would have to be adjusted if a company completed an acquisition after the latest financials, because the EV will be impacted (market cap or EV will increase to account for the merged company), while the historical EBITDA will only include the financials of the acquiring company.

Typically, these adjustments are required for LTM or historical multiples because estimates for future periods (often taken as consensus estimates from research analysts) already account for incremental earnings from the target company.  However, sometimes estimates need to be adjusted as well since the research analyst will typically only include the results of the acquired company from the closing date of the acquisition.

Making Pro Forma Multiple Adjustments

If the numerator (i.e. enterprise value) of a financial / valuation multiple already accounts for the material event, only the denominator will need to be adjusted. For example, if an acquisition closed in the last quarter, the acquirer’s balance sheet will already reflect the capital raised to fund the acquisition. However, since the EBITDA of the target only gets included from the date of the acquisition, the combined EBITDA will need to be adjusted to include any target EBITDA from the beginning of the year to the date of closing.

As a simple example, the table below shows a situation where an acquisition has closed on June 30 (assume a calendar fiscal year-end), assuming 2018 is the current fiscal year in progress. The balance sheet and therefore EV reflect the capitalization for the purchase, but the estimated full year 2018 EBITDA only includes the target from the date of closing (i.e. half the year). To make the multiple “apples to apples”, we need to include the missing 1st half of 2018 EBITDA for the acquired business:

In the case where an announcement has been made but the transaction has yet to close, both the numerator and denominator may need to be adjusted. For example, in a P/E multiple, the numerator or share price of the company will move right away as soon as an acquisition is announced. In order to keep an “apple to apples” comparison, the denominator, or in this case the EPS metric, will have to be adjusted to reflect the pro forma EPS of the combined company.

Similarly, for an EV / EBITDA multiple, the EV or numerator will account for the current market cap of the company based on the new share price being traded in the market. However, in this case the numerator or Enterprise Value might also need to be adjusted to account for any incremental shares being issued to the target company, or any incremental debt taken by the acquirer in order to finance an acquisition.

Finding Amounts for Pro Forma Multiple Adjustments

Depending on what needs to be adjusted (numerator or denominator) and the type of event (acquisition, financing, divestiture, etc.), the information might be found in any or all of (i) the press releases for the event, (ii) the MD&A or notes to the financial statements, including the subsequent events disclosure (iii) investor presentations or investor call transcripts, or (iv) research reports.

For example, for a debt or equity financing, the information needed can usually be found in the original press release describing the transaction (i.e. the number of new shares being issued, the price of the shares, the fees paid to the underwriters, etc.).

For an acquisition, the information might be more difficult to find. If it’s a large acquisition, the acquiring company will usually have a presentation at the time of announcement with full details on the financials of the target. This is especially the case if the acquirer needs shareholder approval for the transaction. In these presentations, the acquiring company will usually provide estimates for Revenues, EBITDA and future earnings of the target company and also historical financial data for the last twelve months. If the target is a public company, the best source for information for historical data will be the target’s own filed financial statements (from EDGAR or SEDAR, depending if it’s a US or Canadian listed company).

For smaller acquisitions, the acquiring company might not be as transparent regarding the contribution from the target company. In these cases, a better source of information will be sell-side research reports that will often provide estimates of the Revenue, EBITDA and EPS contributions of the target company, and also provide high level accretion-dilution analysis.

Example : A company recently raised $200 mm of debt at 5% interest, after filing its latest quarterly financials. The management will use the proceeds to buy back $200 mm of its own shares in the market. What financial multiples will be impacted, if any, and what adjustments are needed?

Depending on the metrics used in the comparable analysis, both valuation and leverage ratios will need to be adjusted.

Examples of leverage ratios adjustments:

• Debt / EBITDA will need to capture the new debt issued
• Interest coverage will need to account for the higher interest rate expense

Example of valuation multiples adjustments:

• P/E multiple – EPS will be impacted by incremental interest (will decrease Net income) and lower number of shares (assumption needs to be made on buy-back price if not provided in the press release, and the number of shares needs to be adjusted accordingly)
• P/BV multiple – BVPS will be impacted by the reduced number of shares; book value of equity will be reduced by lower re-purchased common equity (on the balance sheet, Debt would increase by $200, while equity would be reduced by $200, assets will remain the same)