Currently Reading

The Truth About Company Valuations

Advertisement

The Truth About Company Valuations

This two-part series explores the impact of valuations on home-building companies. In Part 1, we debunk valuation myths and discuss how a softer market affects valuations


By Jody Kahn Kline July 31, 2006
four people calculating a company's value
Photo: Pxhere

 

First in a two-part series

You can't chat with a group of builders today without hearing about slowing sales, and the industry is anticipating a prolonged period of softer market conditions. This two-part series will explore the impact of valuations on home-building companies.

In this article, we debunk valuation myths and discuss how a softer market affects valuations. In Part 2, we'll detail valuation methodologies.

Assumptions

Our valuation methodology builds on three premises:

  1. A company is worth what a prudent buyer will pay in today's business environment.
  2. Public companies will not close deals that are dilutive to their current or future earnings per share.
  3. No one can buy historic performance.

 

The first two assumptions are better understood than the third. Although builders believe their company will be valued on past performance, our valuations are based on future performance, particularly the next 12 months. Performance can be proven from the backlog and lot inventory and can affect an acquirer's financial performance in the short term. The builder's history adds credibility to the projections. We will discuss valuation methodologies more in depth in the next issue.

 

The Myth of Book Value

We typically use three pricing models to frame a range of value, calculating additional financial ratios used by the acquirers as a cross-check. We then apply subjective criteria to narrow the range.

A common myth is that book value is the key to establishing value. Nearly every builder knows someone who reportedly sold a company for a high multiple of book value. In fact, our models utilize future after-tax income and future EBITDA (earnings before interest, taxes, depreciation and amortization) after the effects of purchase accounting. We calculate the multiple of book value after the valuation has been established. Because the full details of an acquisition are rarely reported, the apparent multiples are in the stratosphere.

 

Multiples Hype

Transactions closed in the last four to five years often had significant cash paid at closing, mistakenly assumed to be outrageous premiums that added to the multiples hype. In reality, buyers were flush with cash and their credit lines nearly untouched. With fairly predictable income streams available for purchase, they preferred to acquire a builder's future profits up front and pay less overall than pay out over time based on actual long-term performance.

 

What Is Changing

Future income projections are now less reliable, and the public builders have been under pressure from Wall Street to use cash to buy back stock. Buyers now prefer to pay for future earnings based on actual performance and will pay less at closing yet potentially more overall for their acquisitions. Sellers can expect scrutiny of their projections with a conservative eye, particularly a year out when the backlog from year-end 2005 is gone and replaced by fewer sales at lower margins.

 

The current softening of land/lot acquisition terms should be followed by softer pricing if history is an indicator, which could impact values for those builders with significant land inventories. The next wave of transactions will probably look more like those we constructed in the early 90s, with earn-outs that reward sellers handsomely for meeting or exceeding projections. Most if not all of our sellers did very well for themselves via earn-outs that had varying degrees of riskiness.

Jody Kahn Kline develops marketing materials for MPKA's seller clients as well as heads many assignments in which MPKA represents buyers. She provides market research support and identifies and screens prospects.

Related Stories

Market Data + Trends

Home Prices Increase in 89% of Markets During Quarter One

Home prices continue to rise across the country with 89% of markets posting price gains and the national median home price hitting $319,200.…

Market Data + Trends

Nearly Half of Americans Say It's Not a Good Time to Buy

The share of American adults expecting home prices to increase over the next year reached its highest point in Gallup history, just 1% above 2005…

Affordability

Today’s Homebuyer Perception of Affordability Exceeds 2020 Levels

A larger share of homebuyers report being able to afford half or more of the homes available for sale in their markets during the first quarter of…

Advertisement
Advertisement

More in Category




Advertisement
Advertisement

Create an account

By creating an account, you agree to Pro Builder's terms of service and privacy policy.


Daily Feed Newsletter

Get Pro Builder in your inbox

Each day, Pro Builder's editors assemble the latest breaking industry news, hottest trends, and most relevant research, delivered to your inbox.

Save the stories you care about

Lorem ipsum dolor sit amet lorem ipsum dolor sit amet lorem ipsum dolor sit amet.

The bookmark icon allows you to save any story to your account to read it later
Tap it once to save, and tap it again to unsave

It looks like you’re using an ad-blocker!

Pro Builder is an advertisting supported site and we noticed you have ad-blocking enabled in your browser. There are two ways you can keep reading:

Disable your ad-blocker
Disable now
Subscribe to Pro Builder
Subscribe
Already a member? Sign in
Become a Member

Subscribe to Pro Builder for unlimited access

Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.