valuation techniques?

I started my working career at Sun Microsystems (in the hardware division - SMCC) in the early 90’s and was very fortunate to work with some extremely talented people in the Valley.  You could say that time really molded my work ethic and I have been watching them ever since.  Since the dot.com bubble burst Sun has always had a depressed share price and a lot of cash - prime acquisition target.  They actually went on a few shopping sprees just to use up some cash so they were less attractive.  Well, after the potential IBM/Sun acquisition went sideways the quick announcement yesterday that Oracle was to buy Sun for $7.4B caught me off guard.  Of course there was a flurry of emails to past and existing Sun employees to get their opinions on the deal but the question posed to me that stuck out was:

how did they value Sun to be $7.4B or $9.50/share?

Ah yes, valuation techniques.  I once joked with a valuation “expert” at PWC that the question should not be “what is the value” but more like “what value would you like?“.  As much as we try to convince ourselves that valuation techniques are a science it really boils down to what the buyer is willing to pay and what the seller is willing to accept.  But there does need to be a starting point so a valuation technique is mandatory.

what techniques can be used to value a company?

Well, there really isn’t one way to do this.  Typically analysts invoke 3 or 4 techniques and triangulate the results.  The ones I most commonly start with (for small private companies) are:

• terminal value;
• enterprise value;
• recurring revenue multiple (multiple provided by recent transactions);
• net income multiple (multiple provided by recent transactions).

I then take an average of all of them in order to get to an approximate number to start with.  From there we get to the “what value would you like?” question.  You see, after you’ve come to an initial number you then make:

valuation adjustments on the basis of your informed and experienced judgment.  This will include consideration of factors such as: the relative applicability of the methodologies based on the nature of the industry and current market conditions; the quality and reliability of the underlying data; the comparability of enterprise or transaction data that has occurred with a similar company; the stage of development of the enterprise; and any other items that are unique to the company. International Private Equity and Venture Capital Valuation Guidelines.

Right then.  So there is the rub.  Your expert opinion allows you to tweak the input assumptions to get to a number you think is “fair”.  So, Sun is a publicly traded company, most of the information is available so you can calculate the four different methods above, triangulate the results and then see what the premium was placed on the deal.

Now that you have the valuation (and a deal) the next bit o’ fun is the “waterfall of funds”: who gets paid what.  I’ll be watching to see how much Scott McNealy and Jonathan Schwartz will get out of the proceeds.  Hah!  Who needs a TV - life provides so much drama already.  If you’re really curious, check out the merger details here - I particularly enjoyed the sums of money if either party breaks the agreement.  Wow.  That’s a whooooole lot of shoes.