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Time to Talk about Comps |
Welcome back! Last week, I sent out a list of buyside shops in Denver Colorado to HYH Premium readers. On Wednesday, I'll be wrapping up the year with my year end piece. |
We're going to talk about "comps" aka how to comparably analyze a situation based on similar datapoints. We can also call these "peer comps", which focuses on evaluating the financial metrics, valuation metrics, and trading dynamics of similar companies. Here's how I'm going to talk about comps: |
1) Looking at this from an Enterprise Value ("EV") lens, and the feasibility of a new transaction/an LBO. |
2) Looking at this from a trading levels perspective (where should a loan or bond trade, aka "relative value") |
Let's start with valuation, and why the leveraged finance market runs on EV/EBITDA. |
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Multiples are a function of the rate environment: As many of you know, 2021's multiple may not be 2024's multiple and part of that is due to projections of levered free cash flow and the interest burden on future cash generation. Everything in life is a DCF, in a way. |
2023 and 2024 have been all about educating sellers and sponsors that yesterday's price is not today's price. There are industries that have seen their multiples cut by 25% (maybe even as high as 50%), without much justification that they should ever trade the way they used to trade again. |
Bigger, and faster growing businesses merit higher multiples: It's a very simple concept. Larger and scaled businesses that are very much professionalized deserve a much higher multiple than a smaller business that may not have an effective ERP system. This is the basis for roll-up strategies. And it's also why a lot of SMB Entrepreneurs can buy something for 4x-6x EV/EBITDA. So ya, I'm kinda stating the obvious, but smaller businesses in xyz high yield industry may be worth 6-8x, while larger, platform operators may be worth 11-14x. |
Larger companies simply have a higher return on investment and a less risky investment profile, deservedly giving them higher EV/EBITDA multiples, while smaller companies (unless they have amazing growth) won't be able to earn that multiple as a stand-alone. |
An Example: |
I might be somewhat checked out from the W-2 side at this point and pretty focused on HYH business related stuff - so let's give a "Internet Media" example on different multiples based on scale/the rate environment. |
Let's take a quick look at Morning Brew's sale to Insider Inc. (the parent of Business Insider) at a $75 million valuation in 2020. |
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Here's the stats Morning Brew had at the time of the $75mm sale: They had 2.5mm readers, 2020E Revenue of $20mm, and a bunch of social platforms, including a growing podcast. Most importantly, this was the "golden age" of newsletters. The right time before it became too saturated. |
Okay, nice so Morning Brew is a 3.5x EV/Revenue business. But no, that does not mean every other newsletter is a 3.5x EV/Revenue business. 2.5mm readers is massive scale (it's well over 4 million now) and they've launched a ton of different verticals and new revenue streams. That is a "scaled" multiple when it comes to internet media businesses. It also may have been driven by a lower-interest rate environment. But the deal still seems like a success despite the soft ad market: Revenue was $46 million in 2021, $70mm in 2022, and it seems like the most recent 12-month revenue number was $70mm in revenue, with 20% EBITDA margins, and 6mm total subs. |
The Newsletter industry is exactly like the rule I laid out above - 3.5x EV/Revenue is a good reference point, and everyone else (unless there's a very unique value prop) deserves a lower multiple. |
As some of you know, we're in a bit of a "washout" phase of newsletters, where a bunch of small new entrants are exiting the space, so I've been providing a liquidity solution for a lot of buyers in a relatively illiquid market. So I look at a lot of these potential deals. I had a newsletter deal approached to me at >8x EV/Sales & didn't bother continuing the conversation given the multiple is so far off the course. |
Valuation: |
When I think about Valuation I primarily measure EV/EBITDA multiples. I know public equity guys look at more multiples than us Credit investors, but this is the big focus for a lot of leveraged finance professionals given this is how a lot of companies 1) transact and 2) hit the right create. There's plenty of other ways to think about valuation though – EV/Sales, net out capex, EV/EBIT if you're looking at industrials, EV/FCF, and to measure valuation on a post-synergy basis. Like "I paid 8x but post synergies it's more like 6.5x". As you notice, I highly prioritize enterprise value over market capitalization – for beginners, this is because this encapsulates all of the financing in the structure (like net debt + preferred). I remember seeing someone say "I love Penn Gaming because it's only xyz market cap" – brother, that name is levered af. |
I've generally had a fixation on EV/EBITDA multiples. I had once pulled down lists upon lists of EV/EBITDA for specific issuers by industry and studied how those multiples changed over 15-20 years. There's a lot you can learn from these types of exercises, and you'll notice how many now "dying" industries used to trade respectively, before the growth and cash flow profile of these businesses dramatically changed. I know NYU has put out some free resources on multiples. Professor Damodaran is the corporate valuation GOAT. |
I would recommend you be thoughtful in how you think about how something should transact/trade. A lot of PMs/MDs put a lot of weight in what valuation range you present. No one I know does this, but you could always get super methodical and build EV/EBITDA backwards 😆. Enterprise Value is net operating profit after taxes x (1- the growth rate/return of invested capital)/(weighted average cost of capital - the growth rate). But we'll skip building out the mechanics and drivers of EV/EBITDA multiples for this edition. |
Generally, I comp towards the other multiples that other peers trade at and then make decisions of whether it should be valued higher, lower, or at the same type of multiple. There's a lot of different distinctions you make and some of the immediate examples relate to 1) scale, 2) growth rate and 3) Sum-of-the-parts ("SOTP") that value some parts of the business at a higher multiple and other parts of the business at a lower multiple. |
Generally, contracted or recurring earnings, faster growing, or higher durability assets, will merit a higher multiple. If this is a SOTP story, then you need to figure out who the most realistic buyer universe is for a specific asset. These stories are a bit tough because generally there's an asset that's really crappy and how that business is managed in the longer term could get pretty ugly, while they're monetizing the most promising asset. Also, think about it, these businesses all came together for a reason. There were scale benefits and back-office/back-end savings as well – breaking apart these segments adds some dis-synergy to equation. |
The street generally overvalues the potential of asset sales: I've seen this a bunch over the past couple of years in particular – a company floats themselves for sale, or an asset or two for sale, due to some level of desperation, and ultimately they're not able to get the interest in the unit they thought they were going to get. Sure, rates are high, but there's so much overpromising and underdelivering which should be pretty easy to spot. I generally don't trust the messaging of 60%-70% of management teams. This has generally proven out, and if I get surprised to the upside then (as Marlo Stanfield would say) "that sounds like one of them good problems". Keep your expectations low so you're less likely to get disappointed – this is why I don't really buy into the multiples that some sell-side analysts float around with assets/asset sales. |
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Trading: |
Let's talk a bit about relative value ("RV"). This means taking a look at whether a loan/bond trades or is being priced at a level that is fair and attractive relative to other comparable companies. Sometimes, it can be "too tight", sometimes it can "trade wide". Generally, syndications and roadshows come with some OID or extra spread to entice you to get involved in the first place. |
What to focus on: |
Discount margin (for loans): This is the estimated average spread on a variable-security, aka a floating rate loan. The DM is meant to equal the future CFs (or interest payments) you should be expecting relative to current pricing. To be frank, I've always leveraged Bloomberg to pull DM for me. This is how I, and pretty much every credit guy I've talked to this about, look at public credit loans. Go to "YAS" in BBG or go to "FLDS" in BBG and then search DM. |
Spread: When we're speaking about spread, we're comparing the difference in yield that a bond trades over a risk-free asset (aka treasuries). These spreads are option-adjusted so they're matched in accordance with the exact time series on the Treasury curve. This is why credit folks mainly reference "OAS", option-adjusted spreads. You need to be compensated for the extra risk you're taking, but the direct correlation does change over time. |
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Yields with bonds: The Yield to Maturity is self-explanatory, but you want to take a look at Yield To Worst (YTW) to look at the minimum return you should expect on a callable bond. Bonds aren't redeemed at maturity…they're called much sooner → when they're callable (whether it's 102, 101, 100, etc.). I generally gravitate towards looking at Yield With Curve, which refers to how a loan/bond's yield varies across different maturities. This is a more holistic way to look at things, given it's showing the interchanging relationship between maturity and yield. |
Using Indices for Comps: So look, if you have a Bloomberg terminal it's very easy to find how something trades and what indices trade at. So we're going to look at things from a "I don't have a Bloomberg" perspective. |
Below is the US High Yield Index for BB rated debt: |
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Below is the US High Yield Index for B rated debt: |
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Below is the US High Yield Index for CCC rated debt: |
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Here's a good chart on BB risk vs B risk vs CCC risk: |
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A Template for the folks at home: |
See attached, an example "Comps Sheet" I put together to analyze relative value. Obviously, these numbers aren't 100% correct and are for mainly illustrative purposes. |
Apologies in advance for how poor the formatting of posting photos to beehiiv is. |
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This gives a good scope of generally how comp sheets in credit look. As we discussed above though, you can also include YTM and YTW in there as well, and you'll use OAS instead of DMs for High Yield Bonds. You can also look include comps from a "Spread/Leverage", "FCF/1L Debt", "FCF/Total Debt", "1L LTV", and "LTV" standpoint, which some credit professionals use as well. LTV = "Loan-To-Value" btw, if that wasn't clear. |
More considerations to think about: |
In terms of other free resources, you can assess the S&P Corporate Bond Index here. You can access some of the loans that are commonly key holdings in the leveraged loan ETFs by looking at the Loan ETF list and then getting a look at portfolio holdings. There are several well-known public names that have leveraged loans within this index (think American Airlines, TransDigm, AppLovin) that you can use for idea generation. |
Who trades this, how liquid is this: Make sure you're using realistic marks when you're calculating relative value. This means making sure the loan or bond is actually liquid (if very small). |
"__ Company should trade __ back of __ Company": Now that you have presumably have enough comps and datapoints, you need to start extrapolating your own opinions. A lot of this is "an art, not science". But this is critical from a relative value standpoint. This generally happens when comparing a "misunderstood" credit, or if you're comping a BB-rated credit vs. a B-rated Credit, or a B-rated Credit vs. a CCC-rated credit. You have to ask yourself what spread should the lower tier company trade at relative to the higher-grade company. You can see some of this relationship via mapping Bloomberg charts. You might end up with a data point such as "_ Company normally trades 90-120bps back of _, they're currently trading 200bps back, we think this should trade more like 100 back." That might be a cool trade to put on. |
Ratings and future ratings matter: I used to call up rating agency analysts a lot when wearing a public credit hat. Talking to them helped because they would generally choreograph their next move. One of the more senior analysts I worked with yelled at a Moody's/S&P analyst for changing the outlook of a name once though lol. If you're in a seat where there is ratings sensitivity, then you need to be highly cognizant of the spread vs. rating trade-off. For example, S+200 was way too tight for me, even if it's IG. Just doesn't make sense from a liability-matching perspective IMO. But let's say S+250 is fine for a BB/BB+ name – but it's not fine for a B2 name. That's a bad current given the ratings profile. |
But then again, a couple of 2nd Liens are pricing at S+475 – so business is booming for some larger liquid loans! |
Until next time. |
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