1) The document discusses various valuation methods that can be applied to mergers and acquisitions, including relative valuation methods like comparable company analysis and recent transactions methods, asset-based methods like tangible book value and liquidation value, and real options valuation. 2) It provides an example of valuing Repsol YPF using comparable integrated oil companies and determining whether Basic Energy Service or Composite Production Services is a more attractive acquisition target using the PEG ratio method. 3) Key things to remember include considering market-based, asset-based, and replacement cost methods, adjusting for non-operating items, and accounting for real options when identifiable and value-adding.

1. Applying Relative, Asset Oriented,
and Real Option Valuation Methods to
Mergers and Acquisitions

2. Applying Market-Based (Relative
Valuation) Methods1
MVT = (MVC / IC) x IT
Where
MVC = Market value of the comparable company C
IC = Measure of value for comparable company C
IT = Measure of value for company T
(MVC/IC) = Market value multiple for the comparable
company
1
Comparable companies may include those with profitability, risk, and growth characteristics similar to the target firm.

3. Market-Based Methods: Comparable Company Example
Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies
Target Valuation Based on Following Multiples (MVC
/VIC
):
Comparable Company Trailing P/E1 Forward
P/E2 Price/Sales Price/Book
Average
Col. 1 Col. 2 Col. 3 Col. 4 Col. 1-4
Exxon Mobil Corp (XOM) 11.25 8.73 1.17 3.71
British Petroleum (BP) 9.18 7.68 0.69 2.17
Chevron Corp (CVX) 10.79 8.05 0.91 2.54
Royal Dutch Shell (RDS-B) 7.36 8.35 0.61 1.86
ConocoPhillips (COP) 11.92 6.89 0.77 1.59
Total SA (TOT) 8.75 8.73 0.80 2.53
Eni SpA (E) 3.17 7.91 0.36 0.81
PetroChina Co. (PTR) 11.96 10.75 1.75 2.10
Average Multiple (MVC
/VIC
) Times 9.30 8.39 0.88 2.16
Repsol YPF Projections (VIT
)3
$4.38 $3.27 $92.66 $26.49
Equals Estimated Value of Target $40.72 $27.42 $81.77 $57.32 $51.81
1
Trailing 52 week average. 2
Projected 52 week average. 3
Billions of Dollars.

4. Market-Based Methods:
Recent Transactions’ Method1
• Calculation similar to comparable companies’
method, except multiples used to estimate target’s
value based on purchase prices of recently
acquired comparable companies.
• Most accurate method whenever the transaction is
truly comparable and very recent.
• Major limitation is that truly comparable recent
transactions are rare.
1
Also called precedent method.

5. Market-Based Methods:
Same or Comparable Industry Method
• Multiply target’s earnings or revenues by
market value to earnings or revenue ratios
for the average firm in target’s industry or a
comparable industry.
• Primary advantage is the ease of use and
availability of data.
• Disadvantages include presumption industry
multiples are actually comparable and
analysts’ projections are unbiased.

6. PEG (Price to Earnings & Growth rate) Ratio
• Used to adjust relative valuation methods for differences in growth rates
among comparable firms.
• Helpful in determining which of a number of different firms in same
industry exhibiting different growth rates may be the most attractive.
(MVT/VIT) = A and
VITGR
MVT = A x VITGR x VIT
Where A = Market price to value indicator relative to the growth rate of
value indicator (e.g., (P/E)/ EPS growth rate)
MVT = Market value of target
VIT = Value indicator for target (e.g., EPS)
VITGR = Projected growth rate in value indicator (e.g., EPS)

7. Applying the PEG Ratio
An analyst is asked to determine whether Basic Energy Service (BAS) or Composite Production
Services (CPS) is more attractive as an acquisition target. Both firms provide engineering,
construction, and specialty services to the oil, gas, refinery, and petrochemical industries.
BES and CPS have projected annual earnings per share growth rates of 15 percent and 9
percent, respectively. BES’ and CPS’ current earnings per share are $2.05 and $3.15,
respectively. The current share prices as of June 25, 2008 for BAS is $31.48 and for CPX is $26.
The industry average price-to-earnings ratio and growth rate are 12.4 and 11 percent,
respectively. Based on this information, which firm is a more attractive takeover target as of the
point in time the firms are being compared?
Industry average PEG ratio:1
12.4/.11 = 112.73
BAS: Implied share price = 112.73 x .15 x $2.05 = $34.66
CPX: Implied share price = 112.73 x .09 x $3.15 = $31.96
Answer: The difference between the implied and actual share prices for BAS and CPX is $3.18
(i.e., $34.66 - $31.48) and $5.96 ($31.96 - $26.00), respectively. CPX is more undervalued than
BAS at that moment in time.
1
Solving MVT = A x VITGR x VIT using an individual firm’s PEG ratio provides the firm’s current or share price in period T, since this
formula is an identity. An industry average PEG ratio may be used to provide an estimate of the firm’s intrinsic value. This
implicitly assumes that both firms exhibit the same relationship between price-to-earnings ratios and earnings growth rates.

8. Asset-Based Methods:
Tangible Book Value
• Tangible book value (TBV) = (total assets - total
liabilities - goodwill)
• Target’s estimated value = Target’s TBV x
[(industry average or comparable firm market
value) / (industry or comparable firm TBV)].
• Often used for valuing
– Financial services firms where tangible book
value is primarily cash or liquid assets
– Distribution firms where current assets constitute
a large percentage of total assets

9. Asset-Based Methods: Liquidation Method
• Value assets as if sold in an “orderly” fashion (e.g., 9-12
months) and deduct value of liabilities and expenses
associated with asset disposition.
• While varies with industry,
– Receivables often sold for 80-90% of book value
– Inventories might realize 80-90% of book book value
depending on degree of obsolescence and condition
– Equipment values vary widely depending on age and
condition and purpose (e.g., special purpose)
– Book value of land may understate market value
– Prepaid assets such as insurance can be liquidated with
a portion of the premium recovered.

10. Asset-Based Method: Break-Up Value
• Target viewed as series of independent operating units,
whose income, cash flow, and balance sheet
statements reflect intra-company sales, fully-allocated
costs, and operating liabilities specific to each unit
• After-tax cash flows are valued using market-based
multiples or discounted cash flows analysis to determine
operating unit’s current market value
• The unit’s equity value is determined by deducting
operating liabilities from current market value
• Aggregate equity value of the business is determined by
summing equity value of each operating unit less
unallocated liabilities and break-up costs

11. Replacement Cost Method
• All target operating assets are assigned a value
based on what it would cost to replace them.
• Each asset is treated as if no additional value is
created by operating the assets as part of a
going concern.
• Each asset’s value is summed to determine the
aggregate value of the business.
• This approach is limited if the firm is highly
profitable (suggesting a high going concern
value) or if many of the firm’s assets are
intangible.

12. Real Options as Applied to M&As
• Real options refer to management’s ability to adopt and later revise
corporate investment decisions (e.g., acquisitions)
• Options to expand (i.e., accelerate investment)
– Acquirer accelerates investment in target after acquisition completed
due to better than anticipated performance of the target
• Options to delay (i.e., postpone timing of initial investment)
– Acquirer delays completion of acquisition until a patent pending
receives approval
• Options to abandon (i.e., divest or liquidate initial investment)
– Acquirer divests target firm due to underperformance and recovers a
portion of its initial investment

13. Things to Remember…
• Alternatives to discounted cash flow analysis include the following:
– Market based methods
• Comparable companies
• Recent transactions
• Same or comparable industries
– Asset based methods
• Tangible book value
• Liquidation value
• Break-up value
– Replacement cost method
– Weighted average method
• Firm value must be adjusted for both non-operating assets and
liabilities.
• Real options should be considered in M&A valuation when clearly
identifiable and when would add significantly to investment’s value