Investment Banking: How to Tabulate Key Ratios for Past Stock Transactions

By Matt Krantz, Robert R. Johnson

Looking up past stock transactions may be like a bit like financial sleuthing for investment bankers. You may have to dig into somewhat obscure financial documents to look up past transactions. If you’re lucky, and the company is public, you can just punch the stock’s symbol into a computer and get the prices and historical quotes.

But obtaining the past transaction data, the number of shares bought or sold, and when they were bought or sold is just part of the puzzle. To complete the historical transaction analysis, investment bankers must combine their knowledge of the company’s outstanding stock to put some real numbers behind the market’s moods.

When companies are invested in, or bought out completely, that presents a whole new opportunity for investment bankers to apply their ratio analysis skills. Investors can look at past transactions to give them a rundown of the company’s valuation.

Take a recent example of leading U.S. pork producer, Smithfield, which in 2013 received a $4.7 billion cash buyout offer from Chinese conglomerate Shuanghui International. The amount paid for the stock is the implied equity value. Specially, Shuanghui was paying $34 a share for each of Smithfield’s 139 million shares outstanding.

The deal, finalized in 2013, gives a fascinating glimpse into how to put a price tag on a past transaction. Digging further into the ratios and terms of the deal reveals much more to investors. First of all, as part of the deal, Shuanghui also agreed to assume Smithfield’s significant liabilities, including debt, amounting to $2.2 billion.

At the same time, though, Shuanghui would pick up the company’s $310 million in cash. Adding the cash buyout and assumed liabilities to the $4.7 billion cash buyout offer, but subtracting Smithfield’s cash, gives the company an implied enterprise value of $7.0 billion.

The implied enterprise value of a proposed transaction can be tricky. Just remember that the cash buyout price for the stock is just part of the deal. The buyer is also on the hook for the liabilities and debt, which adds to the price tag. But the buyer also gets the company’s cash pile, which in effect reduces the cost of the deal.

Think of it this way. It’s like selling your house for $30,000, but the buyer takes on your mortgage of $200,000. The enterprise value of the value is $230,000. The formula for enterprise value is:

Implied Enterprise Value = Implied Equity Value + Assumed Liabilities − Cash

After you measure the deal’s implied enterprise value, you can really put the deal through the ratio wringer. Investment bankers particularly like to see what the buyer is paying for the company’s earnings before interest, taxes, depreciation, and amortization (EBITDA). You can calculate this by dividing the implied enterprise value by EBITDA. This calculation gives you a ratio that you can use to compare with the industry.

Likewise, you can calculate the deal’s implied equity value divided by net income, which can be compared to other companies’ price-to-earnings ratios. And don’t forget implied equity value to book value, which can be compared with other companies’ price-to-book ratios. These ratios typically state how many times value is to the underlying financial measures.

For instance, if a company’s implied enterprise value is $9.20 and the EBITDA is $1, that means implied enterprise value is 9.2 times, or 9.2x, EBITDA.

Ratio Value
Implied enterprise value/EBITDA 9.2x
Implied equity value/net income 25.7x
Implied equity value/book value 1.5x

Source: S&P Capital IQ

The transaction ratios above can then be compared against those of other deals to gauge what kind of deal the buyer has negotiated. For instance, another big meatpacking deal occurred in December 2011 when Leucadia National bought National Beef Packing for $1.4 billion. But that deal was valued at 4.8x enterprise value to EBITDA, well below the 9.2x paid for Smithfield, says S&P Capital IQ.

Sometimes the stock market goes a little crazy. One of the classic examples of when the stock market went cuckoo came in one of the most cuckoo years on Wall Street, the year 2000. In March of that year, 3Com, a network equipment maker, announced that it planned to spin off, or create a separate public company, its Palm unit. Palm was one of the pioneering makers of handheld computers.

There’s where transaction analysis comes in handy. As part of the spinoff of Palm, 3Com announced it would spin off the rest of the company by the end of 2000. For every share of 3Com they owned, 3Com shareholders would get 1.5 shares of Palm.

Logic would tell you that shares of 3Com should have been 1.5 times higher than of Palm, assuming the rest of 3Com had no value, given the terms of the Palm spinoff offer.

Yet, here’s the strange part: The frenzy over shares of Palm, a hot company at the time, caused the Palm shares to soar to $95.06 apiece during the first day of trading for the Palm IPO. Mathematics would dictate, then, that shares of 3Com should trade for $145. But instead, shares of 3Com dropped to $81.81 on the first day of trading for Palm.

This disconnect showed that naïve investors were bidding up shares of Palm to ridiculous levels and not paying attention to the terms of the deal, according to research by Owen Lamont and Richard Thaler of the University of Chicago Graduate School of Business. And get this: Shares of Palm ultimately lost 90 percent of their value in the year following their IPO.