VALUATION MODELS
The valuation of companies involved in a Reverse Listing Registration depends on numerous quantitative and qualitative characteristics of the companies involved. Below is an overview explaining how to arrive at a valuation of a company in a Reverse Listing. The determinants of the private company and the public company are based on different factors, so the methods to use for a reverse merger are split into two sections: private and public.
Private Company
Trading Comparables
Trading multiples can be a useful way to value a private company that wants to undertake a Reverse Listing Registration. This method may use several different types of multiples to establish a market price. The reason trading comparables are so useful is that they show what the market is currently willing to pay for specific quantitative factors. Most multiples use one of the following:
- Revenue
- EBITDA
- Net income
- Net assets
Case Study: Company A decides to undergo a Reverse Listing with Company B on a certain date. Company B will issue for example 9,343,920 shares to Company A shareholders, comprising for example 80% ownership in the combined company. With 5 months revenue of for example $21,225,313 and no long term debt, an initial market capitalization of $23,126,202 will imply an annualized revenue multiple of 0.45. Although this revenue multiple seems low, the company has experienced steady net loss, which obviously hurts its valuation. Proper multiples become difficult to arrive at when some companies have such poor operating performances.
In general, a number of similar companies should be gathered, using the average multiples to estimate the value of the company in question. Of course, as this example shows, a revenue multiple can overestimate/underestimate the value of a company if there are other things going on, such as high expenses or a lot of current liabilities.
Transaction Comparables
Other Reverse Listings provide a basis for current company valuations. However, since reverse listings are unique in that they involve a non-material, public company providing the registration requirements for the private company, the actual market value is difficult to establish.
Forward merger prices give an obvious market value that companies are willing to pay for certain revenue/etc multiples. Used in conjunction with trading comps, this valuation method provides a good estimate of the business.
Initial Public Offerings (IPOs) are somewhat common as a method of establishing market value based on certain criteria. However, since IPOs also raise capital, the prices reflect a different process. Also, the systematic underpricing of IPOs lessens the effectiveness of IPO comparables.
Discounted Cash Flow Analysis
The DCF method of valuation is not quite as usual in many instances involved with Reverse Listings. Remember that one of the benefits of a Reverse Listing is that not as long of a track record is necessary, compared to an Initial Public Offering. A DCF values a company well when earnings are easy to project. The private company usually does not have a long operating history to extrapolate from. Also, the private company is small, which generally goes hand-in-hand with high growth expectations. Both of these factors cause shaky earnings forecasts, rendering the DCF model less useful. While still helpful paired next to other valuation methods, the DCF model is not as significant here as it is for large, stable companies.
However, when dealing with development stage companies, sales and earnings projections may be all that is available. In this case, while uncertain over a wider range, the DCF valuation does provide a useful value, compared to trading comps. For example, PanaMed, a private company, completed a Reverse Listing with Micron Solutions, a publicly trading corporation, on March 7, 2002. Micron was a development stage company as defined by SFAS 7. PanaMed is also a development stage company, so revenue projections are difficult to make. Also, PanaMed's business plan is centered on FDA approval of a therapeutic drug. As a development stage company, revenue and earnings multiples are not helpful, since there aren't really any sales or earnings. An initial market cap of $169,348,354 means that a substantial amount of growth was expected from this company. With a current market cap of $1,003,546, we see how difficult it is to make some of the growth assumptions involved in a DCF of a development stage company.
Public Corporation
The valuation of the public entity is more dependent on qualitative factors. Since there usually aren't any real operations or assets, the value of a public corporation involved in a Reverse Listing is not going to be extremely large. Also, some of the following factors are more important in certain cases, so the valuation is partly dependent on what the private company is looking for.
What contributes to a higher valuation of a public corporation?
- Clean history - a trading company with a past operating history requires due diligence to avoid hidden liabilities or lawsuits, which can be very dangerous
- Trading status - already having an active stock price gives the issuer much more visibility, which helps subsequent offerings
- Shareholder base - a wider shareholder base means more investors know about the company
- Average trading volume - higher volume increases investor interest and creates a more liquid stock
- Time to public - the faster a private company needs to complete a Reverse Listing, the more important are the trading status and market characteristics of the public corporation
There are many difficulties involved in finding a good estimate of company value, such as lack of long-term operating history or potentially changing business plans in the future. But while the valuation process can be time-consuming, in the end this can make a big difference. Part of the Reverse Listing Registration Program is making sure your company is represented by a market price that fairly values your operations.
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