Introduction
The past 18 months have been difficult for business owners and financing markets as the economic recession curtailed growth prospects and tightened credit markets. While improving economic indicators are motivating strategic buyers to take advantage of their cash-heavy balance sheets, there remains a great deal of uncertainty as to what fair market value truly is in the 2010 economy. Rumors and anecdotes surrounding M&A activity often conflict, indicating rebounding, flat, or falling valuations. Additionally, sellers and buyers cannot be confident a bank will provide financing for a transaction until a deal is closed, given that banks are avoiding risk. The uncertainty over the reliability of valuations and financing may discourage M&A activity, though the prospect for advantageous deals remains strong going into the third quarter.
Despite the favorable environment for M&A activity, sellers must be aware that buyers, though interested, are unlikely to pay a premium price during a transaction and will offer a low valuation, citing the uncertainty over the current definition of fair market value. In order to obtain a market premium, sellers must prove their company’s worth. In order to prove worth, sellers will have to understand the details of the valuation process in an uncertain economy.
Valuation Process
While the valuation process utilizes quantitative techniques to estimate a market value for a business, there is a substantial element of subjectivity. Valuation is also influenced by institutional, economic, and personal perceptions of attributes and detriments. The qualitative factors utilized in valuations include the discounted cash flow method and the market approach.
Discounted Cash Flow (DCF)
DCF is a relatively simple premise that measures the worth of a company based on the total amount of after-tax cash it generates for the shareholders’ benefit. The value is indicated by an estimation of the company’s future economic capabilities, calculated as the present value of projected cash flows for a predetermined period in addition to the present value of residual value at the end of the projection period. DCF is typically computed as a range of values, including best- and worst-case scenarios in addition to the expected value.
While buyers typically favor the DCF methodology of valuation, it is rarely used for companies pursuing multiple offers.
Market Approach
The market approach uses either comparable companies or comparable transactions as the basis for preparing a valuation. The comparable companies approach uses the values of public companies similar to the company looking to be acquired as a benchmark for determining fair market value. The theory with the comparable companies approach is that the market is an efficient evaluator of a company’s worth, since price of exchanged securities is a reflection of available information in addition to the supply and demand created by rational buyers and sellers. Therefore, a company’s worth on the marketplace is an expression of the market’s valuation of that company. When buyers and sellers utilize this approach, a peer-group of publicly traded companies are compiled, multiples are applied, and a valuation is calculated based on a variety of factors.
The comparable transactions approach is similar to the comparable companies method, except that the benchmark is recently acquired companies. A portfolio of recently acquired or divested companies similar to the subject company is compiled and the multiples that were implied in these companies’ purchase prices are used to determine the subject company’s value. The most widely used quantitative analysis is EBITDA times market multiplier.
Challenges of Valuations in an Economic Recession
While a sound valuation is always a complex and nuanced undertaking, there are particular challenges to completing an appropriate valuation in the current economic environment.
First, choosing the companies to form the basis of a comparable transactions analysis is very difficult. The companies that have been acquired or divested over the preceding 18-month period have most likely been in distress or similar unfavorable fiscal situations. Therefore, these purchase prices are likely to be low, misleading a valuation analysis to place a company’s value below fair market value. However, reaching beyond the preceding 18 months into the time period prior to the recession for transaction history is likely to yield valuations that were too high, yielding an above-market valuation that buyers will be reluctant to accept on the basis of the transaction history analyzed.
Compounding the challenges of finding the appropriate transactions for benchmarking, buyers are typically very reluctant to discuss the types of attributes that would induce a selling price that is a market premium. Multipliers are typically discussed in a wide range to garner interest among sellers, but determining the exact circumstances that would lead a buyer to pay above this range are difficult to gauge in the absence of an expert who works with both buyers and sellers on a regular basis. Additionally, determining if a company is worth a market premium requires in-depth analysis of each component that goes into a valuation.
Wyatt Matas & Associate’s Valuation Matrix and Expert Guidance
Wyatt Matas & Associates has developed a valuation matrix that serves as guidance for a business owner to determine the valuation price of his or her company. When formulating the variables for this matrix, Wyatt Matas & Associates formulated and weighted the variables that buyers usually look for when deciding to place a valuation on a company. While the matrix is a helpful standalone tool for determining the general baseline of a company’s standing in the market, Wyatt Matas & Associates also provides the expert guidance throughout the valuation process that will always be a seller’s best option if he is seriously considering strategic alternatives for his business.
The Matrix
To use the matrix, one must first identify comparable transactions, typically between 5 and 10 transactions that are similar in revenue size to the subject company. Given the challenges noted above in determining appropriate transactions, engaging the services of a valuation expert may be an appropriate strategy to ensure proper benchmarks are selected. Once identified, the price/EBITDA mean of those transactions should serve as a benchmark range for the subject company’s valuation. The valuation matrix will serve as the tool for determining whether the subject company is worth above or below the mean range.
The matrix is divided into three separate general sectors that a seller must take note of when deciphering the value of his company:
? Individual Company Inputs
? Industry Inputs
? General Economic Inputs
Each of these general inputs contain metrics that affect the valuation of a company, and each metric’s weight has been appropriated based upon the importance of the variable from a buyer’s perspective. By using a ranking system based on a scale of -3 to 3, one can determine a number which can tell whether a company will sell below market value (negative), at market value (0), or for a premium (above market value), after weighting and summing. Once completed for all categories, the sum should be a number anywhere from -3 to 3 depending on the grading.
Designating rankings to a business is in itself a fairly subjective measure, however Wyatt Matas & Associates provides a description of each variable and what is considered to be a “-3” and a “3” for each metric, outlined in detail in an appendix accompanying the valuation matrix.
The valuation matrix is also a powerful tool for determining strategic plans. For example, once an owner calculates a final number, a number that is negative or around 0 indicates that it may not necessarily be the right time to sell a business, and if considering retirement soon, owners should develop a value enhancing strategic initiatives for the business in order to ensure an accretive exit as quickly as possible. Numbers closer to 1-3 are a good sign, and these owners should consider taking the next step by having an official valuation performed and contacting an investment banking professional for further guidance.

The past 18 months have been difficult for business owners and financing markets as the economic recession curtailed growth prospects and tightened credit markets. While improving economic indicators are motivating strategic buyers to take advantage of their cash-heavy balance sheets, there remains a great deal of uncertainty as to what fair market value of companies truly are in the 2010 economy. Rumors and anecdotes surrounding M&A activity often conflict, indicating rebounding, flat, or falling valuations. The uncertainty over the reliability of valuations seems to have discouraged many sellers from considering their exit option, though the prospect for advantageous deals remains interesting going into the rest of 2010.

Despite an improving environment for M&A activity, sellers must be aware that buyers, though interested, are unlikely to pay a premium price during a transaction and will offer a low valuation, citing the uncertainty over the current definition of fair market value. In order to obtain a market premium, sellers must prove their company’s worth.

In order to prove worth, sellers will have to understand the details of the valuation process in an uncertain economy. We developed a valuation tool for those sellers interested in determining if their company is worth a premium.

Valuation Process

While the most valuation processes utilizes quantitative techniques to estimate market value for a business, there is a substantial element of subjectivity. Valuations are also influenced by institutional, economic, and personal perceptions of attributes and detriments. The qualitative factors utilized in valuations include the discounted cash flow method and the market approach.

Discounted Cash Flow (DCF)

DCF is a relatively simple premise that measures the worth of a company based on the total amount of after-tax cash it generates for the shareholders’ benefit. The value is indicated by an estimation of the company’s future economic capabilities, calculated as the present value of projected cash flows for a predetermined period in addition to the present value of residual value at the end of the projection period. DCF is typically computed as a range of values, including best- and worst-case scenarios in addition to the expected value. While the premise is simple, there are multiple components that can be disputed, argued and/or negotiated when using a DCF and it is not often used when a seller is receiving offers from multiple buyers.

Market Approach

The market approach uses either comparable companies or comparable transactions as the basis for preparing a valuation. The comparable companies approach uses the values of public companies similar to the company looking to be acquired as a benchmark for determining fair market value. The theory with the comparable companies approach is that the market is an efficient evaluator of a company’s worth, since price of exchanged securities is a reflection of available information in addition to the supply and demand created by rational buyers and sellers. Therefore, a company’s worth on the marketplace is an expression of the market’s valuation of that company. When buyers and sellers utilize this approach, a peer-group of publicly traded companies are compiled, multiples are applied, and a valuation is calculated based on a variety of factors.

The comparable transactions approach is similar to the comparablecompanies method, except that the benchmark is recently acquired companies. A portfolio of recently acquired or divested companies similar to the subject company is compiled and the multiples that were implied in these companies’ purchase prices are used to determine the subject company’s value. The most widely used quantitative analysis is EBITDA times market multiplier.

Challenges of Valuations in an Economic Recession

While a sound valuation is always a complex and nuanced undertaking, there are particular challenges to completing an appropriate valuation in the current economic environment.

First, choosing the companies to form the basis of a comparable transactions analysis is very difficult. The companies that have been acquired or divested over the preceding 18-month period have most likely been in distress or similar unfavorable fiscal situations. Therefore, these purchase prices are likely to be low, misleading a valuation analysis to place a company’s value below fair market value. However, reaching beyond the preceding 18 months into the time period prior to the recession for transaction history is likely to yield valuations that were too high, yielding an above-market valuation that buyers will be reluctant to accept on the basis of the transaction history analyzed.

Compounding the challenges of finding the appropriate transactions for benchmarking, buyers are typically very reluctant to discuss the types of attributes that would induce a selling price that is a market premium. Multipliers are typically discussed in a wide range to garner interest among sellers, but determining the exact circumstances that would lead a buyer to pay above this range are difficult to gauge in the absence of an expert who works with both buyers and sellers on a regular basis. Additionally, determining if a company is worth a market premium requires in-depth analysis of each component that goes into a valuation.

Our Valuation Matrix and Expert Guidance

We developed a valuation matrix that serves as guidance for a business owner to determine the valuation price of his or her company. When formulating the variables for this matrix, we formulated and weighted the variables that buyers usually look for when deciding to place a valuation on a company. While the matrix is a helpful standalone tool for determining the general baseline of a company’s standing in the market, we also provides the expert guidance throughout the valuation process that will always be a seller’s best option if he is seriously considering strategic alternatives for his business.

The Matrix

To use the matrix, one must first identify comparable transactions, typically between 5 and 10 transactions that are similar in revenue size to the subject company. Once identified, the price/EBITDA mean of those transactions should serve as a benchmark range for the subject company’s valuation. The valuation matrix will serve as the tool for determining whether the subject company is worth above or below the mean range.

The matrix is divided into three separate general sectors that a seller must take note of when deciphering the value of his company:

• Individual Company Inputs
• Industry Inputs
• General Economic Inputs

Each of these general inputs contain metrics that affect the valuation of a company, and each metric’s weight has been appropriated based upon the importance of the variable from a buyer’s perspective. By using a ranking system based on a scale of -3 to 3, one can determine a number which can tell whether a company will sell below market value (negative), at market value (0), or for a premium (above market value), after weighting and summing. Once completed for all categories, the sum should be a number anywhere from -3 to 3 depending on the grading.

Designating rankings to a business in itself requires market knowledge, however we provide a description of each variable and what is considered to be a “-3” and a “3” for each metric, outlined in detail in an appendix accompanying the valuation matrix.

The valuation matrix is also a powerful tool for determining strategic plans. For example, once an owner calculates a final number, a number that is below 0 indicates that it may not necessarily be the right time to sell a business, and if considering retirement soon, owners should develop value enhancing strategic initiatives for the business in order to ensure an accretive exit as quickly as possible. Numbers closer to 1-3 are a good sign, and these owners should consider taking the next step by having an official valuation performed and most likely have multiple strategic options open to them.

We developed this matrix after several years of transactional experience where we were asked to prove or defend a client’s valuation premium. Our expertise in business valuations and our ability to understand how the market will perceive a company’s strategic initiatives from a valuation perspective allows us to assist our clients identifying all the options available to them in today’s market.

To receive a copy of the Valuation Matrix Excel Worksheet, email research@wyattmatas.com.

WESCO International is a distributor of products and supply chain services for the industrial, construction, utility, commercial, and government markets. With 400 full-service branches and over 1M products, WESCO is a major player in the distribution market. Due to a number of factors, including softening demand in construction markets, rising commodity prices, and an eight-year low in industrial demand for power, WESCO experienced somewhat disappointing margin performance in 2009, leading management to engage in a series of strategic cuts, including reducing headcount by 16%, reducing the number of branches, and enacting a number of discretionary spending freezes.

Despite the challenging market conditions and overall reduction in SG&A, management invested aggressively in the front end of the business, expanding the sales force by 5% in 4Q09. WESCO generates more revenue per employee compared to its industry peer group. Additionally, management organized a dedicated group to identifying opportunities to capitalize on the federal stimulus. WESCO also expanded international operations by establishing subsidiaries in China, Australia, and Africa. Overall, analysts are optimistic about the company’s future financial performance, growth opportunities, and overall direction and management.

WESCO has a strong history of deal activity. Due in large part to the overall trend in the distribution market towards increased consolidation, WESCO has been active, completing 34 deals since 1998, seven of which have been completed since 2004. Currently, WESCO holds 7% market share. Management notes that the economic downturn has negatively impacted the smaller players in the distribution industry, who may be looking to WESCO as a potential buyer. While the company remains open to accretive acquisitions, management is also firm in their stance that any potential deal must meet their profit expectations. WESCO is not currently engaged in an ongoing acquisition.

Revenue in 2009 was down 24% compared to 2008, due in large part to serious declines in WESCO’s major markets. Operating margins declined to 3.8% in 2009 from 5.4% the previous year. While gross margin was steady QoQ at 19.2%, this was down 70bps from the previous year, due largely to inventory reduction and less volume rebates. SG&A was down $140M from 2008, a 17% decrease. While some of this reduction was due to discretionary spending freezes on bonuses and similar line items that are expected to return in 2010, the company did manage to realize savings of approximately $70M in net permanent structural cost reductions. WESCO’s liquidity is solid, with analysts estimating the company is capable of generating approximately $75M in free cash flow in 2010. Management anticipates 2010 capital expenditures will be approximately $20M for growth initiatives. Additionally, management intends to convert 85% to 90% of 2010 net income to free cash flow.

Latest article published by Wyatt Matas & Associates discusses the issues of confidentiality throughout the M&A process. With the rise of strategic buyers looking to acquire competitors and across business lines, confidentiality is in the forefront of every potential sellers mind. The article discusses strategies on how to manage the M&A process so that confidentiality breeches are not a problem for either the buyer or the seller.

A confidentiality agreement is typically the first agreement entered into by the parties considering a potential merger or ac¬quisition. While seemingly straightforward, the issue of confidentiality is often critical to the success or failure of the transac¬tion. Both buyers and sellers have several key reasons to be concerned about confidentiality, including client/customer and employee reactions, market intelligence, and competitors.

2010 continues to show signs that merger and acquisition activity will increase, such as increased confidence in private and public sectors, companies with plenty with cash on hand, and improving economic indicators. As such, sellers in 2010 and 2011 can reasonably expect that they will encounter an M&A market with multiple targets looking to be acquired and an increased number of buyers looking to pay better multiples.

Wyatt Matas & Associates expects strategic buyers (competitors or those in similar businesses as the seller) to be the most active buyers and be willing to pay bet¬ter valuations. Financial buyers are still reliant debt markets to finance much of the transactions, which have yet to work themselves out. To this end, managing the vetting of the buyer, due diligence, and transaction process while maintaining confidentiality will be very difficult and more important.

Given the challenges in protecting confidentiality, companies should consider the following to help mitigate risk, manage confidentiality, and ensure a smooth transaction process.

While a confidentiality agreement is typically the first agreement to be entered into during a M&A transaction, the importance of confidentiality starts when the seller decides to pursue a sale.

The following are key points for confidentiality in the beginning of the M&A process:

Limiting exposure early on is key. Those sellers that plan on using an M&A advisor should be careful to pick an advisor that can access key decision makers directly. Do not sign with a broker that “lists” businesses for sale on websites, blast faxes or emails. These approaches are typical for business brokers. The vast majority of responses to business-for-sale advertisements are not serious or qualified. Businesses need to protect exposure to only serious buyers during this process. A broker will place a blind ad to attract interest and prematurely divulge information before appropriate buyer due diligence has been preformed. Typically, an investment banker will vet a potential buyer before contacting them and have the credibility to access C-level executives directly, assuming the strategic route is the preferred strategy. This allows for a frank conversation about the real interest of the potential buyer and how confidentiality will be handled within the buying company.

Identify potential warning signs early in the process. While time consuming, the potential buyer vetting process is critical to protect confidentiality. If asked in a blind call without the appropriate due diligence, most potential strategic and financial buyers will initially express interest in reviewing the seller’s “selling documents,” if only to gain insight into a competitor or industry. While these selling documents are a necessary part of the acquisition process, only those qualified buyers should receive such documents. The vetting process should serve to identify potential buyers’ business plans, legal structures, competition approvals, and other strategic considerations that could potentially enhance or derail the deal later.

Avoid premature disclosure. As mentioned above, it is necessary to disclose certain information about the seller’s business in order to have productive conversations with potential buyers. However, sellers have significant motivation to avoid the premature disclosure of certain information that might do irreputable harm to the business if the transaction does not close or if they do not decide to sell. Failing to manage the release of information or preparing for the inevitable rumors surrounding a deal can result in several unfavorable consequences:

• If employees learn their company is looking to sell, they may quit out of fear of the unknown. Disruptions in staff or operations can serve as a deterrent to potential buyers to continue the deal.
• Competitors may use the information to undermine your company’s standing with clients/customers and other business partners by painting an air of weakness or uncertainty.
• If there are negative issues within the selling company that will eventually need to be disclosed to a potential buyer, managing the release and positioning of that information is essential to preventing the derailment of the transaction.

Maintain confidentiality throughout the transaction. Confidentiality does not stop with the introduction of the selling company to one or multiple buyers at the start of the acquisition process. Protection of confidentiality continues through the transaction process all the way through the closing of the potential deal. This requires some give and take from both the buyer and seller. The seller wants to be assured that the transaction will close on the terms agreed to in the letter of intent, and the buyer wants to be assured that they are buying what they were presented during the pre-LOI stages. Protecting confidentiality during this stage of the transaction requires a firm hand on the seller’s part where appropriate, but a willingness to compromise once milestones are hit by the potential buyer.

If a transaction is being managed properly, weekly calls between the buyer and seller will take place to update each side on the progress of the transaction. Part of the weekly agenda should be a discussion of confidentiality issues that might develop in the coming week. This reminds the buyer that confidentiality is important to seller and addresses how to proactively handle specific areas of concerns before they occur.

Ensuring confidentiality in the M&A process is key for a successful deal. While deals typically do not suffer from too much discretion, a failure to limit exposure, manage information, and protect information can derail a transaction and have negative consequences for a company. Enlisting the services of an real advisor helps to ensure appropriate confidentiality throughout the transaction.

Quarterly Overview: Odyssey Healthcare turned in a record quarter that can be attributed to expense management, lower Medicare cap rates and a reduction in bad debt expenses. Aggregate admissions were up 4%, but same-store-sales were up only 1%. Q1’10 admissions were 12,744 patients, while discharges were 12,692. The specialty programs continue to be a major focus for the company’s marketing effort; particularly, their COPD specialty program. These programs enhance care by assessing patient needs based on their terminal diagnosis. The programs give Odyssey the ability to expand acuity capabilities, allowing for a greater gain of market share through diversification of services. Odyssey has developed four other programs that it intends to release over the next few quarters in an effort to jump start admissions. The Company changed its corporate logo, but indicated it remains committed to keeping its local brands of VistaCare, Avalon and Odyssey Hospice. The Company is spending a significant amount of time and effort to better train the local sales force. This includes training on the CareBeyond specialty programs and developing a marketing dashboard. The marketing dashboard will give local sales people daily feedback, goal progression and access to referral information and tips on how to market to them. With the Company’s success of managing the expense side of the P&L, they are clearly turning their attention to growing the revenue side.

Acquisitions and Market Developments: Odyssey completed no acquisition in the 1st quarter; however, the company said it was active on the business development front. Most of the discussions are in the early states with nothing imminent. Management remains very price sensitive, as they should with their own Enterprise Value/EBITDA trading at only 7.06 times. While this shows discipline, it also suggests there is a disconnect between buyers and sellers with sellers’ expectations above reasonable market valuations. The Company did consolidate two Medicare provider numbers into one and had two programs certified by Medicare (OR and CA). The Company now operates 92 Medicare certified programs. According to the recently filed 10-Q, Odyssey received an administrative subpoena for records from the HHS Office of Inspector General (OIG) requesting various documents and certain patient records of one its hospice programs relating to services performed from January 1, 2006 through December 31, 2009. These types of issues tend to work themselves out and do not seem to be a distraction for the company.

Financial and Operational Performance: Total revenue increased yr/yr by 2.4%, but was down 1.1% sequentially to $171.5M. Net patient revenue per day was $154.63. The average daily census (ADC) has only grown only 1% from the prior year; however, operations are now significantly much more efficient, and the company has improved cash flow. We expect management to turn more of its attention to growing its ADC whether organically or inorganically. Average Length of Stay (ALOS) was up to 87 days, which was up 4 days both sequentially and yr/yr. This is was primarily due to patient mix. Gross margins reached 43.8%, its highest level since Q2’05. Primary contribution to this margin improvement has been the use of technology by field staff. G&A expense also declined to 27.4% of revenue as the company leverages its corporate and program overhead. Adjusted Operation Expense Per Patient Day was $132.03 for the 1Q’10 compared to a year ago, $137.19/Patient Day. The improvements in GM and G&A expenses resulted in record EBITDA margins of 14.6% of revenue. Long-term, management believes EBITDA margins will run in the 13%-13.5% range. Odyssey continues to hoard cash, accumulating another $11.9M in the quarter. This was primarily achieved through improved expense management and a reduction of DSO from 58 to 56. Currently the Company has in excess of $141M of cash on hand and plans to pre-pay $29 million in debt in 2Q’10.