Why Value the Enterprise en route to Equity? Valuation Practice in M&A

In recent decades, M&A advisors have primarily and increasingly used enterprise-value (EV) multiples in the valuations they provide to directors and shareholders as benchmarks for valuing their shares. This contrasts with equity analysts, who predominantly use direct equity-value multiples (especially, price-to-adjusted-earnings). We find that advisors’ use of EV multiples is not systematically driven by the target’s capital structure, but is driven by non-recurring items in its most recent income statement. This indicates that the valuation numerator follows the choice of value-driver denominator, and advisors move up the income statement for smoother metrics, with more “non-GAAP exclusions.” (Capitalizing metrics at or above EBIT entails EV valuation for consistency.) M&A advisors almost never use explicitly “adjusted” bottom-line earnings measures. Using commonly-recognized income-statement levels like EBITDA may serve as an indirect means to the same end, while appearing less discretionary, in this litigious setting. We contribute by explaining variation in valuation practice, and identifying a novel manifestation of the broader “non GAAP” phenomenon in M&A