Equity discount premium between public and private companies in

EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
33
Jaime Álvarez* y Paula Herrera**
Equity discount premium between
public and private companies in
the Eurozone
Prima de descuento entre las empresas cotizadas y
no cotizadas en la Eurozona
ABSTRACT
Non-listed firms analyzed by investors show poor firm marketability and financial information. Due to these factors, there is a higher perceived risk and, as a consequence, the private-held firms are sold at a discount over similar listed firms and over firms that generate acceptable levels of financial information within the Euro area. This
paper concludes that the discount on privately-own companies across industries is economically reasonable and
statistically significant.
Keywords: Equity premium, discount premium, private transactions, Eurozone transactions.
JEL Classification: G34, G39
RESUMEN
En el análisis de valoración de las empresas no cotizadas los inversores potenciales consideran la falta de información financiera y liquidez. Esto hace que se incremente el riesgo percibido y, por tanto, se generen primasde descuento con relación a las empresas cotizadas y sobre las que se maneja todo tipo de información dentro de la
Eurozona. Este trabajo estudia las transacciones realizadas en diferentes sectores con el resultado de que dicho descuento es razonable y estadísticamente significativo.
Palabras Clave: Prima de descuento, transacciones privadas, empresas no cotizadas, transacciones en la Zona
Euro.
Código JEL: G34, G39
Recibido: 20 de junio de 2012
Aceptado: 3 de septiembre de 2012
* Facultad de Ciencias Económicas y Empresariales. Universidad Complutense de Madrid (España). Contacto: jaime@jaimealvarez.com
** Universidad de los Andes (Colombia).
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
Prima de descuento entre las empresas cotizadas y no cotizadas en la Eurozona
Análisis Financiero, n.º 120. 2012. Págs.: 33-47
34
ANÁLISIS FINANCIERO
1. INTRODUCTION
When valuing assets and investments, investors analyze several key factors, like risk, size, liquidity, and interest rates.
Nevertheless, the process is more complex when the firm is
not listed, due to a lack of liquidity, company-specific information, and, most important, an observable market price. As a
consequence, specific and appropriate valuation methods
should be considered.
This lack of marketability and information make those firms
less interesting to potential investors. Thus, the lower the level of appeal to investors in a particular stock, the higher the
expected return. As a consequence, these type of firms should
be sold at a discount over similar listed firms.
As the discounted cash flow (DCF) model requires some
parameters not available to the unlisted firm, the analyst
requires a complementary model using estimations through
comparable firms. A well known model to value private companies is the Relative Valuation Method (RVM), which,
besides its simplicity, incorporates some market values. In
this way, the value of an unlisted firm is approximated by the
prices paid for similar firms, after being standardized for performance measures. The accuracy and reliability of the
method is a function of how similar the comparables firms
are. However, there are many factors that affect the decision
to buy or sell stocks of a particular listed firm, differing considerably in terms of value creation (size, earnings, cash
flows, and risk). Accordingly, the valuation process should
take into account these different features.
Many studies, using different measurement methods, provide
evidence of a liquidity discount. Nevertheless, few studies
have tried to estimate the value of a firm based on others nonstandard features besides liquidity. Koeplin et al (2000) tried
to estimate what they called ‘Private Company Discount’, just
for the American market. They acknowledge that any private
placement discount should be valued differently than listed
firms. Accordingly, the discount should be associated with
other factors besides liquidity, and thus, taken into account.
One way to find out the private company discount is to calculate the difference between the lower price paid by a closely
held firm, and the price paid by a portfolio of listed firms, both
groups with similar value features.
To examine the Private Company Discount embedded in the
Euro Zone, we compare historical transaction multiples of
privately held companies with transactions multiples of similar publicly held firms. The values used in the multiples are
Deal Equity Value and Deal Enterprise Value against Profit
before and after tax, EBITDA, EBIT, Operating Income,
Total Assets and Shareholders’ funds.
This article proceeds as follows. Section I presents a literature
review, Section II describes the sample data set, Section III
explains the methodology, Section IV describes and analyzes
the empirical results. Finally, Section V concludes.
I. LITERATURE REVIEW
Potential investors of unlisted firms don’t have a direct access
to an observable equity price posted on any platform. If the
investor decides to value a specific private company by comparing it to industry-like listed firms, the accuracy of that valuation will depend on how similar are both firms in terms of
value characteristics like risk, growth rate, capital structure,
the size and timing of cash flows, and liquidity. However, the
fundamentals of listed companies within a specific industry
may differ considerably, thus a discount may be applied to
account for these differences in characteristics.
The most outstanding characteristic is marketability, meaning
the ease at which an asset could be traded since the market is not
frictionless or free of trading costs. Marketability could be
defined as the degree to which an asset can be converted into
cash quickly with almost no transaction costs (Bajaj et al, 2001).
The estimation of the marketability discount has thoroughly
been studied and measured using different models whose
results differ substantially (Koeplin et al., 2000; Chiming Wu,
2010; Officer, 2006; Bajaj et al, 2001). Other studies (Hibbert
et al, 2009) attempted to estimate a liquidity premium or marketability discount exclusively. In relative terms it refers to
the price discount or excess return that bears an asset when it
is compared against a security with higher level of liquidity,
and with equivalent key characteristics like credit and market
risk, sector of activity, etc. The methods to estimate the marketability discount could be grouped in i) Pre-IPO approach
ii) restricted stock approach, and iii) comparable acquisitions
approach.
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
In the first approach, the discount is estimated by comparing
the Initial Public Offering (IPO) price of a firm with the price
of previous transactions when the firm was private. Emory
(1997) found an average marketability discount of 44%
(median of 43%) for transaction prices relative to the IPO
prices, being the average discount steady through the period
1985-1997. Likewise, Williamette Management Associates
estimated an average marketability discount ranging from
32% to 74%.
The Pre-IPO approach has several deficiencies in the estimation of the marketability discount. First, the transactions
before the IPO might differ substantially from the ones
embedded in the IPO itself. Pre-IPO dealings probably are
issued for insiders, like managers or other investors that provide monitoring or administration services (Damodaran,
2002a). Therefore, part of the price discount for private preIPO transactions reflects some type of management compensation for providing those services. Second, only successful
firms or the ones with high expectations of improvement carried the IPO ahead, resulting in sample bias, since unsuccessful firms are not included. Also, changes in the characteristics
of values, and in the macroeconomic environment between
private transactions and IPO dates, affect the prices, and thus
the discount estimation.
The restricted stock approach compares the difference in prices
between market and restricted stocks (common shares not marketable during a period of time). The lack of liquidity of the
restricted type explains the difference in prices. At Bajaj et al
(2001) is shown a review of 8 authors that estimated the average
marketability discount within a 20% - 30% range, inlcuiding his
own estimation of 22,21%. Silber (1991) reported an average
discount of 33,75% within a -12,7% - 84% range. He suggested
that the discount should not be the same for all types of companies. Wruck (1989), and Hertzel & Smith (1983) found mean
marketability discounts of 17,6% and 13,5% respectively1.
Nevertheless, the majority of the restricted stock issues are
placed to insiders and accredited investors who typically are
committed to management and monitoring activities of the
firms, thus the discount reflects some compensation for services provided and monitoring costs. Additionally, Bajaj et al.
(2001) found significant factors affecting the discount from a
cross-sectional analysis. Those factors were percentage of
shares issued over total shares after issue, business risk measured by volatility, financial distress, and total income.
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The comparable acquisitions approach compares the acquisition price multiples of private and public held firms. As it was
the case for the other two approaches, the discount reduction
accounts for more factors than just marketability. Koeplin et al
(2000) used the following simple approach:
They reported that private targets were, in domestic and foreign transactions, significantly smaller in net sales and assets
than their public peers. Furthermore, the cumulative growth
rate for the 3 years before the acquisition was in domestic
transactions higher for private targets than public targets.
They showed that private companies sell at a significant discount based on EBIT and EBITDA2. In case of domestic
transactions, the mean was 28.26% and 20.30% respectively.
For foreign targets, average was 43.87% and 53.85%. As for
sales multiples, the discount was not significant for neither
domestic nor foreign transactions. Keoplin et al. (2000) suggested that to value revenue, different industries follow different procedures. Additionally, attempting to control for the difference in companies’ characteristics, Koeplin et al. (2000)
estimated regressions separately for domestic and foreign
transactions. The independent variables were size, growth,
industry, and a dummy variable indicating privately / publicly
held. They found that private company discount is still significant for earnings multiples.
Officer (2006) compared the multiples paid for unlisted targets3 with portfolios of comparable publicly held firms. The
multiples used were price to equity book value, price to earnings, deal value to EBITDA and deal value to sales. Officer
found that multiples of unlisted firms had an average discount
of 15% -30% relative to the multiples paid to control – related
publicly held firms. Although the approach is similar to
Koeplin et al. (2000), Officer attributes the discount to the
lack of liquidity.
A flaw in the comparable acquisitions approach is that it relies
in the systematic differences in features between private and
public firms, ie, closely held companies have smaller assets
and revenues, and higher earnings growth rates. Additionally,
Bajaj et al. (2001) show that in contrast to a public transaction
of a comparable firm, private transactions for Pre-IPO, and
restricted stock approaches are acquired by insiders who
receive compensation for services or employment contracts,
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
Prima de descuento entre las empresas cotizadas y no cotizadas en la Eurozona
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resulting in a reduction of price. Nevertheless, those differences are not relevant to our case, because the goal is to capture the total reduction in price of a private held firm compared to a public held one, and where marketability is just one
of the factors accounted for. In fact, applying just a liquidity
discount is only appropriate when valuing firms based on
multiples of comparable transactions.
IPOs, private equity, and venture capital transactions, covering all the European Stock Exchange spectrum, and the targets
represent almost all European countries. The data included
5.881 and 8.827 transactions of public and private held targets
respectively, from September 1996 to April 2011. The data
was depurated to eliminate all transactions with missing information as industry, date and deal type.
To value a firm, it is common to use the discount cash flow
(DCF) method along with a comparable multiples approach
(CMA, also called relative valuation), because the market values similar companies in similar ways. Nevertheless, the DCF
valuation method fits better to publicly held than privately
held companies. This is due mainly to the difficulties to measure the market risk of unlisted firms and, therefore, their cost
of capital. The less reliable these factors are, the less reliable
is also the value of the estimated firm.
The original idea was to estimate private company discounts
based on matching private transaction with public acquisition
within the same country, industry division, and similar time
period. Unfortunately, due to the large private unmatched
transactions, the sample became significantly reduced. For
example, France is the country with more private and listed
transactions, but only 130 pairs fit the conditions. In consequence, the results for each country could fall into a sort of
selection biased, failing to be statistically significant. To overcome these obstacles, it was decided to analyze the private
company discount for the total Euro Zone instead.
There are two main reasons to apply the CMA to our work.
First, the use of this method is quite spread among analysts of
unlisted firms. Three reasons: easy to understand, fewer
explicit assumptions, and the incorporation of the ‘market factor’. According to Damodaran (2002b), relative valuations
yield values that are closer to the market price than DCF´s.
Kaplan and Ruback (1996) found that the relative method in
the same industry have lower valuation errors, although the
DCF method provides better reliable value estimations. However, the value of the firm should be adjusted somehow, since
the characteristics of private and public firms are different.
The second reason to use the CMA instead of the DCF method
is embedded in the analysis. The DCF method is not very suitable to obtain some conclusions based on hundred of firms
across the Euro Zone. Apply the DCF method to so many
firms would generate many drawbacks. This is due to the fact
that there are many variables playing in the field: CF calculations, expectations, risks, etc., that surely would be a burden
in the process of DCF valuation, generating more noise than
information. The relative valuation method, on the other hand
is more useful and practical, generating less errors, and, therefore, easier to identify facts and reach conclusions.
II. THE SAMPLE
The source of the data is Zephyr, a Bureau Van Dijk data base
with information ranging from mergers and acquisitions to
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EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
The sample displayed various categories. As shown in 1, the
deal types can be classified in two groups regarding the controlling interest. Transactions with a controlling interest is just
1.41% of total listed companies while in closely held companies is 63.94%.
We define acquisition following the Zephyr4 as “Any deal
where the acquirer ends up with 50% or more of the equity of
the Target is coded as an Acquisition as the Acquirer now has
control of the Target. Even if the acquired stake is very small;
if the final stake is 50% or above the deal is classed as an
Acquisition. The Acquirer has purchased a number of shares
in the Target and the resulting stake held is less than 50%. Be
aware that a stake of only 2% could be classified as an acquisition if the Acquirer’s overall stake reaches 50% or above”.
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It could be expected that when new investors buy participations in unlisted firms, they have the intention to be involved
directly in managing it, or indirectly, in monitoring it. On the
contrary, investors in public, listed firms, usually hold a portfolio of diversified firms, letting managers and board directors
to run the firms.
Thus, when investors are involved in the administration of the
firm, two things could occur: i) the acquired price has taken a
discount to compensate management and/or monitor services;
ii) a premium is paid for acquiring a controlling interest5 and,
therefore, reducing discount on the private company. Following these lines, the sample was broken down in two groups
based on transactions ending or not in a controlling interest. (1
and 2).
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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All transactions have been sort out following three dimensions: country (Europe), year (1999-2011), and industry (classified by 2 digit NACE code list). For each dimension, the
number of deals has been further broken down in controlling
or not controlling interest, and private and public transactions
(see Table 2). The appendix shows the results by industry.
Some sectors have been eliminated to accommodate data,
being reduced from 84 to 52 sectors.
As shown in Table 2, these selection criteria reduced the sample to 83 and 5,310 public transactions, and 950 and 2,342 private transactions in controlling and no controlling interest
respectively. Although the sample is significantly reduced
mostly in the controlling interest segment, almost all countries
in the Euro Zone are well covered.
Table 3 reports some statistics on Operating revenue, EBITDA, EBIT, Profit before & after taxes, Total Assets, and
Shareholders Funds for the four variables studied. The mean
and median are higher for public than private companies. In
fact, the mean of the listed firms is statistically different than
the one of the unlisted at a significance level of 1%. The
exception is Total Assets in the controlling interest sample,
where the significance level is 6%. This could be attributed to
a high level of variance for Total Assets, so that the mean plus
one standard deviation in private transactions exceeds the
mean for public targets.
Although median and mean are unbiased estimators of the
central tendency, the mean is highly sensitive to extreme outliers, whereas the median is hardly sensitive and, therefore, a
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
more robust metric. Observing both metrics for all groups,
there is an outstanding difference between them, and this is
factored in the estimation of the private company discount.
Finally, Table 3 shows a large standard deviation for most of
the variables, indicating a great dispersion from the average.
III. METHODOLOGY
To estimate a liquidity discount for unlisted firms in the Euro
Zone, we developed a method following Koeplin et al. (2000),
and Officer (2006).
Valuation Multiples Used
The main idea is to approximate the value of a firm through
the use of multiples of publicly held comparable firm with
similar growth rates, industry, risk, cash flow generation, and
size. This methodology standardizes the prices paid by transforming them into fundamental measures or «value characteristics» of the firm acquired. The ratios or multiples obtained
are then applied to any firm being valued. For example, if the
price paid for a comparable firm B (similar to A) was 100
and the net assets of B were of 50, then the multiple price to
net assets for B is 2,00 ( 100 / 50). Thus, for A who has 25
of net assets, the value is 50 EUR ( 25 x 2,00), A’s net assets
x Multiple price to net assets of comparable firm B.
Usually prices are standardized relative to revenues, book value (such as net assets or stock/equity’s book value) and earnings. It is also common in some industries to use additional
specific parameters such as employees, clients, etc., each one
with some advantages and pitfalls (see Mascareñas, 2005).
The multiples selected must be precise and accurate in reflecting the essentials of the firm, the cash flow generated by the
firm, with its associated risk, and the growth rate. In other
words, they should be potential measures of value for both
public and private firms. However, it is hard to decide the
most appropriate multiples without knowing which specific
firm is going to be valued, and for the purpose of estimating
the private company discount, many measures of performance
should be used, and this is the reason this paper makes use of
all multiples available from Zephyr.
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Zephyr® defines Deal Equity Value as: If stated, equity value
equals deal value. If not specified, the value equals the value
of shares given and the estimated price per share. Deal Enterprise Value: If stated, enterprise value equals deal value. If not
specified, use the following definition: equity value + short
term & long term interest bearing debts – cash & equivalents.
When the multiple turns negative, the results have not significance. The meaning of each multiple is different due to the
influence that the accounting variables have upon it. P/E multiples are influenced by the mix debt and equity, or capital
structure because earnings are computed after interest expenses and taxes. Price to EBITDA multiples are influenced by
capital intensity, whereas Price to EBIT by depreciation.
Both, nevertheless, are independent of the capital structure.
However, these multiples do not reflect how the firm is controlling costs, and it varies extensively among industries.
Private Company Discount
The mean and median of multiples based on all unlisted firm
transactions were compared to those listed firms under the
same industry and year. In comparison to Koeplin et al.
(2000), who match just one private transaction with a public
comparable company, or Officer (2007), with a portfolio of
comparables, we take a different path. Thus, with the intention
to avoid an excessive sample size reduction and selection bias,
a group of similar public and private firms are compared. With
the intention to only count multiples that were economically
reasonable, negative parameter values and their associated
multiples were deleted.
The private company discount was estimated by matching
listed and unlisted firms for each of the two controlling segments, and for every sector, multiple, and year. The discount
was estimated by the following formula (see Koeplin et al,
2000):
Hypothesis Tests
We carried out the Student T – Test to each multiple of unlisted firms to check if there is a statistical significance in the
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
Prima de descuento entre las empresas cotizadas y no cotizadas en la Eurozona
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ANÁLISIS FINANCIERO
mean estimation. This type of test is used to judge goodness of
the estimator compared to the data in the sample when the
variance is unknown. In other words, to test if the private company discount is likely to occur by chance or not.
The null hypothesis used for multiple i is:
Ho:mean private equity discount for multiple i=0
In the other hand, the alternative hypothesis is:
Ha:mean private equity discount for multiple i =/ 0
Therefore, it is used a two tailed t-test expecting a rejection for
the null hypothesis for a given significance level.
IV. RESULTS & ANALISYS
Table 4 exhibits the mean, median and standard deviation of
deal equity value relative to each fundamental. It can be
observed the difference between means and medians. Medians are always lower than means in both sample types (controlling and not controlling), but it is even more outstanding
in private firms transactions. Thus, it can be inferred the
presence of high outliers in both samples. In addition, the
standard deviation is usually higher than the mean (some
reach 300%); ie, see deal equity value to EBITDA in the not
controlling interest, and to EBIT in the controlling interest
sample respectively, reinforcing the thought of considerable
outliers in the sample.
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
The most outstanding –and surprising - fact about table 4 is
that these deal equity value multiples suggest that the private
company discount is instead a premium. In both sample types,
almost all medians and means are higher in privately held
transaction multiples than in listed firms. Additionally, in private firms the standard deviation of multiples is higher. Also,
when a controlling interest is acquired, the mean earnings
multiples are higher than when it is not acquired, but this is not
the case for the median. Also, this result is not as clear for
mean transactions of private firms, although it is for the median, perhaps, reflecting the presence of outliers in transactions
of private firms since means are more sensitive to them than
medians.
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For example, only the mean of deal equity to EBIT is higher
when a controlling interest is acquired. But for the median, the
operating income multiple, and all earnings multiples (EBITDA, EBIT, and profit before and after tax) are higher when a
premium is paid for the controlling interest.
The statistics of deal enterprise value multiples are shown in
Table 5. In this case, the sample is smaller because the corresponding data are not available for all transactions. Particularly, the smaller group in deal enterprise value multiples is in the
financial sector.
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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In this case, the statistics show quite similar results. First,
medians are lower than means in both samples, but high standard deviations, particularly in privately held targets. Second,
in general terms, mean and median multiples are higher in the
acquisition of private firms. Third, roughly, all mean multiples are higher when a controlling interest is acquired.
Table 6 shows the estimates of private company discounts for
the Euro Zone. The mean and median are all negative but one.
This conclusion is similar to the one found in our previous
analysis of the multiples for transactions in both sample types:
there is no private company discount. Instead, the results suggest a premium.
Mean discounts are very large although, these cases have not
statistical significance, others have and a premium of this size
is not rational. This issue is addressed afterward.
DA reach -711% (-40%), and from deal enterprise value multiples 515% (-29%). At last, for total asset multiple, the resulting private company discounts have means (medians) of 726% (-30%) as of deal equity value and -432% (-7%) as of
deal enterprise value. Mean discounts are still very large, but
medians are below 100% though in a wide range and sill negative.
For the first multiple, the mean private company discounts are
-766% and -626% with median of -22% and -6%, respectively. Mean (median) discounts from deal equity value to EBIT-
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
Considering the group “Without controlling interest”, only the
mean discounts of operating revenue, EBIT, and total assets
are statistically significant at 99% level for both, deal equity
and enterprise value. Something similar can be seen in the
“Controlling interest acquired” group. But, only deal equity
value multiples to operating revenue and total assets, and deal
enterprise value multiples to profit before and after tax are statistically significant with confidence level of 99%.
However, for confidence levels of 95% the following mean
discounts are statistically significant: deal equity value multiple to EBITDA, and deal enterprise value multiples to operating revenue, EBITDA, EBIT and total assets. Regarding
shareholders’ funds multiples; they are significant at a level of
10% in both deal value types.
Comparing both groups across fundamentals (Figure 1), every
mean and median deal equity multiple is higher than its corresponding enterprise equity multiple: thin lines are below their
corresponding thick lines. This is reasonable, given that usually deal equity value is lower than deal enterprise value.
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On the other hand, nothing can be concluded about a lower
discount when a controlling interest is acquired or not. Therefore, when the stake acquired does not include a controlling
interest, means & medians deal equity and enterprise value
multiples all have similar patterns. But when a controlling
interest is acquired, then, there is barely any correlation. At
any rate, this is less obvious than in the previous case, and
changes are more variable. Also, the patterns between mean
deal types (for means and medians) are less similar.
As it can be seen in the analysis of targets’ features (section
II), and in the descriptive statistics of the multiples used, the
fact that mean discounts are extremely larger than median discounts suggests again the presence of large outliers. But, even
though medians are in the negative two digit bracket, there is
no economical reason to think in a premium instead of a discount for private equity. An explanation is that this estimation
of the private company discount for the Euro zone does not
have any comparable value within the same country. Instead,
many transactions are compared for many countries with different macro & micro economic features and risk levels. Fur-
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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ther, it cannot be ignored the possibility of faulty data and,
therefore, an erroneous estimation of multiples.
With the intention of controlling some of these possible drawbacks, the private company discount was computed again, this
time taking into account only the previously estimated positive private company discounts for each sector and year.
exhibits the new results.
Although the sample is significantly reduced, all mean private
equity discounts are statistically significant at level of 1% or
5%. As expected, the discounts are positive after acquiring a
controlling interest. Additionally, all means (medians) are in a
range of 37% - 77% (33%-79%), much lower than those pre-
viously found. Since mean and median ranges are quite similar, then, we could assume that the private company discount
for the euro zone is in that range.
Figure 2 plots the results in Table 7. Mean private equity discounts (Panel A) follow similar patterns between deal types,
but for median discounts, the likeness is beyond doubt. It is
remarkable that, when a controlling interest is acquired, median discounts (Panel B) of the EBIT multiples are higher than
70%, while median discounts of other multiples are below
64%. Mean discounts with multiples EBIT tend to be higher
for both Panels A & B. This may suggest that when buying a
private firm, the market penalizes more the EBIT multiple.
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
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EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
V. CONCLUSIONS
The private company discount computed for the Euro Zone is
not economically reasonable. First, a negative private company discount suggests a premium over public firms. This goes
against the standard theory of a discount price paid for a firm
with less liquidity, lower size, and higher risk. Second, mean
values are extremely large (reaching a 25,000% premium).
Thus, when applying private equity discounts to transactions
of listed firms, the resulting multiples are very large. For
example, the multiple deal equity value to operating revenue
of a public firm is equal to 3. Applying a discount of 10.000%, the resulting multiple is 303 (3 x (1-(-10.000%)).
This is not a credible multiple for any firm. On the contrary,
median discounts (above -100%) are more reasonable in value, although they are still negative.
The large values, and the gap between means and medians can
be explained by the presence of large outliers, since the mean
45
is more sensitive to them. These results can also be attributed
to the fact that this study compares transactions across all
countries in the Euro Zone. In other words, in order to compute the private company discount of a private firm, a one-toone comparison between firms in different countries should
be arranged.
When outliers and negative values for mean and median private company discounts are left out, then, the discount is economically reasonable and statistically significant for all deal
value types and multiples. It was found that mean private
company discounts (medians) range between 37% (33%) and
77% (79%).
Although all countries in the Euro zone use the same currency, they differ in economic features (business cycle, GDP…)
and risk levels. Besides, as we cover many countries across
Europe with different accounting and fiscal systems, there is
the possibility of faulty information and, therefore, miscalcu-
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
Prima de descuento entre las empresas cotizadas y no cotizadas en la Eurozona
Análisis Financiero, n.º 120. 2012. Págs.: 33-47
46
ANÁLISIS FINANCIERO
lation of multiples in the Zephyr ®´s database. Therefore,
these two factors could account for both, the large figures, and
the large percentage of the discount found.
An additional limitation is that those who buy privately held
firms tend to be high ranking officers and private equity funds.
As they provide services like managing and monitoring, part
of the discount reflects the compensation for those services.
And, although this study controls for differences based in the
controlling stake, no significant differences between each
sample type (controlling & not) were found.
REFERENCES
Anson, M., 2010: Measuring a Premium for Liquidity Risk. The
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Bajaj, M,, Denis, D. J., Ferris, S.P., Sarin, A., 2001: Firm Value and
Marketability Discounts. Journal of Corporation Law. Vol 27.
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in Sweden. In GUPEA - Gothenburg University Publications
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Koeplin, J., Sarin, A., Shapiro, A., 2000: The Private Company Discount. Journal of Applied Corporate Finance. Vol 12 n°4. Winter. Pp: 91-101.
Mascareñas, J., 2005: Fusiones y Adquisiciones de Empresas.
McGrow Hill. Madrid.
Officer, M. S., 2006: The Price of Corporate Liquidity: Acquisition
Discounts for Unlisted Targets. Journal of financial Economics.
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Silber, W. L., 1991: Discounts of Restricted Stock: The Impact of
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Notes
1.- Quoted in Bajaj, et al. (2001) at 99-100.
Chiming W., 2010: Liquidity Discount in Valuing unlisted targets
–Japanese M&A market evidence. In BAII 2011 International
Conference On Business and Information.
2.- EBITDA: earnings before interest, taxes, depreciation & amortization
Emory, J., 1997: The Value of Marketability as Illustrated in Initial
Public Offerings of Common Stock. Business Valuation Review.
Vol 16 n°3. September. Pp: 123-131.
4.- B u r e a u Va n D i j k . “ G l o s s a r y ” . I n Z e p h y r – U s e r G u i d e .
http://webhelp.bvdep.com/Robo/BIN/Robo.dll?project=ZephyrNeo_E
N&newsess=1 at Deal Classifications. Date of access: May 04, 2011
Hibbert, J., Kirchner, A., Kretzschmar, G., Li, R., McNeil, A., 2009:
Liquidity premium Literature Review of theoretical and empir-
5.- See Damodaran (2002a) at 1; Bajaj et al. (2001) at 97, and Koeplin et al
(2000) at 95.
3.- Officer (2006) defines unlisted targets as “stand – alone private corporations, and not listed subsidiaries of publicly held firms”.
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
Prima de descuento entre las empresas cotizadas y no cotizadas en la Eurozona
Análisis Financiero, n.º 120. 2012. Págs.: 33-47
EQUITY DISCOUNT PREMIUM BETWEEN PUBLIC AND PRIVATE COMPANIES IN THE EUROZONE
APPENDIX - DEALS AVAILABLE FOR EACH ECONOMIC ACTIVITY. SOME SECTORS HAVE BEEN ELIMINATED TO
ACCOMMODATE DATA
Jaime Álvarez y Paula Herrera: Equity discount permium between public and private companies in the Eurozone
Prima de descuento entre las empresas cotizadas y no cotizadas en la Eurozona
Análisis Financiero, n.º 120. 2012. Págs.: 33-47
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