Question

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1. Valuation of Firms The private equity firm Greylock Group LLC is looking to sell a stake in the automotive manufacturer VRT Automotive Co, a relatively new entrant in the auto parts manu- facturing industry, via an initial public offering (IPO). Greylock acquired its stake in VRT several years ago and has been able to improve the efficiency of the company's operations, having increased operating margins from 2.1% at the point of purchase to 5.1% in the most recent fiscal year. In order to set an offering price, Greylock is looking to comparable companies to estimate the value of VRT's equity. Greylock has identified four (4) publicly traded comparable automotive manufacturers, includin . Two legacy automotive manufacturers. Argos Inc (operating margin-_0.6%) and » Two younger, nimbler auto parts manufacturers: Magnus Co (operating margin - Enterprise multiples based on sales and EBIT for the comparable companies are provided Žimeon Corp (operating margin-_4%) 7.3%) and Autodel Inc (operating margin-7.5%) below: Argos Zimeon Magnus Autodei EV/Sales 0.3 EV/EBIT 0.1 0.5 13 The following information is provided from VRT's most recent financial statements (all figures in Smillions) Revenue (Sales) - 10,937 Operating income (EBIT)-557 » Net Income 116 » Cash & Marketable Securites -415 ·Total (Gross) Debt 3,710 (a) (1 point) Comment on why EV/EBIT multiples were not made available for the legacy auto parts manufacturers. (b) (1 point) Calculate VRT's equity value based on the multiples approach using the average EV/Sales multiple across all four comparable firms (c) (3 points) Greylock believes that the legacy auto parts makers are too dissimilar to VRT due to differences in age and profit margins, thereby dropping them from the set of comparables. Repeat your estimation of VRT's equity value based on the multiples approach using both EV/Sales and EV/EBIT, based on the following sets of comparable firms i Magnus and Autodei (average) 11 Magnus only iii Autodei only d) (1 point) Based on the information provided, briefly discuss why the equity val uation calculated in part b) using EV/Sales is lower than the equity valuations calculated in part c) using EV/Sales. Do not simply state that the EV/Sales mul- tiple is lower in part b) (e) (2 points) The figure that Greylock ultimately chose to price the IPO was $823 million for the value of equity. Briefly discuss what this valuation reveals about VRT's current position/prospects relative to its Magnus and Autodei in the eyes of Greylock and investors

Answer 1

(a). The EBITx multiples of the legacy auto part manufacturers would be very different from those of the new auto parts manufacturers' entrants. Also, age-wise, they are not suitable comparables so it would provide an erroneous valuation to use them as comparables.

(b). Average EV/Sales multiple = (0.3+0.1+0.5+1)/4 = 0475

VRT EV = 0.475*Sales = 0.475*10,937 = 5,195.08

Equity value = EV - debt + cash = 5,195.08 - 3,710 + 415 = 1,900.08 (Answer)

(c).

Formula		Magnus	Autodei	Average
	EV/Sales	0.50	1.00	0.75
	VRT Sales	10,937.00	10,937.00	10,937.00
(EV/Sales multiple*Sales)	VRT EV	5,468.50	10,937.00	8,202.75
	Less: gross debt	-3,710.00	-3,710.00	-3,710.00
	Add: cash	415.00	415.00	415.00
	VRT Equity	2,173.50	7,642.00	4,907.75

VRT Equity value (using Magnus EV/Sales) = 2,173.50

VRT Equity value (using Autodei EV/Sales) = 7,642.00

VRT Equity value (using the average EV/Sales) = 4,907.75

Formula		Magnus	Autodei	Average
	EV/EBIT	8.00	13.00	10.5
	VRT EBIT	557.00	557.00	557.00
(EV/EBIT multiple*EBIT)	VRT EV	4,456.00	7,241.00	5,848.50
	Less: gross debt	-3,710.00	-3,710.00	-3,710.00
	Add: cash	415.00	415.00	415.00
	VRT Equity	1,161.00	3,946.00	2,553.50

VRT Equity value (using Magnus EV/EBIT) = 1,161.00

VRT Equity value (using Autodei EV/EBIT) = 3,946.00

VRT Equity value (using the average EV/EBIT) = 2,553.50

(d). The equity value calculated in part (b) is lower than the equity value calculated in part (c) mainly because of the effect of the legacy auto parts manufacturer's multiples. From the information provided, it appears that the legacy companies are running in losses (negative operating margins) while VRT is not. Including their multiples in calculating the equity value of VRT will skew the valuation.

(e). Compared to the equity value calculated in part (c), the IPO price of $823 million is quite low. This indicates that investors are not very confident about the future prospects of VRT and expect it to not perform favorably compared to its competitors, namely Autodei and Magnus.