The Ballooning Valuations In Private Equity Deals
Private equity is getting increasingly expensive. As a result, the pricing of an average deal today, by the EV/EBITDA metric, is expected to be at a premium relative to the last decade.
The EV/EBIDTA ratio breaks down into two parts:
- Enterprise Value (EV): Adding debt to market capitalization, while subtracting cash gives us the enterprise value. This gives us the total value of a company.
- EBITDA: Earnings before interest, tax, depreciation, and amortization or, EBITDA, provides a popular way to look at earnings. By removing these expenses, we obtain a clearer look at operating performance.
Overall, EV/EBITDA shows the relationship between a company’s total value and its earnings, and is often seen as the price-to-earnings ratio’s sophisticated sibling, used to view companies the way acquirers would.
However, the EV component is not necessarily intuitive, so let’s expand a little on it:
Why is Debt Added Back to Enterprise Value?
To acquire a company completely, one must pay out all stakeholders in order to reach the final cost of the acquisition. This includes the stock (equity holders) and the debt holders, subsequently, adding back the market value debt to market cap does just this.
Why is Cash Subtracted from Enterprise Value?
Subtracting cash can also be seen as arriving at net debt. That is, the remaining debt after using the cash and equivalents on a company’s balance sheet to pay it down. In other words, if cash exceeds debt, enterprise value shrinks, and the cost of acquiring the company becomes cheaper. Whereas if debt exceeds cash, the acquirer would have to pay off more debt holders, thus making the acquisition more expensive.
What’s Driving Higher Valuations in Private Equity?
1. The Link Between All Equities
First, the public markets are often used as a starting point to derive valuations for deals. Generally, companies with similar business models and operations should be assigned similar valuation multiples. For instance, Lowes and Home Depot, or alternatively, Pepsi and Coca-Cola. Therefore, a company under consideration in private equity often has peers trading publicly.
Furthermore, the average multiple assigned to businesses in the stock market fluctuates through peaks and troughs. Today, they’re trading at a premium to historic averages, a result of a rallying prices and elevated investor risk appetite. Naturally, these public valuations spills over into the private equity space.
2. A World of Cheap Money
Second, asset markets move based on relativity and opportunity cost. A low interest rate environment pairing with the trillions in money printing is placing debt securities at unattractive levels. Hence, low rates of return on debt is resulting in money moving elsewhere.
For private equity though, debt is considered fuel. And in this industry firms use high levels of leverage to acquire companies. For this reason, low rates and cheap debt are a private equity manager’s dream.
But what’s true for one private equity firm can be true for all. Because access to cheap debt means more money chasing deals, and this heightened level of competition is reflecting in the higher multiples and expensive deals today.
Here’s What $1,000 Invested in Vaccine Stocks Would Be Worth Now
Ever wonder what you would have gotten if you invested $1,000 into the different vaccine stocks at the start of the pandemic?
Vaccine Stocks During a Pandemic
It’s often said that with every crisis comes great opportunity.
While such catastrophes do create upheaval and uncertainty in financial markets, they can also lead to new opportunities for investors, as asset classes react to different environments.
Since the World Health Organization (WHO) declared COVID-19 to be a pandemic on March 11, 2020, the performance of vaccine stocks have been varied—but with some notable winners that notched triple or quadruple digit returns.
Here’s how much a $1,000 investment would be worth as of March 31, 2021, if you had put money into each vaccine stock at the start of the pandemic:
|Stock||Value of Investment||% Growth||Market Cap ($B)|
|Johnson & Johnson||$1,252||25.2%||$419.8|
The Business of Vaccines
The returns on vaccine stocks have varied greatly. They are staggering in the case of Novavax and Moderna, but also seem quite underwhelming, when considering the likes of Sanofi, AstraZeneca, and Pfizer.
One factor for the discrepancy in stock price performance is the revenue potential from vaccine sales relative to the rest of the existing business, as vaccine sales will have a much greater impact on the fundamentals of smaller companies.
For example, before the pandemic, Novavax had revenues of just $18.7 million—this meant that capturing any portion of global vaccine sales would create massive value for shareholders. On the flipside, vaccine sales are much less likely to impact the fundamentals of Sanofi’s business, since the company already is generating $40.5 billion in revenue.
To put it into perspective, analysts are expecting total sales from COVID-19 vaccines to be around $100 billion, with $40 billion in post-tax profits.
Vaccine Stocks vs the S&P 500
Even in a booming and valuable industry, it’s difficult to identify the long-term leaders. For example, in the mobile phone market, there was a time where the likes of Motorola, Nokia, and Blackberry appeared untouchable, but eventually lost out.
Similarly, with the limited information available at the start of the pandemic, few, if any, could have separated the winners and losers from this group with accuracy.
In the past year, the S&P 500 grew 44.9%—meaning that only three of the seven vaccine stocks have seen their share prices outperform the market.
Nobody said helping solve a global pandemic guarantees a pay off.
Bitcoin is the Fastest Asset to Reach a $1 Trillion Market Cap
Bitcoin is now part of a select very few assets that hold a market cap greater than $1 trillion. How long did it take to get there?
Bitcoin is the Fastest Asset to Reach $1 Trillion
The world is moving forward at an accelerated pace. Historically, it’s taken multiple decades for companies to be worth $1 trillion. For bitcoin, it took just 12 short years to reach such a milestone.
To help put things into perspective, here’s a look at how long it took America’s biggest tech companies to reach the $1 trillion market cap.
|Asset||Time To Reach $1 Trillion||Current Market Cap|
|Microsoft||44 years||$1.9 trillion|
|Apple||42 years||$2.2 trillion|
|Amazon||24 years||$1.7 trillion|
|21 years||$1.5 trillion|
|Bitcoin||12 years||$1.1 trillion|
Market caps as of April 12, 2021
Extreme Bullish Sentiment
Bitcoin has been subject to widespread commotion in markets.
At the start of 2021, the cryptocurrency had a more modest market cap of $500 billion, but has gained more than another $500 billion since. An onslaught of headlines has contributed to extremely bullish investor sentiment, including:
1. CEOs begin to show interest
Elon Musk and Jack Dorsey have made sizable investments in bitcoin through Tesla and Square, respectively. It’s estimated the gain from Tesla’s $1.5 billion bitcoin investment was greater than the profits from the entirety of their business in 2020.
2. New ETFs on the block
Multiple Bitcoin ETFs focused were recently approved by Canadian regulators and some have already launched on the Toronto Stock Exchange (TSX). For many years, the Grayscale Bitcoin Trust (GBTC) was the only readily accessible investment vehicle trading on equity markets that had exposure to BTC.
3. Financial institutions finally joining in?
Mastercard, Visa, and Bank of New York Mellon have made announcements to make it easier for customers to use cryptocurrencies.
On to the Next Trillion?
Future projections for the price of bitcoin are garnering more extreme and widening price targets.
The accelerated rate of change today has many of the Big Tech companies already inching closer to the next trillion in value. Will bitcoin follow suit?
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