Corporate Finance in Atlantic Canada

Commentary on corporate finance issues for small- & mid-market private companies in Atlantic Canada

Archive for May 2012

Ocean Nutrition sells

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Royal DSM of the Netherlands announced a deal to buy Halifax’s Ocean Nutrition, the maker of fish oil-derived omega-3 acids used in food supplements, for $540 mil.  Ocean is currently owned by John Risley’s Clearwater Fine Foods and private equity firm Richardson Capital.

Written by Dan Jennings

May 18, 2012 at 8:44 pm

Posted in Announced Transactions

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How many years of historical financial analysis do you consider?

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One of the more common questions I get (or where I critique other professionals) is:  What is the appropriate period for the historical financial analysis in a valuation or M&A pricing analysis?

Of course, the ‘standard’ is 5 years … almost everyone considering the value or price of a business does a revenue & profit analysis of the last five years of history, although I have seen many analyses done for shorter or longer time periods.  But is the norm of 5 years the ‘correct’ period to be looking at?

The answer (of course) is it depends on a variety of circumstances and is fact specific.

Some professionals forget the valuation principle that history is only a guide to the future; the point of reviewing historical results is to develop a proxy for the near-term future of the business.  When my client acquires a business, he/she doesn’t get last year’s cash flow, they will receive next year’s … the history is reviewed in order to give that acquirer comfort about the risk that next year’s cash flow will be as expected.

When businesses have cyclical earnings and/or are dependent upon cyclical customers, it is often appropriate to analyze financial results over a longer period than five years.   Valuation professionals and acquirers often use historical averages (simple or weighted) or most recent trailing results with which to gauge the value/price of a business.  The selection of a specific number of years in the average is a function of a number of factors, such as:

  • where in the earnings cycle you believe the business is at the valuation date;
  • the track record of observed cycles;
  • consideration of the underlying economic conditions that give rise to the cyclicality of earnings; and
  • the actual outlook for the business, industry and economy as of the valuation date.

In cases where I have used longer than five years of historical financial performance, it’s been because there was a specific circumstance for the selection.  For example, in valuing a mineral quarry at the outset of the 2009 recession, I considered 10-20 years of historical cash flows because of the uncertainty about the future of the commodities markets.  It wasn’t reasonable in that case to use the last 5 years of ‘boom’ when the near-term future was so uncertain, but yet it wasn’t realistic to say the quarry had no value because next year’s cash flow was expected to be negative during the recession.  10-20 years was selected in order to demonstrate the cyclical swings in the business historically, which was a reasonable proxy for the long term future of the quarry.  In that specific case, the volume/quantity of supply in the quarry itself also had to be considered, as well as historical commodity prices and exchange rates.

For the same reason, I have often focused the review of historical financial results on the last 3 years (or less), particularly in rapidly growing businesses.  For example, a business that has doubled in size over the last 5 years cannot be appropriately valued/priced based on an average over the last 5 years (unless the next 5 years are expected to be the downside of a cyclical business operating in roughly 10 year cycles).

As with so many things in valuation and M&A, the answer is … it depends upon the specifics of the business.

Written by Dan Jennings

May 16, 2012 at 12:19 pm

PEI pub acquired

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PEI’s Murphy Group has acquired the Merchantman Pub in Charlottetown, along with Gooners Bar and The Galley Cafe.

Written by Dan Jennings

May 7, 2012 at 2:06 pm