Google’s recent bid to buy Groupon’s business offers interesting lessons in valuation. Rather than rewrite the story, I want to point you to a finance tutor‘s article on business valuation.

Finance Tutor addresses the article from the perspective of testing the valuation concepts you learn in business school. With their permission, I repost finance Tutor’s article here. This is the second part and focuses on explaining multiples based valuation methods.

Part 2

Valuation Multiples: Groupon’s $6 Billion value using multiples

Our last post on business valuation spoke about how you can approach business valuationusing the discounted cash flow method or the valuation multiples method.  Here we show you how you can estimate the value of Groupon’s business using the multiples valuation method.

Your first task when trying to arrive at a multiples based valuation is to find comparable companies. Comparable companies are similar companies or companies that are in the same business, companies with similar characteristics, growth rates, profit margins, etc. Often it is not possible to get an exact match so picking a company with similar characteristics, growth rates and profit margins is sufficient.

For Groupon, Google itself may be a comparable company to arrive at valuation multiples. Google is significantly larger and but its slower growth rates compensate for the size difference. Apple has shown great growth but is much larger and is not a purely service business. Ebay can be a comparable firm to arrive at valuation multiples too. Lets start with Google.

Sales Multiples (valuation multiple)

According to the NYT, Groupon’s revenue may top $1 billion a year. This is a good place to start.  Google has revenues of 27.55 billion and a business valuation of 149.21 billion (enterprise value) today according to yahoo finance. This works out to a sales valuation multiple of 5.4x (149.21/27.55).

Using this 5.4x sales valuation multiple, Groupon’s business value will be $1 Billion*5.4 = $5.4 billion! This business valuation is in the ball park of the rumored deal price!

Earnings Multiples (valuation multiple)

Google has a PE multiple of 23.23. PE stands for Price/Earnings per share. This indicates that its business valuation is approximately 23.23 times its earnings as Google has very little debt.  If we assume that Groupon has the same profit margins as Google (28.8%), we can estimate its potential earnings at 288 million (28.8%*$1 Billion).

Using the above estimates, we can arrive at Groupon’s business valuation of $6.69 billion (288*23.23). This business valuation is again in the ball park of the rumored deal price! At first sight, it looks like Google is overpaying for Groupon. But it may not be overpaying. It may be a steal!

So are the business valuation concepts you learn in class used in business valuations in the real world? Looks like a resounding YES! So make sure you get your MBA finance concepts clear. You may be called to use it in the near future!

Go ahead and try the same with EBAY or AAPL’s valuation multiples. Let us know what you would pay for Groupon business using valuation multiples.