Valuing a closely held manufacturer.

• Author: Ellentuck, Albert B.

Facts: FabrikCo Inc. is a Texas corporation engaged in the custom metal and plastic fabrication business. The company has been in existence for 25 years and is owned by three sisters, Karen, Ingrid and Helen. Karen and Ingrid manage the business, while Helen is an inactive investor. * Throughout its history, the company has been moderately successful, with sales and profits growing by about 8% annually. However, FabrikCo is now poised for a period of higher sales and profitability due to anticipated new business in the former Eastern Bloc countries. Over the next five years, the company expects to increase sales and profits by about 25% annually, before returning to a more normal growth rate of about 10%. * As of the most recent year-end, FabrikCo's net asset value is $45 million; its liquidation value is $30 million; its after-tax GAAP income is $3 million; and its normalized income is $3.5 million. FabrikCo has no significant identifiable intangible assets and is not highly leveraged (corporate debt is about $10 million). * There are two small publicly traded corporations comparable to FabrikCo in terms of products and past financial performance. They have traded at an average price/earnings (PE) ratio of 13 over the past 12 months. Unlike FabrikCo, however, they have not identified any new markets, and expect sales and earnings to increase only by 7-10% annually in the foreseeable future. * The two sisters who are active in the business both want to cash out and invest the proceeds in a new venture that will produce virtual reality vacation experiences for sale and distribution via the Internet. (The third sister is also amenable to selling out.) They contact their tax adviser to advise them on determining a suitable sale price for the business. Issue: How should FabrikCo be valued for sale to an outside party?

Analysis

Although an earnings-based valuation method would appear to be appropriate, a practitioner can still use the net asset value of $45 million as a check for the absolute lowest value derived from the earnings-based methods. Because comparable company data is available, one of the valuation methods should be a value-multiples method. In this situation, basing a value on the average PE ratios of the two comparable publicly traded companies makes sense. However, because their growth prospects are less favorable than those of FabrikCo, it would be appropriate for a practitioner to use a somewhat higher PE ratio, or to use the...