pragmatic. Multiples such as price to earningsor price to
bookvalueoftencannotevenbe computedforadistressed
firm. Analysts therefore move up the income statement
lookingfor a positive number.Forfirms thatmake heavy
infrastructure investments, where depreciation and
amortizationareasignificantchargeagainstoperatingincome
and therearesubstantial interest expenses, theEBITDA is
oftenpositivewhilenetincomeisnegative.Forsomefirms,
though,evenEBITDAisnegative,andrevenuemultiplesare
the only multiples that yield positive values.
2.Analystswhoareawareofthepossibilityofdistressoften
considerdistresssubjectivelywhentheycomparethemultiple
forthefirmtheyareanalyzingtotheindustryaverage.For
example,assume thattheaverage telecomfirmtradesat 2
timesrevenuesandthatthefirmweareanalyzingtradesat
1.25 times revenues. Assume also that the firm has
substantially higher default risk than the average telecom
firm.Wemayconcludethatthefirmisnotundervaluedeven
though it trades at a significant discount on the average,
becauseofthepotentialfordefault.Theperilsofsubjective
adjustment are obvious. Barring the most egregious
misvaluations,analystswillfindawaytojustifytheirprior
biases about firms.
Adapting Relative Valuation to Distress
Isthereawayinwhichrelativevaluationcanbeadaptedto
cover distressed firms? We believe so, although the
adjustments tendto bemuch moreapproximatethanthose
describedinthediscountedcashflowsection.Weconsider
two ways of building distress explicitly into relative
valuations.Inthefirst,wecomparea distressedcompany’s