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CFO Network – Business valuation

CFO Network – Business valuation



Business valuations presentation by Wayne Lonergan for the CFO Network 18 May 2011

Business valuations presentation by Wayne Lonergan for the CFO Network 18 May 2011



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    CFO Network – Business valuation CFO Network – Business valuation Presentation Transcript

    • Azure Group CFO Network – valuation overview
      Wayne Lonergan
      18 May 2011
    • Overview
      Enterprise value – what is it?
      Calculating value
      Discount rates
      Impairment testing
      Where its all gone / going
    • Enterprise value
      Equity value (i.e. market value of shares plus premium for control)
      Net interest bearing debt
      Enterprise value
    • How valuations are done
      Capitalise maintainable earnings
      Discount future cash flows
    • Different multiples
      Equity value = price earnings ratio x profit after tax
      Enterprise value = EBIT multiple x EBIT
    • Discount rate – deriving cost of debt
      Current entity borrowing interest rate less tax at 30%
      i.e. market based rate
    • Discount rate – deriving cost of equity
      Ke = Rf + β (MRP)
      i.e. cost of equity = Risk free rate + beta x Market risk premium
    • Discount rates – deriving cost of equity
    • Example – BHP
      Government bonds 6%
      Beta of BHP 1.2 x
      MRP 6%
      Calculation for equity discount rate:
      = Rf + β (MRP)
      = 6% + 1.2 x 6%
      = 6% + 7.2%
      = 13.2% (note, after tax)
      Discount rate
    • Funding – part debt / part equity
      BHP’s weighted average cost of capital:
      70% equity x 13.2% (from slide 9)
      30% debt 7% less 30% tax = 4.9%
      Equals WACC 10.71% (after tax)
      (70% x 13.2% + 30% x 4.9%)
    • Calculating value
      Discount Rate x CFY1
      x CFY2
      x CFY3
      Discounting is like compound interest in reverse
    • Discounting 10%
    • Impairment testing
      Can’t reverse goodwill write-downs (even if impairment is due to interest rate rise)
      Unrecognised intangible values “hide” goodwill losses
      Upgrades and hence future benefits have to be “committed”, or else ignored
      Many DCF’s are only 5 years
      Too short a forecast period
      Most value is in terminal value
      Terminal value easy to get wrong
      Lots of silly rules
    • Impairment testing
      If its (barely) profitable, its not impaired
      If profit exceeds interest cost of debt, its not impaired
      You only impair fixed assets. Stock, debtors etc are subject to their own different accounting standards and are excluded from the asset base for impairment testing
      In reality
      This isn’t correct
      What many directors (wrongly) believe
    • Impairment testing – the reality
      AIFRS impairment test higher of:
      Market value
      Value in use (VIU)
      VIU uses company view of cash flows not market views
      VIU = L.O.O.C.
      But most companies use it (guess why?)
      VIU reduces write-downs
    • ASX All Ordinaries Index
    • Impairment testing – overview
      Things generally aren’t too bad in Australia
      Things are very bad overseas in Western World ( large govt debt and deficits in USA, UK, Spain, Portugal, Ireland etc)
      China has saved us, so far
      Australian consumers are worried (house values, interest rates, electricity costs, etc)
      On balance
      Tread carefully
      Watch China
      If China falters significantly – watch out!
    • GFC – what many forget
      Mean reversion applies in a crisis
      Forced down by Government.
      Much lower in USA etc.
      At least.
      Or lower, if debt available at all.
    • The GFC hangover
      Interest costs still higher than pre-GFC (credit spread up 1% or more)
      Credit availability reflected in debt / equity ratio significantly lower
      End result – values have generally fallen
      Index 2007 6,000 (+)
      2011 5,000 (-)
    • Valuation trends 2007 – 2011
      Lower earnings multiples in 2011
      Much less debt
      Increased cost of debt
      Significant sectoral differences (e.g. Mining vs Retail)
    • Will it get better?
      Major government debts due espec to bail outs / stimulus packages
      USA (e.g.):
      Large government annual deficit
      Debt exceeds 100% of GDP
      Very low interest rates aren’t stimulating demand much
      Similar, some worse, problems in most of Western world
    • Getting better – “best guess”
      Australia depends on China
      Rest of world (except e.g. Asia) in poor state
      Will take a very long time to fix (e.g. USA, UK, Spain, Portugal, Ireland, Greece, etc)
    • Recommended reading
      Available from leading book stores or
      Allen & Unwin
      Available from leading book stores or Sydney University Press www.sup.usyd.edu.au
      (Alternatively contact Lonergan Edwards on 02 8235 7500)