Valuation 090904232636-phpapp01
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  • This is so in the case of companies, just as in the following examples: <br /> land plus house can be less than land separately <br /> existing house – if 1st floor is constructed the value immediately increases more than the cost of construction <br />
  • For total class of investors <br />
  • Many companies look very troubled in recession <br />
  • Land value high, one could consider market value of land or rental from land, whichever may be applicable <br />
  • Perceptions of Risks in the above lead to different valuations. Each element above can again be split into various factors. ie teams entrepreneurship quality and experience in running businesses in the past, professionalism of team, attention to detail <br /> Mgmt team must have clearcut idea – who handles what, one CEO, group dynamics. Also in VC if one team member is known, it is +ve, unlike in banking where this is percieved as favouritsm., bec confidence level goes up. <br /> Bet on team first - very people oriented ie directors, advisors and key team <br /> Financial risk depends on each of these factors <br /> Requirements of clauses of tie-in, statutory environment, shareholding patterns required to be fair for protection of entrepreneur interest, dilution of VC interest on later stages of funding and conversions etc. relevant for exit options will affect valuation ie at each stage valuation depends on return to the investor which is linked to the exit possibility. <br /> Eg. one entrepreneur wanted to list for IPO, but could not because of change in SEBI requirements. Immediately his valuation fell. Angels invested in his company at high premiums in 1st round, anticipating sale at some point. However they later become reluctant to finance 2nd round because no exit was in sight. Entrepreneur was stuck at this time without being able to give value to investors now as compared to few months before this change… and many such stories abound…. <br />
  • Value depends on amounts of funds required. Many persons find in India today that if they require say 25 to 50 lacs, it is difficult to find financiers. In such a case the valuation will be low. If they require larger amounts as there are many VCs, it may be easier to get funding. <br /> Many entrepreneurs prefer to get small amounts from family etc. so that they can go to formal VCs at a later point in time and get better value, ie can give out smaller % of their company for larger amounts. <br />
  • Valuation varies in each of these <br />
  • Methods built up over a certain period of time <br /> As per frame work <br /> laid down and understood by students of finance and those dealing with this subject. <br />
  • Valuation not to be irrational <br /> ie return to investor must be perceived to lead to profit in future <br /> All dotcoms cannot be judged on same parameters and same business models. As we have seen dotcoms can come in different forms and have different ways of adding value. Valuation models to break down elements of models <br /> Let us see some of these elements in the next few slides <br />
  • Who, when, why – being valued <br /> Varies from time to time, today could be Rs. 1000 cr, tomorrow a fraction of this <br /> Of quoted example of Sabeer Bhatia who is reported to have said that he learnt negotiating skills accompanying mother at shopping in Bangalore ( ie form of best bargain, fair value) <br />
  • Ideally the sum of the whole should be greater than the sum of its parts <br />

Valuation 090904232636-phpapp01 Valuation 090904232636-phpapp01 Presentation Transcript

  • Valuation Rs. Anjana Vivek www.venturebean.com beanie@venturebean.com 1
  • FOREWORD ? ? How does one value a company? While at a broad level one may be able to understand why a company may be worth a certain amount to an investor or a buyer, it is not always possible to understand why someone is willing to pay a certain amount for a business. 2 ?
  • FOREWORD ? ? A business worth a significant amount at a certain point in time may suddenly lose much of its value a very short while later. This is what happened in many companies commonly referred to as ‘dot-com companies,’ which were valued at amounts which may seem absurd now…. in hindsight. 3 ? View slide
  • AGENDA Topic Slide no. Background 6 Valuation methods 13 Cost based 16 Book value 18 Goodwill 24 Intangible assets 28 Replacement 31 Liquidation 32 Income based 33 Earnings capitalisation 35 DCF 36 Limitations of DCF 43 Market based 4 52 View slide
  • AGENDA Topic Slide no. What value depends on 63 Valuation process 67 Special situations Multi business 75 M&A 84 Cyclic companies 91 Companies in distress 94 Cross border transactions 97 Privatisation 102 5
  • BACKGROUND - FAQs     Why do values of companies change from time to time? Does value depend on whether one wants to sell a company, to buy a minority stake or to buy the entire company? Will a strategic investor value a company differently from a financial investor? How can a company which is continually losing money have any value? 6
  • VALUATION PROCESS    Review and selection of the methods of valuation Understanding of issues which impact valuation Special situations and their impact on valuation 7
  • What is value  Cost vs. Market Value  Historical vs. Replacement  Differs depending on need of person doing valuation – buyer, seller, employee, banker, insurance company 8
  • Value to user   Valued because of expected return on investment over some period of time; i.e. valued because of the future expectation Return may be in cash or in kind 9
  • Complex nature of valuation Value A + Value B can be greater or less than Value (A+B) 10
  • Why Value When do you think a company is to be valued? 11
  • Why Value To  Purchase  Sell  Transact  Take decisions  Report 12
  • VALUATION METHODS 13
  • Valuation methods These can be broadly classified into:    Cost based Income based Market based 14
  • Valuation methods    Different experts have different classifications of the various methods of valuation Within these methods, there are sub-methods Sometimes the methods overlap 15
  • 1. COST BASED METHODS 16
  • Cost based methods  Book value  Replacement value  Liquidation value 17
  • Book value method Historical cost valuation  All assets are taken at historical book value  Value of goodwill* is added to this above figure to arrive at the valuation *We will see how goodwill is valued in later slides 18
  • Book value method Historical cost valuation  All assets are taken at historical book value  Value of goodwill is added to this above figure to arrive at the valuation  Do you think there would be any difficulties in this? 19
  • Book value method Current cost valuation  All assets are taken at current value and summed to arrive at value  This includes tangible assets, intangible assets, investments, stock, receivables VALUE = ASSETS - LIABILITIES 20
  • Book value method Current cost valuation  All assets are taken at current value and summed to arrive at value  This includes tangible assets, intangible assets, investments, stock, receivables What do you think could be difficulties in this method? 21
  • Book value method Current cost valuation: Difficulties    Technology valuation – whether off or on balance sheet Tangible assets – valuation of fixed assets in use may not be a straightforward or easy exercise Could be subject to measurement error 22
  • Book value method Current cost valuation: More difficulties   The company is not a simple sum of stand alone elements in the balance sheet Organisation capital is difficult to capture in a number – this includes – – – – Employees Customer relationships Industry standing and network capital Etc… 23
  • Valuation of goodwill    Based on capital employed and expected profits vs. actual profits Based on number of years of super profits expected May be discounted at suitable rate 24
  • Valuation of goodwill  Normal capitalisation method – Normal capital required to get actual return less actual capital employed  Super profit method – Excess of actual profit over normal profit multiplied by number of years super profits are expected to continue  Annuity method – Discounted super profit at a suitable rate 25
  • Valuation of goodwill COMPANY A  Capital employed: Rs. 45 cr  Normal rate of return: 12 %  Future maintainable profit: Rs. 5.5 cr    What would be the goodwill under the normal capitalization method? SOLUTION: (change font colour to see this) = (5.5/.12) – 45 = Rs. 0.83 cr 26
  • Valuation of goodwill COMPANY B  Capital employed: Rs. 50 cr  Normal rate of return: 15 %  Future maintainable profit: Rs. 8 cr  Super profit can be maintained for:3 years What would be the goodwill under the super profit method? SOLUTION: (change font colour to see this) = [8 – (50*.15) ] * 3 = Rs.1.50 cr 27 
  • Valuation of IA The value of the IA is from  Economic benefit provided  Specific to business or usage  Has different aspects – Accounting value – Economic value – Technical value – Can you think of examples of these different values? 28
  • Valuation of IA    Depends on objective and can vary widely depending on purpose For accounting purposes – to show in financial statements For acquisition/merger/investment For management to understand value of company for decision making 29
  • IA value in transactions   Often value paid in M&A deals is more than market value/book value. This could be: Partly due to over bidding due to strategic reason (existing or perceived) and Partly due to IA of company, not captured in balance sheet 30
  • Replacement value method  Cost of replacing existing business is taken as the value of the business 31
  • Liquidation value method   Value if company is not a going concern Based on net assets or piecemeal value of net assets 32
  • INCOME BASED METHODS 33
  • Income Based methods   Earnings capitalisation method or profit earning capacity value method Discounted cash flow method (DCF) 34
  • Earnings capitalisation method     This method is also known as the Profit earnings capacity value (PECV) Company’s value is determined by capitalising its earnings at a rate considered suitable Assumption is that the future earnings potential of the company is the underlying value driver of the business Suitable for fairly established business having predictable revenue and cost models 35
  • Discounted cash flow method  Creame Corner wants to acquire Samosa Specials for Rs. 10 million. The net cash flows are in the table below. Creame Corner wants to apply a discount rate of 15%. Should it buy Samosa Specials? Year Net CF Rs. ‘000 15% disc. 1 -10,000 1 2 1,000 0.8696 3 3,000 0.7561 4 5,000 0.6575 5 6,500 0.5718 36
  • Discounted cash flow method   NPV is positive hence based on this method, the answer is YES, the acquisition should be made! Can you think of three deficiencies in this valuation method? Year Net CF 15% disc. Rs. ‘000 NPV Rs. ‘000 1 -10,000 1 -10,000 2 1,000 0.8696 870 3 3,000 0.7561 2,268 4 5,000 0.6575 3,288 5 6,500 0.5718 3,717 5,500 142 37
  • Applicability of DCF method  Cash flow to equity – Discount rate reflects cost of equity  Cash flow to firm – Discount rate reflects weighted average cost of capital 38
  • Discounted cash flow  Cash flow to equity – Valuation of equity stake in business – Based on expected cash flows – Net of all outflows, including tax, interest and principal payments, reinvestment needs 39
  • Discounted cash flow  Cash flow to firm – Value of firm for all claim holders, includes equity investors and lenders – Net of tax but prior to debt payments – Measures free cash flow to firm before all financing costs 40
  • Discounted cash flow t =n CFt Value = ∑ t t =1 (1 + r ) • CF is cash flow • t is the year and • r the discount rate i.e. the cash flow for each year from year 1 to year n (which is the time period under consideration) is discounted to arrive at the present value of future cash flows from year 1 to n 41
  • Applicability   Discounted cash flow is based on expected cash flow and discount rates Sometimes it is difficult to get a reliable estimate for the future and the valuation model may need modification 42
  • Limitations  Companies in difficulty – Negative earnings – May expect to lose money for some time in future – Possibility of bankruptcy – May have to consider cash flows after they turn negative or use alternate means 43
  • Limitations  Companies with cyclic business – May move with economy & rise during boom & fall in recession – Cash flow may get smoothed over time – Analyst has to carefully study company with a view on the general economic trends. The bias of the analyst regarding the economic scenario may find its way into the valuation model 44
  • Limitations  Unutilised assets of business – Cash flow reflects assets utilised by company – Unutilised and underutilised assets may not get reflected in the valuation model – This may be overcome by adding value of unutilised assets to cash flow. The value again may be on assumption of asset utilisation or market value or a combination of these 45
  • Limitations  Companies with patents or product options – Unutilised product options may not produce cash flow in near future, but may be valuable – This may be overcome by adding value of unutilised product using option pricing model or estimating possible cash flow or some similar method 46
  • Limitations  Companies in process of restructuring – May be selling or acquiring assets – May be restructuring capital or changing ownership structure – Difficult to understand impact on cash flow 47
  • Limitations  Companies in process of restructuring – Firm will be more risky, how can this be captured? – Historical data will not be of much help – Analysis should carefully try to consider impact of such change 48
  • Limitations  Companies in process of M&A – Estimation of synergy benefit in terms of cash flow may be difficult – Additional capex may be calculated based on inadequate information or limited data – Difficult to capture effect of change in management directly in cash flow – Analyst should try to study impact of M&A with due care 49
  • Limitations  Companies in process of M&A Historically, many M&As have not done as well as expected. Many times this has been attributed to valuation being too high. To minimise this risk of over valuation, a proper due diligence review (DDR) exercise is to be done, with one of the mandates for this being careful review of the value drivers and the business proposition. 50
  • Limitations  Unlisted companies – Difficult to estimate risk – Historical information may not be indicative of future, particularly in early stage, growth phases – Market information on similar companies can be difficult to obtain 51
  • MARKET BASED METHOD 52
  • Market based method     Also known as relative method Assumption is that other firms in industry are comparable to firm being valued Standard parameters used like earnings, profit, book value Adjustments made for variances from standard firms, these can be negative or positive 53
  • Exercise in Valuation Plantation Co. Enterprise market value/sales 1.4 Enterprise market value/EBITDA 17.0 Enterprise market value/free cash flows 20 Application to Meadows Co. Sales EBIDTA Free cash flow Garden Co. 1.1 15.0 26 Rs. 200 crores Rs. 14 crores Rs. 10 crores 54 Park Co. 1.1 19.0 26
  • Value estimated Plantation Co. Enterprise market value/sales 1.4 Enterprise market value/EBITDA 17.0 Enterprise market value/free cash flows 20.0 Application to Meadows Co. Sales EBIDTA Free cash flow Rs. 200 crores Rs. 14 crores Rs. 10 crores Garden Co. 1.1 15.0 26.0 Park Co. 1.1 19.0 26.0 Average Value 1.2 Rs. 240 crores 17.0 Rs. 238 crores 24.0 Rs. 240 crores 55 Average 1.2 17.0 24.0
  • Exercise in Valuation Enterprise market value/sales Enterprise market value/EBITDA Enterprise market value/free cash flows Application to PenPencil Co. Sales EBIDTA Free cash flow Papers Co 2.6 10.0 21.0 Docs Co. 1.9 21.0 30.0 Rs. 300 crores Rs. 15 crores Rs. 7.5 crores 56 Prints Co. 0.9 4.0 24.0
  • Value estimated ? Papers Co Enterprise market value/sales 2.6 Enterprise market value/EBITDA 10.0 Enterprise market value/free cash flows 21.0 Application to PenPencil Co. Sales EBIDTA Free cash flow Rs. 300 crores Rs. 15 crores Rs. 7.5 crores Docs Co. 1.9 21.0 30.0 Prints Co. 0.9 4.0 24.0 Average 1.8 11.7 25.0 Average Value 1.8 Rs. 540 crores 11.7 Rs. 175.5 crores 25.0 Rs. 187.5 crores Since multiples differ, this cannot be used as a dependable guide for valuation 57
  • Relative Valuation  Using fundamentals – Valuation related to fundamentals of business being valued  Using comparables – Valuation is estimated by comparing business with a comparable fit 58
  • Relative Valuation  Using fundamentals for multiples to be estimated for valuation – Relates multiples to fundamentals of business being valued, eg earnings, profits – Similar to cash flow model, same information is required – Shows relationships between multiples and firm characteristics 59
  • Relative Valuation  Using Comparables for estimation of firm value – Review of comparable firms to estimate value – Definition of comparable can be difficult – May range from simple to complex analysis 60
  • Applicability   Simple and easy to use Useful when data of comparable firms and assets are available 61
  • Limitation    Easy to misuse Selection of comparable can be subjective Errors in comparable firms get factored into valuation model 62
  • VALUATION: What it depends on 63
  • Valuation depends on        Management team Historical performance Future projections Project, product, USP Industry scenario Country scenario Market, opportunity, growth expected, barriers to competition 64
  • Valuation depends on      Nature of transaction Whether 1st round or later round Whether family and friends or other parties Amount of money required Stage of company - early stage, mezzanine stage (pre-IPO), later stage (IPO) 65
  • Valuation depends on    Strategic requirements and need for transaction Demand / supply position Flavour of the season Initial ballpark valuation can also be a deal issue 66
  • VALUATION: Process 67
  • Process of valuation Consider  Net assets tangible and intangible  Financial data  Historical information  Company info  Industry info  Economic environment 68
  • Process of valuation      Include elements of cash, costs, revenues, markets Plan long term not short haul Use more than one model Discount for risks, assign probabilities Arrive at range A valuation range is preferable 69 to a single number
  • Process of valuation Finally after arriving at the value range raise some fundamental questions    Does the value reflect the past performance and the expected future? Does the value reflect the USP as compared to competition? Does the value reflect the quality of the management? 70
  • Process of valuation The last mile…   Does the valuation reflect the picture you have of the business? Would you be willing to pay this price? 71
  • Valuation: for investment   Valuation is perception in the eye of the beholder It is subject to negotiation Investor Value Company Value 72
  • Valuation: in M&A  Value of combined business is expected to be more than value of the individual companies Value (A+B) Value A + Value B 73
  • APPLICATION OF VALUATION MODELS In special cases 74
  • Multi business models     The entire business is valued as a sum of the parts Valuation depends on successful management of different units Strategic decisions usually occur at each business unit level To understand the company one needs to first understand the opportunities and threats faced by each business unit 75
  • Multi business models   Valuation of company that is based on valuation of individual business units provides deeper insight Valuation of individual business units also helps understand whether the company is more valuable as a whole or in parts and to understand where the value is (eg. in some units or in the company as a whole) 76
  • Multi business models   Particularly useful in restructuring and reworking business and financial strategy of the business going ahead Helps understand and get a better picture of costs of the corporate office and understand allocation of these costs and whether these can be reduced 77
  • Multi business models    Identifying business units can be complex Cash flows projection can be complex and interdependent on different units Allocation of corporate office costs and other company costs/benefits may be difficult 78
  • Multi business models  A business unit is identified as one which can be split off as a stand alone unit or sold to another enterprise – Units are to be logically separable – They should not have depend production/sales/distribution etc. – Some joint products may fall under one unit, if there is interdependency which calls for this – If there is limited interdependency, this may be viewed by considering transfer pricing and whether transactions could be considered ‘arms length’ 79
  • Multi business models  Allocation of corporate costs including some or all of these: – Salary and other costs of key management – Board costs – Corporate administration costs – Costs of listing as a public company – Advertising and marketing costs 80
  • Multi business models  Allocation methods are to be carefully thought through and could be a combination of different methods for different costs, including – Based on time spent (time sheets) – Advertising based on revenue 81
  • Multi business models  Benefits are also to be incorporated, including – Saving on operational costs – Information/communications – Tax benefits / shields (ie one loss producing unit would provide a shield to another profit making one – important when one is considering a split up / hive off of some units) – Intangible benefits – can these be quantified? (Eg key person in management team / Board) 82
  • Multi business models  Difficulties and concerns – Partial holdings in units (taken as a percentage of ownership of business unit value) – Double counting may occur – Allocation may pose difficulties – Interdependency may not be easy to separate – Intangibles cannot be easily quantified – Transfer pricing to be viewed in the regulatory context 83
  • Mergers/Acquisitions   These have become very important as companies try to grow inorganically or network to exploit possible synergies Most senior executives may be involved in such transactions – Directly or indirectly – In the buy side or target side 84
  • Mergers/Acquisitions  Rationale for the proposed transaction is to be understood Synergy – Revenues – Costs – Intangibles   Control/ dominance in market Under valuation perceived (LBOs/LBIs) 85
  • Mergers/Acquisitions   Studies show that generally acquired company shareholders gain Reasons for failure – Poor post acquisition management – Over payment for target 86
  • Mergers/Acquisitions  Research has suggested that the following factors have resulted in positive deals – Bigger value creation overall – Lower premiums paid – Better run by acquirers 87
  • Mergers/Acquisitions     Overpayment could be because of a combination of these factors: Market potential - overoptimistic appraisal Synergy – overestimated Due diligence – inadequate Bidding – excessive 88
  • Mergers/Acquisitions  Synergy – Operational (vertical and horizontal M&A eg backward integration, captive customer) – Functional (Production, sales) – Benefits (tax, control etc.) and impact on cash flow to be quantified (eg. increased sales, reduced wages) keeping timing in mind 89
  • Mergers/Acquisitions     LBOs/LBIs Initially high leverage May be followed by rapid reduction in debt This impacts business risk which will change 90
  • Cyclic companies    Fluctuation in earnings over different periods in time One approach taken is that if done correctly, DCF evens out fluctuations /volatility in the long term because all value is reduced to a single period However position of current year in cycle, needs to be factored in as it is considered as base year 91
  • Cyclic companies    Growth rates in different years need to be adjusted based on expected cycles There may be difficulty in estimating cycles accurately If future differs from past, this would impact forecasts and therefore impact valuation 92
  • Cyclic companies   It is important to have different possible scenarios and arrive at a range of values should be arrived This is useful as managers can implement decisions based on the valuation depending on the stage of the cycle the company is in (eg. for buyback, issue of shares, raising of debt funds) 93
  • Companies in distress May have one or all these problems  Negative cash flow  Unable to pay back debt  Liquidity crunch 94
  • Companies in distress   Valuing the company based on expectation of turnaround Assume the company will be healthy soon and look at future based on a healthier past Analyse based on future expected transaction in which cash flow is identifiable 95
  • Companies in distress   Liquidation value Sum of parts based on individual identification of units – Consider different alternate scenarios of units in different combinations – Consider all assets tangible and intangible  Cap at possible realisable value 96
  • Cross border transactions      There are special issues in such cases, including Foreign exchange fluctuations Difference in regulations (statutory, accounting) Estimating cost of capital Country risks Inter country transactions 97
  • Cross border transactions     Analyse past performance Translate Fx into host country financials, based on accounting standards Include any tax implication (eg subsidiary may pay dividend tax only if this is paid out) Arrive at FCF and convert to domestic currency 98
  • Cross border transactions   Consider impact of restrictions on transfer of currency In place of FCF, multiples may also be used 99
  • Cross border transactions  View impact of accounting regulations on financials – Provisions (pension) – Goodwill (amortised or against equity) – Revaluation of assets – Deferred taxes – Fx translations – Non operating assets – Tax 100
  • Cross border transactions  Cost of capital – Market risk premium difficult to estimate, sometimes proxies are used – Risks in changing regulations – Political risks – Illiquid capital markets – Restrictions on cash flows 101
  • Privatisation    Listed companies have the following which may lead to increased costs Increase in information to be provided per listing requirements Separation of ownership and management (good/bad?) Focus on stock prices at the cost of fundamental growth, in many cases 102
  • Privatisation Implication of privatisation  Reduced access to finance  Reduced visibility of company (impact on brand)  Reduced requirement for compliance/governance Impacts to be factored in for valuation, to the extent possible 103