Valuation in Indian Regulatory Environment
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Valuation in Indian Regulatory Environment

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Valuation in Indian Regulatory Environment with focus on Tricky Issues: the presentation given by Mr. Chander Sawhney, Vice President (chander@indiacp.com) of Corporate Professionals at the CKF ...

Valuation in Indian Regulatory Environment with focus on Tricky Issues: the presentation given by Mr. Chander Sawhney, Vice President (chander@indiacp.com) of Corporate Professionals at the CKF Masterclass "Corporate Valuations- Techniques and Applications"...

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    Valuation in Indian Regulatory Environment Valuation in Indian Regulatory Environment Presentation Transcript

    • What has never been doubted has never been proven.. Valuation in Indian Regulatory Environment (With focus on tricky issues) By: Mr. Chander Sawhney Vice President Corporate Professionals Capital Private Limited
    • Agenda 3) Valuation in Indian Regulatory Environment 2) Tricky Valuation Issues 1) Stem of Valuation
    • S Standard of Valuation T Thesis of Valuation E Economics of Valuation M Methodologies of Valuation Corporate Valuations – Techniques and Application
    • FAIR MARKET VALUE INTRINSIC VALUE FAIR VALUE INVESTMENT VALUE Standard of Valuation Thesis of Valuation Economics of Valuation Methodologies of Valuation Standard of Value is the hypothetical conditions under which a business is valued. While selecting the Standard of Value following points is to be taken care of  Subject matter of Valuation;  Purpose of Valuation;  Statute;  Case Laws;  Circumstances. Types of Standard of Value: Corporate Valuations – Techniques and Application
    • Standard of Valuation Thesis of Valuation Economics of Valuation Methodologies of Valuation Thesis of Value is Premise of value which relates to the assumptions upon which the valuation is based. Premise of Value  Going Concern – Value as an ongoing operating business enterprise.  Liquidation – Value when business is terminated . It could be „forced‟ or „orderly‟.  Value-in-use  Value-in-exchange Corporate Valuations – Techniques and Application
    • Growing Cos.  Turnover/Profits: Increasing still Low  Proven Track Record: Limited  Valuation Methodology: Substantially on Business Model  Cost of Capital: Quite High High Growth Cos.  Turnover/Profits : Good  Proven Track Record: Available  Valuation Methodology: Business Model with Asset Base  Cost of Capital: Reasonable Mature Cos.  Turnover/Profits: Saturated  Proven Track Record: Widely Available  Method of Valuation: More from Existing Assets  Cost of Capital: May be High Declining Cos. `  Turnover/Profits: Drops  Proven Track Record: Substantial Operating History  Method of Valuation: Entirely from Existing Assets  Cost of Capital: N.A.  Turnover/Profits: Negligible  Proven Track Record: None  Valuation Methodology: Entirely on Business Model  Cost of Capital: Very High Start Up Cos. Turnover/Profits Time Valuation across business cycle follow the law of economics Standard of Valuation Thesis of Valuation Economics of Valuation Methodologies of Valuation Corporate Valuations – Techniques and Application
    • Standard of Valuation Thesis of Valuation Economics of Valuation Methodologies of Valuation Valuation Income Based Method Market Based Method Asset Based Method Other Methods Capitalization of Earning Method (Historical) Discounted Cash Flow Method (Projected Time Value) Comparable Companies Market Multiples Method (Listed Peers) Comparable Transaction Multiples Method (Unlisted Peers) Market Value Method (For Quoted Securities) Book Value Method Liquidation Value Method Replacement Value Method Contingent Claim Valuation (Option Pricing) Price of Recent Investment Method Rule of Thumb (Multiples: Customers, Rooms, Seats, No. of visitors etc.) - Depends upon Industry Corporate Valuations – Techniques and Application
    • CASH FLOW Investor assign value based on the cash flow they expect to receive in the future - Dividends / distributions - Sale of liquidation proceeds Value of a cash flow stream is a function of - Timing of cash Receipt - Risk associated with the cashflow ASSETS Operating Assets - Assets used in the operation of the business including working capital, Property, Plant & Equipment & Intangible assets - Valuing of operating assets is generally reflected in the cash flow generated by the business Non - Operating Assets - Assets not used in the operations including excess cash balances, and assets held for investment purposes, such as vacant land & Securities - Investors generally do not give much value to such assets and Structure modification may be necessary Key drivers of valuation That’s why DCF is most prominent valuation method Need for Restructuring Corporate Valuations – Techniques and Application
    • Tricky Valuation Issues Corporate Valuations – Techniques and Application
    • • Mergers • IPO • RBI • Income Tax • ESOP • Companies Act • SEBI • Stock Exchange Purpose Regulatory Accounting • Purchase Price Allocation Dispute Resolution • Company Law Board/ Courts • Impairment / Diminution • Arbitration • Mediation • Acquisitions / Investment • Voluntary Assessment Value Creation • Equity Research • Credit Rating • Corporate Planning Valuation depends upon Corporate Valuations – Techniques and Application
    • Choice of Valuation Approaches “Value in Valuation is a question, and Your choice of Method is the first step towards answer” Applicability of a particular approach depends upon: On whose behalf? – one buyer vs another buyer, buyer vs seller; For what purpose? – independent strategic acquisition, group company consolidation, cross border transaction; When? – distress situation, industry downturn, boom etc; Corporate Valuations – Techniques and Application
    • Choice of Valuation Approaches • In General, Income Approach is preferred; The dominance of profits for valuation of share was emphasised in “McCathies case” (Taxation, 69 CLR 1) where it was said that “the real value of shares in a company will depend more on the profits which the company has been making and should be capable of making, having regard to the nature of its business, than upon the amount which the shares would realise on liquidation”.  This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.) (122 ITR 38). • However, Asset Approach is preferred in case of Asset heavy companies and on liquidation; •Market Approach is preferred in case of listed entity and to evaluate the value of unlisted company by comparing it with its listed peers; Corporate Valuations – Techniques and Application
    • Enterprise / Business Value EnterpriseValue Net Debt# Equity# Fixed Assets Net Current Assets Intangibles Stakeholders Assets ValueofBusiness # Based on Market Values Corporate Valuations – Techniques and Application
    • Valuation Methodologies and Value Impact Major Valuation Methodologies Ideal for Result Net Asset Value Net Asset Value (Book Value) Minority Value Equity Value Net Asset Value (Fair Value) Control Value Comparable Companies Multiples (CCM) Method Price to Earning , Book Value Multiple Minority Value Equity Value EBIT , EBITDA Multiple Enterprise Value Comparable Transaction Multiples (CTM) Method Price to Earning , Book Value Multiple Control Value Equity Value EBIT , EBITDA Multiple Enterprise Value Discounted Cash Flow (DCF) Equity Control Value Equity Value Firm Enterprise Value Corporate Valuations – Techniques and Application
    • Discounts • Discount for Entity Level Discounts & Premiums come into picture when there exist difference between the subject being valued and the Methodologies applied. As this can translate control value to non-control and vise versa , so these should be judiciously applied. – Impact on entity as a whole  Key Person Discount  Discount for Contingent Liability  Discount for diversified company  Discount for Holding Company • Discount for Shareholders Level – Impact on specific ownership interest  Discount Lack of Control (DLOC)  Discount Lack of Marketability (DLOM) • Size of distribution or dividends • Dispute • Revenue / Earning – Growth / Stability • Private Company  Tax Payout • % stake & special rights • Shareholders Agreement caveats Global Studies over the years on diversified companies and holding companies has shown that companies trade at a discount in the range of 20%. to 40% each. DLOM: As per CCI Guidelines, 15% discount has been prescribed; however practically DLOM and DLOC depends upon following factors: Corporate Valuations – Techniques and Application
    • Premium •Control Premium - An investor seeking to acquire control of a company is typically willing to pay more than the current market price of the company. Control premium is an amount that a buyer is usually willing to pay over the fair market value of a publicly traded company to acquire controlling stake in a company Research has shown that the control premium in India has ranged from 20% to 37% in the past few years. Corporate Valuations – Techniques and Application
    • Excess Cash and Non Operating Assets Excess cash is defined as „total cash (in balance sheet) – operating cash (i.e. minimum required cash) to sustain operations (working capital) and manage contingencies Key Issue: Estimation of Excess Cash ? Non operating Assets are the Surplus assets which are not used in operations of the business and does not reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should be separately added to the value derived through valuation methodologies to arrive at the value of the company. One of the solutions is to estimate average cash/sales or total balance sheet size of the company’s relevant Industry and then estimate if the company being valued has cash in excess of the industry’s average. What is an asset is not yielding adequate returns ? Corporate Valuations – Techniques and Application
    • Cross Holding and Investments Holdings in other firms can be categorized into: Types of Cross Holding Meaning Minority, Passive Investments If the securities or assets owned in another firm represent less than 20% of the overall ownership of that firm Minority, Active Investments If the securities or assets owned in another firm represent between 20% and 50% of the overall ownership of that firm Majority, Active Investments If the securities or assets owned in another firm represent more than 50% of the overall ownership of that firm Investment Value Ways to value Cross Holding and Investments: Dividend Yield Capitalization or DCF based on expected dividends Seperate Valuation (Preferred) By way of Shareholders Agreement even less % holding may command control value Corporate Valuations – Techniques and Application
    • Accounting Practices and Tax issues Most of the information that is used in valuation comes from financial statements. which in turn are made on certain Accounting practices considered appropriate. • Cash Accounting v/s Accrual Accounting • Operating Lease v/s Financial Lease • Capitalization of Expenses • Notional Tax vs. Actual Tax • Treatment of Intangible Assets • Companies Paying MAT • Treatment of Tax benefits and Losses Corporate Valuations – Techniques and Application
    • Intangible Valuation Identification of Intangible Assets: • Market Related : Trade Marks, Service Marks etc. • Customer Related : Customer Lists, Order backlogs etc. • Artistic Related : Plays, Books, Pictures, Music, Video etc. • Contract Related : Licensing, Royalty, Lease agreements etc. • Technology Related : Patented Technology, Databases, computer software's etc. Corporate Valuations – Techniques and Application
    • Intangible Valuation Cont. Choice of Valuation Approaches and Methodologies Income Approach • Excess Earnings • Relief from Royalty • Discounted Cash Flow • Comparative Business Valuation Cost Approach • Historical Cost • Replacement Cost Market Approach • Based on sale of similar license / intangible asset Other Approach • Option Pricing Model Corporate Valuations – Techniques and Application
    • Purchase Price Allocation What is a Purchase Price Allocation? - an acquiring entity must allocate the purchase price to the assets acquired and liabilities assumed based on estimated fair values at the date of acquisition; - The excess of the cost of an acquired entity (including tangible and intangible assets) over the net of the amounts assigned to assets acquired and liabilities assumed is recorded as “Goodwill”; Consideration paid for acquisition Allocated to Tangible Assets Intangible Assets Goodwill In Proportion to Fair Value Balancing Figure Intangible Valuation Cont. Corporate Valuations – Techniques and Application
    • Private Company Valuation Some Data Issues: Valuation of Unlisted Company.. • Industry Misclassification • Infrequent Collection • Mixing Data from Different Sources • Omission or Inclusion of Information • Poor Data Quality • Tiny Sample Size Guidance Note: The valuation of shares should be carried out on the gross profits earned by the Company, as held in Rakhra Sports Private Limited and Ors. v. Khraithilal Rakhra and Ors. (1993) Vol. 74 CC 545 While carrying out the valuation of shares, the valuer must take into account the salaries and perquisites paid to the directors and related party transactions. Corporate Valuations – Techniques and Application
    • Rule of Thumb A rule of thumb or benchmark indicator is used as a reasonableness check against the values determined by the use of other valuation approaches. Industry Valuation Parameters Hospital EV/Room Engineering Mcap/Order Book Mutual Fund Asset under management OIL EV/ Barrel of equivalent Print Media EV/Subscriber Power EV/MW, EBITDA/Per Unit Entertainment & Media EV/Per screen Metals EBITDA/Ton, EV/Metric ton Textiles EBITDA depend upon capacity utilization Percentage & per spindle value Pharma Bulk Drugs New Drug Approvals , Patents Airlines EV/Plane or EV/passenger Shipping EV/Order Book, Mcap/Order Book Cement EV/Per ton & EBITDA/Per ton Banks Non performing Assets , Current Account & Saving Account per Branch However, Exclusive use of Rule of Thumb is not recommended Corporate Valuations – Techniques and Application
    • Company Specific Factors • Management, Promoter Group Fundamental to any valuation • Operating, Capital and Corporate Finance Strategies • Competitive advantages and cost position • Product / Service offering / differentiation / pricing power •Scale & Diversification •Customer / Supplier concentration •Corporate Governance •Future prospects / Growth potential •Industry peer group •Regulatory environment Corporate Valuations – Techniques and Application
    • Industry Risk Analysis • Good vs. Difficult industry • Porter’s 5 forces • Industry life cycle (growth) • Industry cyclicality (earnings quality) • Leading indicators • Competition (ROIC) • Pricing dynamics; Demand vs. Supply (ROIC) • Changing business environments • Regulation (ROIC) • Product characteristics (earnings quality) • Capital intensity and cost base (ROIC) • Event risk Following factors are required to be considered: Corporate Valuations – Techniques and Application
    •  Pre Money or Post Money: If the effect of the money coming in Company is taken in Projections, the Expanded capital base should be considered or else the Equity Value should be reduced by the inflow amount to reconcile with the existing capital base.  Projection Validation via-a-vis Industry: Need to have Sanity check of the projections with the trend of the industry.  Terminal growth rate: Since it is tough to estimate the perpetual growth rate of a company, it is preferred to take the perpetuity growth rate factoring in long term estimated GDP of the Country and Historical/Projection Inflation of the Country.  Adjustment of Company Specific Risk Premium or Small Company Risk Premium: Small Companies are generally more risky than big companies. CAPM model does not take into consideration the size risk and specific company risk as Beta measures only systematic risk and Market Risk Premium (generally pertaining to Sensex Companies). These risks should also be taken into account while computing the cost of equity.  Length of Projections: The Projected Cash Flows should factor in the entire Business Cycle of a Company.  Notional/Actual Tax: Actual Tax Liability may be worked out and replaced for the Notional Tax Liability. In perpetuity tax should be computed at full rate Some other tricky issues in valuation (From DCF perspective) Corporate Valuations – Techniques and Application
    • Valuation in Indian Regulatory Environment Corporate Valuations – Techniques and Application
    • Inbound Investment DFCF Gift of Unquoted Equity Shares (Min) NAV Outbound Investment Valuer Discretion Gift of Unquoted Shares other than Equity Shares Price it would fetch if sold in open market Takeover Code/ Delisting - Infrequently Traded Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis Industry Average Takeover Code/ Delisting - Frequently Traded Based on Market Price Reserve Bank of India ESOP Tax Valuer Discretion ESOP Accounting Option – Pricing Model Income Tax SEBI CA / MB >5Mn$ - MB, otherwise CA/MB - MB MB - CA/MB - Stock Exchanges Preferential Allotment to promoters / their relatives for consideration other than cash Valuer Discretion Companies Act Sweat Equity Valuer Discretion CA / MB - Transactions Prescribed Methodologies Mandate to be done by SNAPSHOT OF REGULATORY VALUATIONS IN INDIA Gift of Unquoted Equity Shares from Resident (Max) DCF (Valuation Based on Assets, Business & Intangibles is also acceptable) FCA / MB Corporate Valuations – Techniques and Application
    • IRS Revenue Ruling (59-60),USA • Revenue Ruling (RR) 59-60 is one of the oldest guidance available on Valuation in the world but still most relevant for Tax Valuations specifically for Valuing closely held common stock. It is the most widely referenced revenue ruling, also often referenced for Non Tax Valuations. • While Valuing , it gives primary guidance on eight basic factors to consider- • Nature of the Business and the History of the Enterprise from its inception • Economic outlook in general and outlook of the specific industry in particular • Book Value of the stock and the Financial condition of the business • Earning Capacity of the company • Dividend-Paying Capacity of the company. • Goodwill or other Intangible value • Sales of the stock and the Size of the block of stock to be valued • Market prices of stock of corporations engaged in the same or a similar line of business Corporate Valuations – Techniques and Application
    • Any Specific Valuation Query may be mailed @ info@corporatevaluations.in / chander@indiacp.com M: +91 9810557353; Ph: 011-40622252 W: www.corporatevaluations.in; corporateprofessionals.com Mr. Chander Sawhney (FCA, ACS, Certified Valuer (ICAI) Disclaimer: This presentation contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither corporatevaluations.in nor any other member of the Corporate Professionals organization accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this presentation. On any specific matter, reference should be made to the appropriate advisor. © 2013, Corporate Professionals. All rights reserved