Valuation Anjana Vivek [email_address] Rs.
FOREWORD <ul><li>How does one value a company? While at a broad level one may be able to understand why a company may be w...
FOREWORD <ul><li>A business  worth  a significant amount at a certain point in time may suddenly lose much of its value a ...
AGENDA www.bizkul.com Topic Slide no. Background  6 Valuation methods 13 Cost based 16 Book value 18 Goodwill 24 Intangibl...
AGENDA www.bizkul.com Topic Slide no. What value depends on 63 Valuation process 67 Special situations Multi business 75 M...
BACKGROUND - FAQs <ul><li>Why do values of companies change from time to time?  </li></ul><ul><li>Does value depend on whe...
VALUATION PROCESS <ul><li>Review and selection of the methods of valuation </li></ul><ul><li>Understanding of issues which...
What is value <ul><li>Cost vs. Market Value </li></ul><ul><li>Historical vs. Replacement </li></ul><ul><li>Differs dependi...
Value to user <ul><li>Valued because of expected return on investment over some period of time; i.e. valued because of the...
Complex nature of valuation <ul><li>Value A + Value B can be  </li></ul><ul><li>greater  </li></ul><ul><li>or   </li></ul>...
Why Value  <ul><li>When do you think a company is to be valued? </li></ul>www.bizkul.com
Why Value  <ul><li>To </li></ul><ul><li>Purchase </li></ul><ul><li>Sell </li></ul><ul><li>Transact </li></ul><ul><li>Take ...
<ul><li>VALUATION METHODS </li></ul>www.bizkul.com
Valuation methods <ul><li>These can be broadly classified into: </li></ul><ul><li>Cost based </li></ul><ul><li>Income base...
Valuation methods <ul><li>Different experts have different classifications of the various methods of valuation </li></ul><...
<ul><li>1. COST BASED METHODS </li></ul>www.bizkul.com
Cost based methods <ul><li>Book value </li></ul><ul><li>Replacement value </li></ul><ul><li>Liquidation value </li></ul>ww...
Book value method <ul><li>Historical cost valuation </li></ul><ul><li>All assets are taken at historical book value </li><...
Book value method <ul><li>Historical cost valuation </li></ul><ul><li>All assets are taken at historical book value </li><...
Book value method <ul><li>Current cost valuation </li></ul><ul><li>All assets are taken at current value and summed to arr...
Book value method <ul><li>Current cost valuation </li></ul><ul><li>All assets are taken at current value and summed to arr...
Book value method <ul><li>Current cost valuation: Difficulties </li></ul><ul><li>Technology valuation – whether off or on ...
Book value method <ul><li>Current cost valuation: More difficulties </li></ul><ul><li>The company is not a simple sum of s...
Valuation of goodwill <ul><li>Based on capital employed and expected profits vs. actual profits </li></ul><ul><li>Based on...
Valuation of goodwill <ul><li>Normal capitalisation method </li></ul><ul><ul><li>Normal capital required to get actual ret...
Valuation of goodwill <ul><li>COMPANY A </li></ul><ul><li>Capital employed:    Rs. 45   cr </li></ul><ul><li>Normal rate o...
Valuation of goodwill <ul><li>COMPANY B </li></ul><ul><li>Capital employed:  Rs. 50 cr </li></ul><ul><li>Normal rate of re...
Valuation of IA <ul><li>The value of the IA is from  </li></ul><ul><li>Economic benefit provided </li></ul><ul><li>Specifi...
Valuation of IA  <ul><li>Depends on objective and can vary widely depending on purpose </li></ul><ul><li>For accounting pu...
IA value in transactions  <ul><li>Often value paid in M&A deals is more than market value/book value. This could be: </li>...
Replacement value method <ul><li>Cost of replacing existing business is taken as the value of the business </li></ul>www.b...
Liquidation value method <ul><li>Value if company is not a going concern </li></ul><ul><li>Based on net assets or piecemea...
<ul><li>INCOME BASED METHODS </li></ul>www.bizkul.com
Income Based methods <ul><li>Earnings capitalisation method or profit earning capacity value method </li></ul><ul><li>Disc...
Earnings capitalisation method <ul><li>This method is also known as the Profit earnings capacity value (PECV) </li></ul><u...
Discounted cash flow method <ul><li>Creame Corner wants to acquire Samosa Specials for Rs. 10 million. The net cash flows ...
Discounted cash flow method <ul><li>NPV is positive hence based on this method, the answer is YES, the acquisition should ...
Applicability of DCF method <ul><li>Cash flow to equity </li></ul><ul><ul><li>Discount rate reflects cost of equity </li><...
Discounted cash flow <ul><li>Cash flow to equity </li></ul><ul><ul><li>Valuation of equity stake in business </li></ul></u...
Discounted cash flow <ul><li>Cash flow to firm </li></ul><ul><ul><li>Value of firm for all claim holders, includes equity ...
Discounted cash flow www.bizkul.com <ul><li>CF is cash flow  </li></ul><ul><li>t is the year and  </li></ul><ul><li>r the ...
Applicability  <ul><li>Discounted cash flow is based on expected cash flow and discount rates </li></ul><ul><li>Sometimes ...
Limitations <ul><li>Companies in difficulty </li></ul><ul><ul><li>Negative earnings </li></ul></ul><ul><ul><li>May expect ...
Limitations <ul><li>Companies with cyclic business </li></ul><ul><ul><li>May move with economy & rise during boom & fall i...
Limitations <ul><li>Unutilised assets of business </li></ul><ul><ul><li>Cash flow reflects assets utilised by company </li...
Limitations <ul><li>Companies with patents or product options </li></ul><ul><ul><li>Unutilised product options may not pro...
Limitations <ul><li>Companies in process of restructuring </li></ul><ul><ul><li>May be selling or acquiring assets </li></...
Limitations <ul><li>Companies in process of restructuring </li></ul><ul><ul><li>Firm will be more risky, how can this be c...
Limitations <ul><li>Companies in process of M&A </li></ul><ul><ul><li>Estimation of synergy benefit in terms of cash flow ...
Limitations <ul><li>Companies in process of M&A </li></ul><ul><ul><li>Historically, many M&As have not done as well as exp...
Limitations <ul><li>Unlisted companies </li></ul><ul><ul><li>Difficult to estimate risk </li></ul></ul><ul><ul><li>Histori...
<ul><li>MARKET BASED METHOD </li></ul>www.bizkul.com
Market based method <ul><li>Also known as relative method </li></ul><ul><li>Assumption is that other firms in industry are...
Exercise in Valuation  www.bizkul.com
Value estimated www.bizkul.com
Exercise in Valuation www.bizkul.com
Value estimated ? www.bizkul.com Since multiples differ, this cannot be used as a dependable guide for valuation
Relative Valuation <ul><li>Using fundamentals </li></ul><ul><ul><li>Valuation related to fundamentals of business being va...
Relative Valuation <ul><li>Using fundamentals for multiples to be estimated for valuation </li></ul><ul><ul><li>Relates mu...
Relative Valuation <ul><li>Using Comparables for estimation of firm value </li></ul><ul><ul><li>Review of comparable firms...
Applicability <ul><li>Simple and easy to use </li></ul><ul><li>Useful when data of comparable firms and assets are availab...
Limitation <ul><li>Easy to misuse </li></ul><ul><li>Selection of comparable can be subjective </li></ul><ul><li>Errors in ...
<ul><li>VALUATION:  What it depends on </li></ul>www.bizkul.com
Valuation depends on <ul><li>Management team </li></ul><ul><li>Historical performance </li></ul><ul><li>Future projections...
Valuation depends on <ul><li>Nature of transaction </li></ul><ul><li>Whether 1st round or later round </li></ul><ul><li>Wh...
Valuation depends on <ul><li>Strategic requirements and need for transaction </li></ul><ul><li>Demand  / supply position <...
VALUATION:  Process  www.bizkul.com
Process of valuation  <ul><li>Consider </li></ul><ul><li>Net assets tangible and intangible </li></ul><ul><li>Financial da...
Process of valuation <ul><li>Include elements of cash, costs, revenues, markets  </li></ul><ul><li>Plan long term not shor...
Process of valuation <ul><li>Finally after arriving at the value range </li></ul><ul><li>raise some fundamental questions ...
Process of valuation <ul><li>The last mile… </li></ul><ul><li>Does the valuation reflect the picture you have of the busin...
Valuation: for investment <ul><li>Valuation is perception in the eye of the beholder  </li></ul><ul><li>It is subject to n...
Valuation: in M&A <ul><li>Value of combined business is  expected  to be more than value of the individual companies </li>...
<ul><li>APPLICATION OF  </li></ul><ul><li>VALUATION MODELS </li></ul><ul><li>In special cases </li></ul>www.bizkul.com
Multi business models <ul><li>The entire business is valued as a sum of the parts  </li></ul><ul><li>Valuation depends on ...
Multi business models <ul><li>Valuation of company that is based on valuation of individual business units provides deeper...
Multi business models <ul><li>Particularly useful in restructuring and reworking business and financial strategy of the bu...
Multi business models <ul><li>Identifying business units can be complex </li></ul><ul><li>Cash flows projection can be com...
Multi business models <ul><li>A business unit is identified as one which can be split off as a stand alone unit or sold to...
Multi business models <ul><li>Allocation of corporate costs including some or all of these: </li></ul><ul><ul><li>Salary a...
Multi business models <ul><li>Allocation methods are to be carefully thought through and could be a combination of differe...
Multi business models  <ul><li>Benefits are also to be incorporated, including </li></ul><ul><ul><li>Saving on operational...
Multi business models <ul><li>Difficulties and concerns </li></ul><ul><ul><li>Partial holdings in units (taken as a percen...
Mergers/Acquisitions <ul><li>These have become very important as companies try to grow inorganically or network to exploit...
Mergers/Acquisitions <ul><li>Rationale for the proposed transaction is to be understood </li></ul><ul><li>Synergy  </li></...
Mergers/Acquisitions <ul><li>Studies show that generally acquired company shareholders gain </li></ul><ul><li>Reasons for ...
Mergers/Acquisitions <ul><li>Research has suggested that the following factors have resulted in positive deals </li></ul><...
Mergers/Acquisitions <ul><li>Overpayment could be because of a combination of these factors: </li></ul><ul><li>Market pote...
Mergers/Acquisitions <ul><li>Synergy </li></ul><ul><ul><li>Operational (vertical and horizontal M&A eg backward integratio...
Mergers/Acquisitions <ul><li>LBOs/LBIs </li></ul><ul><li>Initially high leverage </li></ul><ul><li>May be followed by rapi...
Cyclic companies <ul><li>Fluctuation in earnings over different periods in time </li></ul><ul><li>One approach taken is th...
Cyclic companies <ul><li>Growth rates in different years need to be adjusted based on expected cycles </li></ul><ul><li>Th...
Cyclic companies <ul><li>It is important to have different possible scenarios and arrive at a range of values should be ar...
Companies in distress <ul><li>May have one or all these problems </li></ul><ul><li>Negative cash flow </li></ul><ul><li>Un...
Companies in distress <ul><li>Valuing the company based on expectation of turnaround </li></ul><ul><li>Assume the company ...
Companies in distress <ul><li>Liquidation value </li></ul><ul><li>Sum of parts based on individual identification of units...
Cross border transactions <ul><li>There are special issues in such cases, including </li></ul><ul><li>Foreign exchange flu...
Cross border transactions <ul><li>Analyse past performance </li></ul><ul><li>Translate Fx into host country financials, ba...
Cross border transactions <ul><li>Consider impact of restrictions on transfer of currency </li></ul><ul><li>In place of FC...
Cross border transactions <ul><li>View impact of accounting regulations on financials </li></ul><ul><ul><li>Provisions (pe...
Cross border transactions <ul><li>Cost of capital </li></ul><ul><ul><li>Market risk premium difficult to estimate, sometim...
Privatisation <ul><li>Listed companies have the following which may lead to increased costs </li></ul><ul><li>Increase in ...
Privatisation <ul><li>Implication of privatisation </li></ul><ul><li>Reduced access to finance </li></ul><ul><li>Reduced v...
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Valuation

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Valuation

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