CFO Network – Business valuation


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

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CFO Network – Business valuation

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