1) Smaller companies have higher expected returns than larger companies due to lower market attention from investors. 2) Acquisitions can lead to higher valuations by increasing company size and reducing risk. However, the post-acquisition valuation must account for intangible asset amortization and impairment charges. 3) Valuation methods include market approach, income approach, and cost approach. The purchase price allocation between goodwill and identifiable intangible assets affects future financial statements through amortization and impairment testing.

1. M&A for Catalist Companies
Valuation Issues
5 March 2009

2. Smaller Cap = Higher Expected Return
Long-Term Returns in Excess of CAPM Estimation for Decile Portfolios of the NYSE/AMEX/NASDAQ
1926 - 2007
Estimated Return in Size Premium
Realised Return in Excess of Riskless Rate (Return in Excess
Decile Beta Excess of Riskless Rate (N1) of CAPM)
A B A-B
1 - Largest 0.91 6.10% 6.45% -0.35%
2 1.03 7.95% 7.27% 0.68%
3 1.10 8.51% 7.75% 0.76%
4 1.12 8.86% 7.93% 0.93%
5 1.16 9.64% 8.17% 1.47%
6 1.18 9.93% 8.33% 1.60%
7 1.24 10.26% 8.76% 1.50%
8 1.30 11.38% 9.18% 2.20%
9 1.35 12.07% 9.51% 2.56%
10 - Smallest 5.82%
1.41 15.77% 9.95%
Mid-Cap, 3 - 5 (N2) 1.12 8.81% 7.88% 0.93%
Low-Cap, 6 - 8 (N3) 1.22 10.29% 8.64% 1.65%
3.66%
Micro-Cap, 9 -10 (N4) 1.36 13.25% 9.59%
Source: SBBI Valuation edition 2008
Notes:
N1 - Theoretical equity risk premium computed based on the Capital Asset Pricing Model
N2 - Market capitalisations of US$2,411,794,001 - US$9,206,713,000
N3 - Market capitalisations of US$723,258,001 - US$2,411,794,000
N4 - Market capitalisations below US$723,258,000
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3. How to improve valuation?
P0 DIV * (1 + gn)
=
r - gn
EPS0
Capitalisation multiples with varying WACC and g
WACC
8% 9% 10% 11% 12% 13% 14% 15%
0% 12.5x 11.1x 10.0x 9.1x 8.3x 7.7x 7.1x 6.7x
1% 14.3x 12.5x 11.1x 10.0x 9.1x 8.3x 7.7x 7.1x
2% 16.7x 14.3x 12.5x 11.1x 10.0x 9.1x 8.3x 7.7x
g
3% 20.0x 16.7x 14.3x 12.5x 11.1x 10.0x 9.1x 8.3x
4% 25.0x 20.0x 16.7x 14.3x 12.5x 11.1x 10.0x 9.1x
5% 33.3x 25.0x 20.0x 16.7x 14.3x 12.5x 11.1x 10.0x
Note: Capitalisation multiples calculated as 1/WACC-g
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4. How M&A Can Create New Value
Taking advantage of economies of scale
Improve target management
Combine complementary resources
Capture tax benefits
Provide low-cost financing to a financially
constrained target
Create value through restructuring
Penetrating new geographies
Reducing competition
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5. M&A require thorough preparation
5

6. Taking a Disciplined Approach to Find the
Right Value
Pre mium o ffe re d
Year Averag e Me dium De als
Transaction 1986 38.2% 29.9% 333
costs 1987 38.3% 30.8% 237
1988 41.9% 30.9% 410
1989 41.0% 29.0% 303
1990 42.0% 32.0% 175
1991 35.1% 29.4% 137
Synergies 1992 41.0% 34.7% 142
1993 38.7% 33.0% 173
generated 1994 41.9% 35.0% 260
1995 44.7% 29.2% 324
1996 36.6% 27.3% 381
1997 35.7% 27.5% 487
1998 40.7% 30.1% 512
1999 43.3% 34.6% 723
Value of 2001
2000 49.2% 41.1% 574
Stand 57.2% 40.5% 439
target after 2002
alone 59.7% 34.4% 439
realising 2004
2003 62.3% 31.6% 371
value of 30.7% 23.4% 322
synergies 2005
target 34.5% 24.1% 392
2006 31.5% 23.1% 454
Average 42.1% 31.0% 361
Median 41.0% 30.9% 366
Averag e 5 Ye ars 43.7% 27.3% 396
S ource : Me rge rs tat R evie w
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7. M&A Valuation
Post Deal
Pre Deal Post Deal
Pre Deal
Business Impairment of
Combinations assets
FRS 12/38/103 FRS 36
Financial Share Based
Instruments Payments
FRS 32/39 FRS 102
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8. Implications of FRS 103 - Overview
Excess of purchase price over net
assets acquired – formerly known
entirely as “goodwill” has to be
allocated to intangible assets
Fair Value of Net
Fair Value of Net previously not identified
Tangible Assets
Tangible Assets
Purchase
Purchase Technology
Consideration
Consideration
Trade Name
Identifiable
Identifiable Identification
Process
Intangible Assets
Intangible Assets Customer Relationships
Copyrights
Resulting
Resulting
Goodwill
Goodwill
8

9. Different Types of Intangible Assets
Marketing-related Customer-related Contract-based Technology-based Artistic-related
• Trademarks, • Customer lists • Licensing, royalty, • Patented technology • Compositions,
tradenames, brands standstill agreements • Computer software advertising jingles
• Order or production
• Service marks, backlog • Lease agreements • Unpatented • Pictures,
certification marks photographs
• Customer contracts • Construction permits technology
• Internet domains and related customer • Franchise • Video and
• Trade secrets
relationships audiovisual material
• Non-competition agreements • Registration
agreements • Non-contractual • Operating and
customer relationships broadcasting rights
• Employment contracts
• Advertising,
construction,
management, service
or supply contracts
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10. FRS 103 – Amortisation
Financial Impact
Monthly charge to
Definite Amortisation
Profit & Loss
useful life over useful life
Intangible
Assets
Impairment Loss
Indefinite Annual
charged to Profit &
useful life impairment
Loss
M&A Considerations
Are profit guaranteed inclusive of amortisation charges?
Is the intangible Asset supportable by cashflow projections – auditors’ focus
on revenue growth rate, profit margin and discount factor used.
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11. Methodologies
Valuation Approaches
Market Approach Income Approach Cost Approach
Value Estimate Value Estimate Value Estimate
Based on multiples or Present value of Reproduction /
prices from market earnings attributable replacement cost
transactions involving to the asset; or costs adjusted for
the sale of avoided as a result of depreciation &
comparable assets owning the asset obsolescence
Decreasing hierarchy for estimating value
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12. FRS 103 – Resulting Goodwill
Financial Impact
Any impairment
Goodwill Impairment? Loss charged to
Profit & Loss
M&A Considerations
What does the goodwill represent? Synergies? Economies of
Scale?
Is the premium paid for acquisition supportable by cashflow
projections used to test for annual impairment?
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13. Comparison of Value Concepts
13

14. Impairment Test
14

15. Key Points
Smaller Capitalisation = less attention from market
investors = higher expected return = lower valuation
(all else equal)
Acquisitions or mergers can lead to higher
capitalisation, lower risk and higher valuation, but…
Consider the post deal valuation issues early, i.e. in
the pre deal valuation exercise
Impact on post merger/acquisition financials
(definite lived vs. indefinite intangibles)
Robustness of business model and forecast
assumptions (pre deal “euphoria” can lead to
serious post deal consequences)
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