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Insight of Valuation

The document provides an extensive overview of corporate valuation techniques, discussing the distinction between value and price, as well as the methods used to estimate a company's worth. It outlines various standards of value and valuation approaches, including income, asset, and market methods, while considering the regulatory environment in India. The piece emphasizes the need for professional judgment in the valuation process, incorporating factors such as the business model, market conditions, and financial forecasts.

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Insight of Valuation
“In the business world, the rearview mirror is always clearer than the windshield” Warren Buffett 20/12/2013 Corporate Valuations – Techniques & Application
Valuation (Part – A) What and Why 5 How 12 Valuation in Indian Regulatory Environment (Part – B) When and Who 23 Macro Valuation Issues in M&A (Part – C) Why Merger 58 Valuation for Merger 64 Case Study 70 Some Specific Tricky Issues (Part – D) Tricky Issues 74
Part – A Valuation 20/12/2013 Corporate Valuations – Techniques & Application
WHAT & WHY
Value & Valuation Value is* An Economic concept; An Estimate of likely prices to be concluded by the buyer and seller of a good or service that is available for purchase; Not a fact. Valuation is the process of determining the “Economic Worth” of an Asset or Company under certain assumptions and limiting conditions and subject to the data available on the valuation date. * Source -International Valuation Standard Council 20/12/2013 Corporate Valuations – Techniques & Application
Key Facts PRICE IS NOT THE SAME AS VALUE VALUE VARIES WITH PERSON, PURPOSE AND TIME TRANSACTION CONCLUDES AT NEGOTIATED PRICES VALUATION IS HYBRID OF ART & SCIENCE 20/12/2013 Corporate Valuations – Techniques & Application
S Standard of Valuation T Thesis of Valuation E Economics of Valuation M Methodologies of Valuation 20/12/2013 Corporate Valuations – Techniques & Application
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: FAIR MARKET VALUE INVESTMENT VALUE INTRINSIC VALUE FAIR VALUE 20/12/2013 Corporate Valuations – Techniques & 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 20/12/2013 Corporate Valuations – Techniques & Application
Standard of Valuation Thesis of Valuation Economics of Valuation Methodologies of Valuation Valuation across business cycle follow the law of economics Turnover/Profits: Drops   Declining Cos. `    Mature Cos.      sti f or P / r ev onr uT High Growth Cos.   Growing Cos. Start Up Cos. 20/12/2013         Proven Track Record: Substantial Operating History Method of Valuation: Entirely from Existing Assets Cost of Capital: N.A. Turnover/Profits: Saturated Proven Track Record: Widely Available Method of Valuation: More from Existing Assets Cost of Capital: May be High Turnover/Profits : Good Proven Track Record: Available Valuation Methodology: Business Model with Asset Base Cost of Capital: Reasonable Turnover/Profits: Increasing still Low Proven Track Record: Limited Valuation Methodology: Substantially on Business Model Cost of Capital: Quite High Turnover/Profits: Negligible Proven Track Record: None Valuation Methodology: Entirely on Business Model Cost of Capital: Very High Corporate Valuations – Techniques & Application Time
HOW
Enterprise / Business Value Intangibles# Equity# Net Current Assets# Net Debt # Stakeholders # Based on Market Values 20/12/2013 Corporate Valuations – Techniques & Application Fixed Assets# Assets
Standard of Valuation Thesis of Valuation Economics of Valuation Methodologies of Valuation Valuation Approaches Fundamental Method Income Based Method 20/12/2013 Relative Method Asset Based Method Market Based Method Corporate Valuations – Techniques & Application Other Method
Need of several valuation methods? Each has strengths and weaknesses Different methods useful in different situations Each gives a different “take” on the value of the company’s stock Provides a range of valuations instead of point estimates Helps in Sanity Check While concluding Value, all the methodologies must be considered and then weights applied as per the facts of the case. In other words, Value conclusion should be based on the Professional Judgement and Simple Average should best be avoided while concluding Value.
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; 20/12/2013 Corporate Valuations – Techniques & 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; 20/12/2013 Corporate Valuations – Techniques & Application
Valuation depends upon Purpose • Mergers • IPO • Acquisitions / Investment • Voluntary Assessment 20/12/2013 Regulatory Dispute Resolution Accounting • RBI • ESOP • Income Tax • Purchase Price Allocation • SEBI • Impairment / • Stock Exchange Diminution Value Creation • Company Law • Equity Research Board/ Courts • Credit Rating • Arbitration • Corporate • Mediation • Companies Act Corporate Valuations – Techniques & Application Planning
Sources of Information for Valuation Historical financial results – Income Statement, Balance Sheets and Cash Flows Sources of Information Data available in Public Domain – Stock Exchange / MCA/SEBI/Independent Report Data on comparable companies – SALES/EVEBITDA/ PAT/BV Promoters and Management background Discussion and Representation with/by the management of the Company 20/12/2013 Data on projects planned/under implementation including future projection Corporate Valuations – Techniques & Application Industry and Regulatory trends
Key drivers of valuation CASH FLOW Investor assign value based on the cash flow they expect to receive in the future - Dividends / distributions That’s why DCF is most - Sale of liquidation proceeds Value of a cash flow stream is a function of - Timing of cash Receipt - Risk associated with the cashflow prominent valuation method 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 Need for Restructuring 20/12/2013 Corporate Valuations – Techniques & 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 20/12/2013 Corporate Valuations – Techniques & Application
Part – B Valuation in Indian Regulatory Environment 20/12/2013 Corporate Valuations – Techniques & Application
WHEN & WHO
SNAPSHOT OF REGULATORY VALUATIONS IN INDIA Transactions Inbound Investment Inbound Investment Prescribed Methodologies Mandate to be done by DFCF DFCF CA // MB CA MB Valuer Discretion Valuer Discretion >5Mn$ - MB, otherwise CA/MB >5Mn$ - MB, otherwise CA/MB Gift of Unquoted Equity Gift of Unquoted Equity Shares (Min) Shares (Min) NAV NAV - Gift of Unquoted Equity Shares Gift of Unquoted Equity Shares from Resident (Max) from Resident (Max) DCF (Valuation Based on Assets, DCF (Valuation Based on Assets, Business & Intangibles is also Business & Intangibles is also acceptable) acceptable) FCA // MB FCA MB Price it would fetch if sold in open Price it would fetch if sold in open market market MB MB ESOP Tax ESOP Tax Valuer Discretion Valuer Discretion MB MB Transfer Pricing Transfer Pricing Arm Length Price Arm Length Price - ESOP Accounting ESOP Accounting Option – Pricing Model Option – Pricing Model - Takeover Code/ Delisting Takeover Code/ Delisting Infrequently Traded Infrequently Traded Only Parameters Prescribed – Return Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis on Net Worth, EPS, NAV vis-a vis Industry Average Industry Average CA/MB CA/MB Takeover Code/ Delisting Takeover Code/ Delisting Frequently Traded Frequently Traded Based on Market Price Based on Market Price - Preferential Allotment to Others Preferential Allotment to Others Based on 26 weeks // 2 weeks Market Based on 26 weeks 2 weeks Market Price Price - Valuer Discretion Valuer Discretion CA // MB CA MB Reserve Bank of India Outbound Investment Outbound Investment Income Tax SEBI Stock Exchanges Gift of Unquoted Shares other Gift of Unquoted Shares other than Equity Shares than Equity Shares Preferential Allotment to Preferential Allotment to promoters / their relatives for promoters / their relatives for consideration other than cash consideration other than cash Companies Act, 1956 Sweat Equity Sweat Equity Companies Act, 2013 any property, stock, shares, any property, stock, shares, debentures, securities or goodwill debentures, securities or goodwill or any other assets or the net or any other assets or the net worth of the Company or its worth of the Company its liabilities liabilities Valuer Discretion Valuer Discretion To be prescribed To be prescribed - REGISTERED VALUER REGISTERED VALUER
RBI Valuation Guidelines
FDI VALUATION • Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000. •In terms of Schedule 1 of the Notification, an Indian company may issue equity shares/compulsorily convertible preference shares and compulsorily convertible debentures (equity instruments) to a person resident outside India under the FDI policy, subject to inter alia, compliance with the pricing guidelines. •The price/ conversion formula of convertible capital instruments should be determined upfront at the time of issue of the instruments.
FEMA Guidelines to Valuation Particulars Valuation before April 21, 2010 Guidelines in Force CCI Guidelines Methods Prescribed Net Assets Value (NAV) Profit Earning Capacity Value(PECV) Market Value (in case of Listed Company) Valuation after April 21, 2010 In case of FDI Transactions: Listed Company: Market Value as per SEBI Preferential Allotment Guidelines Unlisted Company: DFCF In case of ODI Transactions: No method has been prescribed Discount 15% Discount has been prescribed on account of Lack of Marketability No such Discount has been prescribed Historical / Futuristic It is based on Historical Values It is based on Future Projections Possibility of variation As valuation is more Formulae in Value Conclusion based, final values came standardized As valuation is more dependent on Assumptions and choice of factors like Growth Rate, Cost of Capital etc, value conclusion may vary significantly. Note: Valuation guidelines do not apply to SEBI registered venture capital
Approaches to FDI Valuation Discounted Free Cash Flow Method (DFCF)  RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for initial subscription); but has not provided any guidance on its technical aspects. Though DFCF is one of the most acceptable Valuation methods used by Business valuers worldwide; however DFCF for all FDI transactions-excluding for initial subscription (like minority stake/start up valuation etc) may not yield Fair Value in line with the Commercial understanding. However Law being such, suitable Logical adjustments may be necessary on a case to case basis. DFCF expresses the present value of the business as a function of its DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off. cash flow to equity holders, after debt holders have been paid off.
Major Characteristics of DFCF Valuation  Forward Looking and focuses on cash generation  Recognizes Time value of Money  Allows operating strategy to be built into a model  Incorporates value of Tangible and Intangible assets  Only as accurate as assumptions and projections used  Works best in producing a range of likely values  It Represents the Control Value
DFCF Valuation Process  Understand Business Model  Identify Business Cycle  Analyze Historical Financial Performance  Review Industry and Regulatory Trends  Understand Future Growth Plans (including Capex needs)  Segregate Business and Other Cash Generating Assets  Identify Surplus Assets (assets not utilized for Business say Land/Investments)  Create Business Projections (Profitability statement and Balance Sheets)  Discount Business Projections to Present (Explicit Period and Perpetuity)  Add Value of Surplus Assets and Subtract Value of Contingent Liabilities
Free Cash Flows- Value Trend Terminal Value is calculated for the Perpetuity period based on the Adjusted last year cash flows of the Projected period.
Free Cash Flow calculation FREE CASH FLOWS Free cash flows to firm (FCFF) is calculated as Taxes EBITDA EBITDA Change in Non Cash Working capital Capital Expenditure Free Cash Flow to Firm Note that an alternate to above is following (FCFE) method in which the value of Equity is directly valued in lieu of the value of Firm. Under this approach, the Interest and Finance charges is also deducted to arrive at the Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows) over the definite period of Cash Flows and also in Perpetuity workings. Theoretically, the value conclusion should remain same irrespective of the method followed (FCFF or FCFE), (Provided, assumptions are consistent).
Cost of Capital calculation DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL WACC (Kd x D) + (Ke x E) (D + E) Where: D = Debt part of capital structure E = Equity part of capital structure Kd = Cost of Debt (Post tax) Ke = Cost of Equity In case of following FCFE, Discount Rate is Ke and Not WACC
Cost of Equity calculation DISCOUNT RATE - COST OF EQUITY The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing Model (Mod. CAPM) Mod. CAPM Model ke = Rf + B ( Rm-Rf) + SCRP + CSRP Where: Rf = Yield) B = Ke = Rm= of Risk free rate of return (Generally taken as 10-year Government Bond Beta Value (Sensitivity of the stock returns to market returns) Cost of Equity Market Rate of Return (Generally taken as Long Term average return Stock Market) SCRP = Small Company Risk Premium CSRP= Company specific Risk premium
Terminal value calculation PERPETUITY FORMULA – Usually comprises a Large part of Total Value and is sensitive to small changes – Capitalizes FCF after definite forecast period as a growing perpetuity; – Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows – Gordon Formula is often used to derive the Terminal Cash (1 + g) Flows by applying the last year cash flows as a multiple of (WACC – g) the growth rate and discounting factor – Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of last year projected cash flows IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation Multiples to the Terminal Year Financials and also doing Scenario Analysis.
An Insight of Valuationwww.CorporateValuations.in
SEBI / Stock Exchange Valuation Guidelines
Takeover Regulations APPLICABLE LAW: SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011 FREQUENTLY TRADED SHARES Traded Turnover of Shares ≥ 10% [In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)] Method of Valuation 1.Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A. 2.The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks; 3.The Highest Price paid or payable by acquirer or PAC in last 26 Weeks; 4.Volume weighted average Market Price of Shares for a period of 60 trading days HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A. INFREQUENTLY TRADED SHARES Traded Turnover of Shares < 10% [In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)] Method of Valuation 1.Book value, 2.Comparable Trading Multiples; Such other Parameters as are customary for valuation of shares of such companies
Preferential Issue (1 of 3) APPLICABLE LAW: SEBI (ICDR) Regulations, 2009 Equity shares of issuer have been listed on recognized stock exchange for a period of 26 weeks or more as on relevant date Method of Valuation 1.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during 26 weeks preceding the relevant date, or 2.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during 26 weeks preceding the relevant date. HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE
Preferential Issue ( 2 of 3) APPLICABLE LAW: SEBI (ICDR) Regulations, 2009 Equity shares of issuer have been listed on recognized stock exchange for a period of less than 26 weeks as on relevant date Method of Valuation 1. The price at which equity shares were issued by the issuer in its IPO or value per share arrived at in a scheme of arrangement under section 391 to 394 of the Companies Act, 1956, pursuant to which the equity shares of the issuer were listed, as the case may be , or 2.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during the period shares have been listed preceding the relevant date, or 3.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during 2 weeks preceding the relevant date. HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE
Preferential Issue ( 3 of 3) APPLICABLE LAW: SEBI (ICDR) Regulations, 2009 Where equity shares have been issued to promoters / their relatives for consideration other than cash, the valuation of assets in consideration for which the equity shares are issued shall be done by an independent valuer Method of Valuation No Method for Valuation has been prescribed. Valuer Chartered Accountant or a Merchant Banker
ESOP Accounting Valuation APPLICABLE LAW: SEBI (ESOS and ESPS) Guidelines, 1999 If a Company listed on recognised stock exchange in India and issued shares under an ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing model (Black-Scholes or a binomial model) which shall be treated as employee compensation cost for the Company. Method of Valuation Black-Scholes Model Valuer Not Prescribed
Income Tax Act-1961
Equity Shares Valuation APPLICABLE LAW: Income Tax Act – 1961 and Rule 11UA If Individual, HUF, Firm or *closely held Company receives Equity shares of a closely held Company – Valuation norms shall apply. Method of Valuation Minimum Valuation- Net Asset Value Maximum Valuation- DCF and other methods factoring Tangible and Intangibles Valuer No specific Valuer prescribed for undertaking Minimum Value FCA / Merchant Banker for determining Maximum Value *If a Public Listed Company receives any shares or anyone receives shares of a Public listed Company, valuation norms are not applicable if transaction takes at market price.
Valuation of shares other than Equity Shares APPLICABLE LAW: Income Tax Act – 1961 and Rule 11UA If Individual, HUF, Firm or *closely held Company receives shares other than Equity shares of a closely held Company – Valuation norms shall apply. Method of Valuation Price at which such shares will fetch in the open market. Valuer Valuation report to be issued by Merchant Banker
ESOP Tax Valuation APPLICABLE LAW: Income Tax Act – 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT To determine the value of perquisite taxable in hands of employees Method of Valuation No method has been prescribed Valuer SEBI registered category – I Merchant Banker
Transfer Pricing APPLICABLE LAW: Section – 92 to 92F of Income Tax Act – 1961 and Rule 10A to 10E of Income-tax Rules, 1962 Any International transaction between associated enterprises at ARM LENGTH PRICE Method of Valuation Arm Length Price Valuer Not Prescribed Role of TPO critical. Recent cases deliberating on Valuation aspects
Registered Valuer Companies Act, 2013 20/12/2013
Registered Valuers Registered Valuers Stock, Shares, Debentures, Securities, Goodwill Financial Valuer Technical Valuer Property Persons eligible to apply for being Registered as Valuer • A Chartered Accountant, • Member of the Institute of Company Secretary or Cost Engineers or Member of Accountant in whole time the Institute of Architects practice or retired member in whole time practice. of Shall have 5 Years of Continuous Experience, Post Qualification Indian Corporate law Service or any other person as prescribed. • A Merchant Banker registered with SEBI and • A person or firm or LLP or which has in employment Merchant under possessing it carrying 20/12/2013 Shall have 5 Years of Continues Experience, Post Qualification CA/CS/CWA out for (signing) Valuation by such qualified persons. Banker both qualifications may act in dual capacity. Registered Valuer to be appointed by Audit Committee or in its absence by the Board of Directors.
Registered Valuers Registered Valuers (Financial Valuation) Value Responsibilities • Valuer to make impartial, true and fair valuation • Not undertake valuation if directly or indirectly interested • Exercise due diligence • Valuation to be done as per rules Upon contravention • Fine – 25,000 to 100,000 With intention to defraud • Imprisonment upto 1 year and • Fine- 1,00,000 to 5,00,000 Additionally upon contravention, to refund remuneration received and also liable for damages. 20/12/2013 Corporate Valuations – Techniques & Application
Section wise Requirement of Registered Valuers Section 62(1)(c) – For Valuing further Issue of Shares Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash transactions involving Directors Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a Scheme of Corporate Debt Restructuring Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a Scheme of Compromise/Arrangement, a copy of Valuation Report by Expert, if any shall be accompanied Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the transferor company is a listed company and the transferee company is an unlisted company, for exit opportunity to the shareholders of transferor company, valuation may be required to be made by the Tribunal Section 236(2) – For Valuing Equity Shares held by Minority Shareholders Section 260(2)(c) – For preparing Valuation report in respect of Shares and Assets to arrive at the Reserve Price or Lease rent or Share Exchange Ratio for Company Administrator Section 281(1)(a) – For Valuing Assets for submission of report by Company Liquidator Section 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency under voluntary winding up Section 319(3)(b) – For Valuing the interest of any dissenting member of the transferor company who did not vote in favour of the special resolution, as may be required by the Company Liquidator Section 325(1)(b) – For valuation of annuities and future and contingent liabilities in winding up of insolvent company 20/12/2013 Corporate Valuations – Techniques & Application
Registered Valuers (Draft Rules) – Methods of Valuation I. Before adopting methods, decide Valuation Approach• Asset Approach • Income Approach • Market Approach II. Valuer to consider following points while undertaking Valuation•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 •Contingent Liabilities or substantial legal issues, within India and Abroad, impacting business •Nature of Instrument proposed to be issued, and nature of transaction contemplated by parties 20/12/2013 Corporate Valuations – Techniques & Application
Registered Valuers (Draft Rules) – Methods of Valuation III. Registered Valuer shall make valuation of any asset in accordance with any one or more of the following methodsa.Net Asset Value Method (NAV) b.Market Price Method c.Yield Method / PECV Method d.Discounted Cash Flow Method (DCF) e.Comparable Companies Multiples Method (CCM) f.Comparable Transaction Multiples Method (CTM) g.Price of Recent Investment Method (PORI) h.Sum of the parts Valuation Method (SOTP) i.Liquidation Value j.Weighted Average Method k.Any other method accepted or notified by RBI, SEBI or Income Tax Authorities l.Any other method that valuer may deem fit provided adequate justification for use of suh method (and not any of the above methods) is provided IV. Registered Valuer shall make valuation of any asset as on the Valuation date and in accordance with applicable standards, if any stipulated for this purpose. V. Contents of Valuation report shall contain information as contained in Form 17.3
Registered Valuers (Forms) – Contents of Valuation report 1) Description of valuation engagement (a) Name of the client: (b) Other intended users: (c) Purpose for valuation: (2) Description of business/ asset / liability being valued (a) Nature of business or asset / liability (b) Legal background (c) Financial aspects (d) Tax matters (3) Description of the information underlying the valuation (a) Analysis of past results (b) Budgets, with underlying assumptions (c) Availability and quality of underlying data (d) Review of budgets for plausibility (e) Statement of responsibility for information received 20/12/2013 Corporate Valuations – Techniques & Application
Registered Valuers (Forms) – Contents of Valuation report (4) Description of specific valuation of assets used in the business: (a)Basis or bases of value (b) Valuation Date (c) Description of the procedures carried out (d) Principles used in the valuation (e) The valuation method used and reasoning (f) Nature, scope and quality of underlying data and (g) The extent of estimates and assumptions together with considerations underlying them (5) Confirmation that the valuation has been undertaken in accordance with these Rules (6) Further it is certified that valuation has been undertaken after taking into account relevant conditions/regulations/rules/notifications, if any, issued by the Central/State Government(s) from time to time. (i)The valuation report must clearly state the significant assumptions upon which the value is based. When reporting there may be instances, where there are confidential figures, these must be summarized in a separate exhibit (ii)In his valuation report, the registered valuer must set out a clear value or range of values along with the reasoning (ii)In case the valuer has been involved in valuing any part of the subject matter of valuation in the past, the past valuation report(s) should be attached and referred to herein. In case a different basis has been adopted for valuation (than adopted in the past), the valuer should justify the reason for such differences
Part – C M acro I ssues of V aluation in M ERGERS & A CQUISITION
Why Merger
Capital Market Valuation Particulars Surplus Assets [including Cash] Excess Debt in Capital Structure Excess Trading Business in Manufacturing Sector Diversified Business Model Excess Business in Subsidiary Company Company Performance [Operating Profits; Net Profits; New Products; Capacity Expansion] Increasing Cash Flows of Business Better Corporate Governance Better Disclosures [Investor, Analysts & Stakeholders Communication] Regular Dividends / Bonus / Buyback Corporate Re-organisation / M&A Joint Ventures / Acquisitions Market Perception 20/12/2013 Corporate Valuations – Techniques & Application Effect Market Cap
Types and Modes of M &A M&A Mergers Acquisitions NON - COURT PROCESS COURT PROCESS Companies Act Asset Purchase Stock Purchase SEBI [TAKEOVER CODE] (only if Listed Co. is involved) Slump Sale 20/12/2013 Itemized Sale Corporate Valuations – Techniques & Application
Key Drivers for Re-organization Unlocking of Value and its Sustainability Restatement of Balance Sheet Business clarity to Investors and Analysts Improving Governance Processes Positioning the businesses to be more competitive Making Businesswise Fund raising possible Business Risk Management Stock & Credit Rerating Investor Relations 20/12/2013
Regulatory aspects under various statues Takeover Regulations Competition Commission of India Companies Act, 2013 SEBI and Stock Exchanges Income Tax (DTC) Indirect Tax (GST) FEMA 20/12/2013 Stamp Duty Corporate Valuations – Techniques & Application
M&A objectives – What it means? Synergies & Economies of Scale Gain access to new markets, customers, products Diversification of Risks Access to New Technology and Knowledge Ability to limit competition / gain market share M&A is primarily driven with motive of achieving Inorganic growth and Synergy i.e. the potential additional value gain from combining two firms, either from operational or financial sources. However, certain studies have shown that most – but not all – M&A fail to deliver value and bridge the price-value gap One of the reasons is that the aggressive promoters in consultation with eager advisors may result in pushing up the acquisition price; Resultantly, the value often get transferred from acquirer’s shareholders to target company’s shareholders; 20/12/2013 Corporate Valuations – Techniques & Application
Valuation for Merger
Valuation for Merger “Valuation is generally the Starting Point of the M&A process” Judicial Pronouncements; WHETHER VALUATION IS REQUIRED FOR MERGER? In the matter of Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. the Regional Director (RD) raised an objection that no valuation report has been filed and that the exchange ratio for amalgamation has not been worked out by an independent valuer. “The Hon’ble High Court of Rajasthan overruled this objection and sanctioned the scheme of amalgamation by holding that there was no legal or factual impediment to grant sanction to the scheme of amalgamation.” Tool for planning Stamp Duty ? WHETHER ANY VALUATION METHODOLDY IS REQUIRED FOR MERGER? Though there are no specific methodology prescribed for valuation under Merger, however In Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others, Bombay High Court “accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the valuation was based.” 20/12/2013 Corporate Valuations – Techniques & Application
Valuation for Merger.. Contd.. APPLICABLE LAW FOR VALUATION FOR MERGER INVOLVING LISTED COMPANY: 1.Companies Act, 1956 [Section 391- 394]; 2.Fairness Opinion [Clause 24 (h) of the Listing Agreement]; 3.SEBI Notification [CIR/CFD/DIL/5/2013], dated 4 th February, 2013 and 21st May 2013 Circular VALUATION REQUIREMENT UNDER SEBI NOTIFICATION Valuation by independent chartered account mandatory other than those specifically exempted. ''Valuation Report from an Independent Chartered Accountant'' is not required in cases where there is no change in the shareholding pattern of the listed company / resultant company. After the SEBI notification, Valuation by Independent CA is required if shares are issued under the merger and there is change in shareholding pattern.
Why is there a Mismatch between Buyer & Seller expectations? 1. Differences in Risk Assessment arising from  Company Specific Risk • Management capability • Future Cash Flows  Industry Risk - Business Cycles, Industry Outlook 2. Intangible Asset Valuations 3. Unproductive, high value fixed assets housed in target company 4. Cash and Stock Payout ratio 5. Ability to raise funding on buyer’s or target company’s b/s 6. Estimation of synergies (cost and revenue) Need for Restructuring 20/12/2013 Corporate Valuations – Techniques & Application
Swap Ratio Valuation • In case of a merger valuation, the emphasis is on arriving at the relative values of the shares of the merging companies to facilitate determination of the swap ratio – Hence, the purpose is not to arrive at absolute values of the shares of the companies • The key issue to be addressed is that of fairness to all shareholders – This is particularly important where the shareholding pattern and shareholders vary between the two companies • There are established legal precedence for merger valuation methodologies – Valuer’s role is to incorporate case specific factors and use appropriate methodologies so as to determine a fair ratio – Usually, best to give weight ages to valuation by all methods – Market price method and Earnings methods dominate. 20/12/2013 Corporate Valuations – Techniques & Application
Impact of Swap Ratio Valuation • If the exchange ratio is set too high, there will be a transfer of wealth from the bidding firm’s stockholders to the target firm’s stockholders. • If the exchange ratio is set too low, there will be transfer of wealth from the target firm to the bidding firm’s stockholders. 20/12/2013 Corporate Valuations – Techniques & Application
CASE STUDY Calculation of Exchange Ratio in M&A and Independent Buyer-Seller perspective 20/12/2013 Corporate Valuations – Techniques & Application
Merger of a Unlisted Power Company into Listed Steel Manufacturing Company Features of Steel Company* o Frequently Traded Listed Company o Low Profit Margin, due to high Power Cost o Running in Low Capacity Utilization due to poor supply of Power Features of Power Company* o Unlisted Company o Company is implementing the Power Plant of 9.5 MW , The Production is expected to start with in Year Acquisition Rationale o Location Advantage, both companies have their unit in same Location o Synergistic benefits- (Captive Power Plant will reduce the Operating cost, because Steel Industry is energy consuming) o Tax benefit from the unabsorbed losses of Power Company o Up the value chain o Capacity utilization will increase in existing steel business, due easy availability of Power 20/12/2013 Corporate Valuations – Techniques & Application *Common Promoter Group
Merger of a Unlisted Power Company into Listed Steel Manufacturing Company EXCHANGE RATIO & VALUATION –MERGER • Valuation on Steel Company Valuation Method Rs Crores Weights Value of Company Weighted Value Market Cap 2 100 200 Income Method 2 95 190 NAV 1 150 150 Fair Value of Company 108 • Valuation on Power Company Valuation Method Rs Crores Weights Value of Company Weighted Value Market Cap 2 NA NA Income Method^ 2 90 180 NAV 1 50 50 Fair Value of Company 20/12/2013 ^ considering 3 years forward earnings and 80-90% Capacity utilization basis 76.67
Pre and Post Shareholding Pre Merger Shareholding of Steel Company Category Promoter No of shares Independent Perspective % Holding 5,000,000 50% Public 5,000,000 50% Total 10,000,000 100% Pre Merger Shareholding of Power Company Category Promoter No of shares 5,000,000 100% - - 5,000,000 100% Public Total % Holding Post Merger Shareholding of Steel Company Category Promoter No of shares % Holding 12,099,074 71% Public 5,000,000 17,099,074 Valuation of Power business on as is basis – Rs.55 crores Assets Method Earnings Method (Includes premium for the license) Valuation of Power business taking into account synergies – Rs. 70 crores An independent Buyer would bid an amount in excess of valuation on standalone basis (Rs. 55 crores) and below Synergy valuation (Rs.70 crores). 29% Total Buyer-Seller 20/12/2013 Acquisition Price finally depend Corporate Valuations – Techniques & Application negotiations. 100% would on
Part – D Some Specific Tricky Issues
Tricky issues in DFCF  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.  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.  Projection Validation via-a-vis Industry: Need to have Sanity check of the projections with the trend of the industry.  Beta of Unlisted Company: It is calculated on relative basis by adjusting the average beta of its comparable companies for differences in Capital Structure of the unlisted company with the listed peers.  Risk Free Rate: Yield of a Zero Coupon Bond or Long Term government Bond yield should be taken as the risk free rate since it does not have any reinvestment risk . 20/12/2013 Corporate Valuations – Techniques & Application
Tricky issues in DFCF (Cont.)  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  Investments: Investments should be valued separately based on their Independent Cash Flows  Surplus Assets: The Value of Surplus Assets (not being utilized for Business purposes) should be added separately and their cash flows should be ignored while computing the Free Cash Flows. Corporate Valuations – Techniques & 20/12/2013 Application
Discounts 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 • Discount for Entity Level Key Person Discount Discount for Contingent Liability Global Studies over the years on diversified Discount for diversified company Discount for Holding Company that companies trade at a discount in the range companies and holding companies has shown of 20%. to 40% each. Tax Payout •Discount for Shareholders Level – Impact on specific ownership interest Discount Lack of Control (DLOC) Discount Lack of Marketability (DLOM) •% stake & special rights DLOM: As per CCI Guidelines, 15% discount has been prescribed; however practically DLOM and DLOC depends upon following factors: 20/12/2013 •Size of distribution or dividends •Dispute •Revenue / Earning – Growth / Stability •Private Company •Shareholders Agreement caveats
Premium “Beauty lies in the eyes of the beholder; valuation in those of the buyer” • An investor seeking to acquire control of a company is typically willing to pay more than the current market price Financial Year No. of Transactio ns Median Premium 2006 25 37% 2007 29 20% 2008 38 26% 2009 44 29% 2010 22 31% 2011 42 32% Total 228 30% 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. • Control can be direct (shareholding or Authority to appoint Board) or indirect (veto power, casting vote etc) • Research has shown that the control premium in India has ranged from 20% to 37% in the past few years having median of 30%. 20/12/2013 Corporate Valuations – Techniques & 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 ? 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. 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. What is an asset is not yielding adequate returns ? 20/12/2013 Corporate Valuations – Techniques & Application
Cross Holding and Investments Holdings in other firms can be categorized into: Types of Cross Holding Minority, Passive Investments Meaning 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 Ways to value Cross Holding and Investments: Investment Value By way of Dividend Yield Capitalization or DCF based on expected Agreement dividends Separate Valuation (Preferred) holding 20/12/2013 Corporate Valuations – Techniques & Application Shareholders even may control value less % command
Accounting Practices and Tax issues Most of the information that is used in valuation comes from financial statements. which in turn Accounting are practices 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 20/12/2013 Corporate Valuations – Techniques & Application made on certain considered
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. 20/12/2013 Corporate Valuations – Techniques & Application
Intangible Valuation Cont. 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”; Tangible Assets Consideration paid for acquisition Allocated to Intangible Assets Goodwill 20/12/2013 In Proportion to Fair Value Corporate Valuations – Techniques & Application Balancing Figure
Private Company Valuation Valuation of Unlisted Company.. Some Data Issues: • 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. 20/12/2013 Corporate Valuations – Techniques & Application
Company Specific Factors It is the alignment of Company’s value via-avis to its external environment • Management, Promoter Group • 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 20/12/2013 Corporate Valuations – Techniques & Application
Valuation Methodologies and Value Impact Major Valuation Methodologies Ideal for Result Net Asset Value Net Asset Value (Book Value) Minority Value Net Asset Value (Fair Value) Control Value Equity Value Comparable Companies Multiples (CCM) Method Price to Earning , Book Value Multiple EBIT , EBITDA Multiple Minority Value Equity Value Enterprise Value Comparable Transaction Multiples (CTM) Method Price to Earning , Book Value Multiple EBIT , EBITDA Multiple Control Value Equity Value Enterprise Value Discounted Cash Flow (DCF) Equity Control Value Firm 20/12/2013 Equity Value Enterprise Value Corporate Valuations – Techniques & Application
Demerger resulted in increased shareholders value Reliance Group Market prices (In Rs) Pre demerger Post demerger Reliance Industries 702 698 Reliance Capital Ventures - 23 Reliance Communication Ventures - 292 Reliance Energy Ventures - 43 Reliance Natural Resource “That is what learning is, you suddenly 18 understand something you have understood all 702 your life, but in a 1074 new TOTAL way” …………………………….. Doris Lessing 20/12/2013 Corporate Valuations – Techniques & Application
Chander Sawhney, Vice President Corporate Professionals Capital Pvt. Ltd. SEBI registered merchant banker Email : chander@indiacp.com Mobile: 9810557353; Direct: 40622252 www.corporateprofessionals.com; D-28, South Extension, Part-I, New Delhi-110049

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Insight of Valuation

  • 1.
  • 2.
    “In the businessworld, the rearview mirror is always clearer than the windshield” Warren Buffett 20/12/2013 Corporate Valuations – Techniques & Application
  • 3.
    Valuation (Part –A) What and Why 5 How 12 Valuation in Indian Regulatory Environment (Part – B) When and Who 23 Macro Valuation Issues in M&A (Part – C) Why Merger 58 Valuation for Merger 64 Case Study 70 Some Specific Tricky Issues (Part – D) Tricky Issues 74
  • 4.
    Part – A Valuation 20/12/2013 CorporateValuations – Techniques & Application
  • 5.
  • 6.
    Value & Valuation Valueis* An Economic concept; An Estimate of likely prices to be concluded by the buyer and seller of a good or service that is available for purchase; Not a fact. Valuation is the process of determining the “Economic Worth” of an Asset or Company under certain assumptions and limiting conditions and subject to the data available on the valuation date. * Source -International Valuation Standard Council 20/12/2013 Corporate Valuations – Techniques & Application
  • 7.
    Key Facts PRICE ISNOT THE SAME AS VALUE VALUE VARIES WITH PERSON, PURPOSE AND TIME TRANSACTION CONCLUDES AT NEGOTIATED PRICES VALUATION IS HYBRID OF ART & SCIENCE 20/12/2013 Corporate Valuations – Techniques & Application
  • 8.
    S Standard ofValuation T Thesis of Valuation E Economics of Valuation M Methodologies of Valuation 20/12/2013 Corporate Valuations – Techniques & Application
  • 9.
    Standard of Valuation Thesis ofValuation 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: FAIR MARKET VALUE INVESTMENT VALUE INTRINSIC VALUE FAIR VALUE 20/12/2013 Corporate Valuations – Techniques & Application
  • 10.
    Standard of Valuation Thesis ofValuation 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 20/12/2013 Corporate Valuations – Techniques & Application
  • 11.
    Standard of Valuation Thesis ofValuation Economics of Valuation Methodologies of Valuation Valuation across business cycle follow the law of economics Turnover/Profits: Drops   Declining Cos. `    Mature Cos.      sti f or P / r ev onr uT High Growth Cos.   Growing Cos. Start Up Cos. 20/12/2013         Proven Track Record: Substantial Operating History Method of Valuation: Entirely from Existing Assets Cost of Capital: N.A. Turnover/Profits: Saturated Proven Track Record: Widely Available Method of Valuation: More from Existing Assets Cost of Capital: May be High Turnover/Profits : Good Proven Track Record: Available Valuation Methodology: Business Model with Asset Base Cost of Capital: Reasonable Turnover/Profits: Increasing still Low Proven Track Record: Limited Valuation Methodology: Substantially on Business Model Cost of Capital: Quite High Turnover/Profits: Negligible Proven Track Record: None Valuation Methodology: Entirely on Business Model Cost of Capital: Very High Corporate Valuations – Techniques & Application Time
  • 12.
  • 13.
    Enterprise / BusinessValue Intangibles# Equity# Net Current Assets# Net Debt # Stakeholders # Based on Market Values 20/12/2013 Corporate Valuations – Techniques & Application Fixed Assets# Assets
  • 14.
    Standard of Valuation Thesis ofValuation Economics of Valuation Methodologies of Valuation Valuation Approaches Fundamental Method Income Based Method 20/12/2013 Relative Method Asset Based Method Market Based Method Corporate Valuations – Techniques & Application Other Method
  • 15.
    Need of severalvaluation methods? Each has strengths and weaknesses Different methods useful in different situations Each gives a different “take” on the value of the company’s stock Provides a range of valuations instead of point estimates Helps in Sanity Check While concluding Value, all the methodologies must be considered and then weights applied as per the facts of the case. In other words, Value conclusion should be based on the Professional Judgement and Simple Average should best be avoided while concluding Value.
  • 16.
    Choice of ValuationApproaches “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; 20/12/2013 Corporate Valuations – Techniques & Application
  • 17.
    Choice of ValuationApproaches • 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; 20/12/2013 Corporate Valuations – Techniques & Application
  • 18.
    Valuation depends upon Purpose •Mergers • IPO • Acquisitions / Investment • Voluntary Assessment 20/12/2013 Regulatory Dispute Resolution Accounting • RBI • ESOP • Income Tax • Purchase Price Allocation • SEBI • Impairment / • Stock Exchange Diminution Value Creation • Company Law • Equity Research Board/ Courts • Credit Rating • Arbitration • Corporate • Mediation • Companies Act Corporate Valuations – Techniques & Application Planning
  • 19.
    Sources of Informationfor Valuation Historical financial results – Income Statement, Balance Sheets and Cash Flows Sources of Information Data available in Public Domain – Stock Exchange / MCA/SEBI/Independent Report Data on comparable companies – SALES/EVEBITDA/ PAT/BV Promoters and Management background Discussion and Representation with/by the management of the Company 20/12/2013 Data on projects planned/under implementation including future projection Corporate Valuations – Techniques & Application Industry and Regulatory trends
  • 20.
    Key drivers ofvaluation CASH FLOW Investor assign value based on the cash flow they expect to receive in the future - Dividends / distributions That’s why DCF is most - Sale of liquidation proceeds Value of a cash flow stream is a function of - Timing of cash Receipt - Risk associated with the cashflow prominent valuation method 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 Need for Restructuring 20/12/2013 Corporate Valuations – Techniques & Application
  • 21.
    Rule of Thumb Arule 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 20/12/2013 Corporate Valuations – Techniques & Application
  • 22.
    Part – B Valuationin Indian Regulatory Environment 20/12/2013 Corporate Valuations – Techniques & Application
  • 23.
  • 24.
    SNAPSHOT OF REGULATORYVALUATIONS IN INDIA Transactions Inbound Investment Inbound Investment Prescribed Methodologies Mandate to be done by DFCF DFCF CA // MB CA MB Valuer Discretion Valuer Discretion >5Mn$ - MB, otherwise CA/MB >5Mn$ - MB, otherwise CA/MB Gift of Unquoted Equity Gift of Unquoted Equity Shares (Min) Shares (Min) NAV NAV - Gift of Unquoted Equity Shares Gift of Unquoted Equity Shares from Resident (Max) from Resident (Max) DCF (Valuation Based on Assets, DCF (Valuation Based on Assets, Business & Intangibles is also Business & Intangibles is also acceptable) acceptable) FCA // MB FCA MB Price it would fetch if sold in open Price it would fetch if sold in open market market MB MB ESOP Tax ESOP Tax Valuer Discretion Valuer Discretion MB MB Transfer Pricing Transfer Pricing Arm Length Price Arm Length Price - ESOP Accounting ESOP Accounting Option – Pricing Model Option – Pricing Model - Takeover Code/ Delisting Takeover Code/ Delisting Infrequently Traded Infrequently Traded Only Parameters Prescribed – Return Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis on Net Worth, EPS, NAV vis-a vis Industry Average Industry Average CA/MB CA/MB Takeover Code/ Delisting Takeover Code/ Delisting Frequently Traded Frequently Traded Based on Market Price Based on Market Price - Preferential Allotment to Others Preferential Allotment to Others Based on 26 weeks // 2 weeks Market Based on 26 weeks 2 weeks Market Price Price - Valuer Discretion Valuer Discretion CA // MB CA MB Reserve Bank of India Outbound Investment Outbound Investment Income Tax SEBI Stock Exchanges Gift of Unquoted Shares other Gift of Unquoted Shares other than Equity Shares than Equity Shares Preferential Allotment to Preferential Allotment to promoters / their relatives for promoters / their relatives for consideration other than cash consideration other than cash Companies Act, 1956 Sweat Equity Sweat Equity Companies Act, 2013 any property, stock, shares, any property, stock, shares, debentures, securities or goodwill debentures, securities or goodwill or any other assets or the net or any other assets or the net worth of the Company or its worth of the Company its liabilities liabilities Valuer Discretion Valuer Discretion To be prescribed To be prescribed - REGISTERED VALUER REGISTERED VALUER
  • 25.
  • 26.
    FDI VALUATION • Notification No.FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000. •In terms of Schedule 1 of the Notification, an Indian company may issue equity shares/compulsorily convertible preference shares and compulsorily convertible debentures (equity instruments) to a person resident outside India under the FDI policy, subject to inter alia, compliance with the pricing guidelines. •The price/ conversion formula of convertible capital instruments should be determined upfront at the time of issue of the instruments.
  • 27.
    FEMA Guidelines toValuation Particulars Valuation before April 21, 2010 Guidelines in Force CCI Guidelines Methods Prescribed Net Assets Value (NAV) Profit Earning Capacity Value(PECV) Market Value (in case of Listed Company) Valuation after April 21, 2010 In case of FDI Transactions: Listed Company: Market Value as per SEBI Preferential Allotment Guidelines Unlisted Company: DFCF In case of ODI Transactions: No method has been prescribed Discount 15% Discount has been prescribed on account of Lack of Marketability No such Discount has been prescribed Historical / Futuristic It is based on Historical Values It is based on Future Projections Possibility of variation As valuation is more Formulae in Value Conclusion based, final values came standardized As valuation is more dependent on Assumptions and choice of factors like Growth Rate, Cost of Capital etc, value conclusion may vary significantly. Note: Valuation guidelines do not apply to SEBI registered venture capital
  • 29.
    Approaches to FDIValuation Discounted Free Cash Flow Method (DFCF)  RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for initial subscription); but has not provided any guidance on its technical aspects. Though DFCF is one of the most acceptable Valuation methods used by Business valuers worldwide; however DFCF for all FDI transactions-excluding for initial subscription (like minority stake/start up valuation etc) may not yield Fair Value in line with the Commercial understanding. However Law being such, suitable Logical adjustments may be necessary on a case to case basis. DFCF expresses the present value of the business as a function of its DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off. cash flow to equity holders, after debt holders have been paid off.
  • 30.
    Major Characteristics ofDFCF Valuation  Forward Looking and focuses on cash generation  Recognizes Time value of Money  Allows operating strategy to be built into a model  Incorporates value of Tangible and Intangible assets  Only as accurate as assumptions and projections used  Works best in producing a range of likely values  It Represents the Control Value
  • 31.
    DFCF Valuation Process Understand Business Model  Identify Business Cycle  Analyze Historical Financial Performance  Review Industry and Regulatory Trends  Understand Future Growth Plans (including Capex needs)  Segregate Business and Other Cash Generating Assets  Identify Surplus Assets (assets not utilized for Business say Land/Investments)  Create Business Projections (Profitability statement and Balance Sheets)  Discount Business Projections to Present (Explicit Period and Perpetuity)  Add Value of Surplus Assets and Subtract Value of Contingent Liabilities
  • 32.
    Free Cash Flows-Value Trend Terminal Value is calculated for the Perpetuity period based on the Adjusted last year cash flows of the Projected period.
  • 33.
    Free Cash Flowcalculation FREE CASH FLOWS Free cash flows to firm (FCFF) is calculated as Taxes EBITDA EBITDA Change in Non Cash Working capital Capital Expenditure Free Cash Flow to Firm Note that an alternate to above is following (FCFE) method in which the value of Equity is directly valued in lieu of the value of Firm. Under this approach, the Interest and Finance charges is also deducted to arrive at the Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows) over the definite period of Cash Flows and also in Perpetuity workings. Theoretically, the value conclusion should remain same irrespective of the method followed (FCFF or FCFE), (Provided, assumptions are consistent).
  • 34.
    Cost of Capitalcalculation DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL WACC (Kd x D) + (Ke x E) (D + E) Where: D = Debt part of capital structure E = Equity part of capital structure Kd = Cost of Debt (Post tax) Ke = Cost of Equity In case of following FCFE, Discount Rate is Ke and Not WACC
  • 35.
    Cost of Equitycalculation DISCOUNT RATE - COST OF EQUITY The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing Model (Mod. CAPM) Mod. CAPM Model ke = Rf + B ( Rm-Rf) + SCRP + CSRP Where: Rf = Yield) B = Ke = Rm= of Risk free rate of return (Generally taken as 10-year Government Bond Beta Value (Sensitivity of the stock returns to market returns) Cost of Equity Market Rate of Return (Generally taken as Long Term average return Stock Market) SCRP = Small Company Risk Premium CSRP= Company specific Risk premium
  • 36.
    Terminal value calculation PERPETUITYFORMULA – Usually comprises a Large part of Total Value and is sensitive to small changes – Capitalizes FCF after definite forecast period as a growing perpetuity; – Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows – Gordon Formula is often used to derive the Terminal Cash (1 + g) Flows by applying the last year cash flows as a multiple of (WACC – g) the growth rate and discounting factor – Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of last year projected cash flows IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation Multiples to the Terminal Year Financials and also doing Scenario Analysis.
  • 37.
    An Insight ofValuationwww.CorporateValuations.in
  • 38.
    SEBI / StockExchange Valuation Guidelines
  • 39.
    Takeover Regulations APPLICABLE LAW: SEBI(Substantial Acquisition of Shares & Takeovers) Regulations, 2011 FREQUENTLY TRADED SHARES Traded Turnover of Shares ≥ 10% [In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)] Method of Valuation 1.Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A. 2.The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks; 3.The Highest Price paid or payable by acquirer or PAC in last 26 Weeks; 4.Volume weighted average Market Price of Shares for a period of 60 trading days HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A. INFREQUENTLY TRADED SHARES Traded Turnover of Shares < 10% [In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)] Method of Valuation 1.Book value, 2.Comparable Trading Multiples; Such other Parameters as are customary for valuation of shares of such companies
  • 40.
    Preferential Issue (1of 3) APPLICABLE LAW: SEBI (ICDR) Regulations, 2009 Equity shares of issuer have been listed on recognized stock exchange for a period of 26 weeks or more as on relevant date Method of Valuation 1.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during 26 weeks preceding the relevant date, or 2.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during 26 weeks preceding the relevant date. HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE
  • 41.
    Preferential Issue (2 of 3) APPLICABLE LAW: SEBI (ICDR) Regulations, 2009 Equity shares of issuer have been listed on recognized stock exchange for a period of less than 26 weeks as on relevant date Method of Valuation 1. The price at which equity shares were issued by the issuer in its IPO or value per share arrived at in a scheme of arrangement under section 391 to 394 of the Companies Act, 1956, pursuant to which the equity shares of the issuer were listed, as the case may be , or 2.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during the period shares have been listed preceding the relevant date, or 3.The average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during 2 weeks preceding the relevant date. HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE
  • 42.
    Preferential Issue (3 of 3) APPLICABLE LAW: SEBI (ICDR) Regulations, 2009 Where equity shares have been issued to promoters / their relatives for consideration other than cash, the valuation of assets in consideration for which the equity shares are issued shall be done by an independent valuer Method of Valuation No Method for Valuation has been prescribed. Valuer Chartered Accountant or a Merchant Banker
  • 43.
    ESOP Accounting Valuation APPLICABLELAW: SEBI (ESOS and ESPS) Guidelines, 1999 If a Company listed on recognised stock exchange in India and issued shares under an ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing model (Black-Scholes or a binomial model) which shall be treated as employee compensation cost for the Company. Method of Valuation Black-Scholes Model Valuer Not Prescribed
  • 44.
  • 45.
    Equity Shares Valuation APPLICABLELAW: Income Tax Act – 1961 and Rule 11UA If Individual, HUF, Firm or *closely held Company receives Equity shares of a closely held Company – Valuation norms shall apply. Method of Valuation Minimum Valuation- Net Asset Value Maximum Valuation- DCF and other methods factoring Tangible and Intangibles Valuer No specific Valuer prescribed for undertaking Minimum Value FCA / Merchant Banker for determining Maximum Value *If a Public Listed Company receives any shares or anyone receives shares of a Public listed Company, valuation norms are not applicable if transaction takes at market price.
  • 46.
    Valuation of sharesother than Equity Shares APPLICABLE LAW: Income Tax Act – 1961 and Rule 11UA If Individual, HUF, Firm or *closely held Company receives shares other than Equity shares of a closely held Company – Valuation norms shall apply. Method of Valuation Price at which such shares will fetch in the open market. Valuer Valuation report to be issued by Merchant Banker
  • 47.
    ESOP Tax Valuation APPLICABLELAW: Income Tax Act – 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT To determine the value of perquisite taxable in hands of employees Method of Valuation No method has been prescribed Valuer SEBI registered category – I Merchant Banker
  • 48.
    Transfer Pricing APPLICABLE LAW: Section– 92 to 92F of Income Tax Act – 1961 and Rule 10A to 10E of Income-tax Rules, 1962 Any International transaction between associated enterprises at ARM LENGTH PRICE Method of Valuation Arm Length Price Valuer Not Prescribed Role of TPO critical. Recent cases deliberating on Valuation aspects
  • 49.
  • 50.
    Registered Valuers Registered Valuers Stock,Shares, Debentures, Securities, Goodwill Financial Valuer Technical Valuer Property Persons eligible to apply for being Registered as Valuer • A Chartered Accountant, • Member of the Institute of Company Secretary or Cost Engineers or Member of Accountant in whole time the Institute of Architects practice or retired member in whole time practice. of Shall have 5 Years of Continuous Experience, Post Qualification Indian Corporate law Service or any other person as prescribed. • A Merchant Banker registered with SEBI and • A person or firm or LLP or which has in employment Merchant under possessing it carrying 20/12/2013 Shall have 5 Years of Continues Experience, Post Qualification CA/CS/CWA out for (signing) Valuation by such qualified persons. Banker both qualifications may act in dual capacity. Registered Valuer to be appointed by Audit Committee or in its absence by the Board of Directors.
  • 51.
    Registered Valuers Registered Valuers (Financial Valuation) Value Responsibilities •Valuer to make impartial, true and fair valuation • Not undertake valuation if directly or indirectly interested • Exercise due diligence • Valuation to be done as per rules Upon contravention • Fine – 25,000 to 100,000 With intention to defraud • Imprisonment upto 1 year and • Fine- 1,00,000 to 5,00,000 Additionally upon contravention, to refund remuneration received and also liable for damages. 20/12/2013 Corporate Valuations – Techniques & Application
  • 52.
    Section wise Requirementof Registered Valuers Section 62(1)(c) – For Valuing further Issue of Shares Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash transactions involving Directors Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a Scheme of Corporate Debt Restructuring Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a Scheme of Compromise/Arrangement, a copy of Valuation Report by Expert, if any shall be accompanied Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the transferor company is a listed company and the transferee company is an unlisted company, for exit opportunity to the shareholders of transferor company, valuation may be required to be made by the Tribunal Section 236(2) – For Valuing Equity Shares held by Minority Shareholders Section 260(2)(c) – For preparing Valuation report in respect of Shares and Assets to arrive at the Reserve Price or Lease rent or Share Exchange Ratio for Company Administrator Section 281(1)(a) – For Valuing Assets for submission of report by Company Liquidator Section 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency under voluntary winding up Section 319(3)(b) – For Valuing the interest of any dissenting member of the transferor company who did not vote in favour of the special resolution, as may be required by the Company Liquidator Section 325(1)(b) – For valuation of annuities and future and contingent liabilities in winding up of insolvent company 20/12/2013 Corporate Valuations – Techniques & Application
  • 53.
    Registered Valuers (DraftRules) – Methods of Valuation I. Before adopting methods, decide Valuation Approach• Asset Approach • Income Approach • Market Approach II. Valuer to consider following points while undertaking Valuation•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 •Contingent Liabilities or substantial legal issues, within India and Abroad, impacting business •Nature of Instrument proposed to be issued, and nature of transaction contemplated by parties 20/12/2013 Corporate Valuations – Techniques & Application
  • 54.
    Registered Valuers (DraftRules) – Methods of Valuation III. Registered Valuer shall make valuation of any asset in accordance with any one or more of the following methodsa.Net Asset Value Method (NAV) b.Market Price Method c.Yield Method / PECV Method d.Discounted Cash Flow Method (DCF) e.Comparable Companies Multiples Method (CCM) f.Comparable Transaction Multiples Method (CTM) g.Price of Recent Investment Method (PORI) h.Sum of the parts Valuation Method (SOTP) i.Liquidation Value j.Weighted Average Method k.Any other method accepted or notified by RBI, SEBI or Income Tax Authorities l.Any other method that valuer may deem fit provided adequate justification for use of suh method (and not any of the above methods) is provided IV. Registered Valuer shall make valuation of any asset as on the Valuation date and in accordance with applicable standards, if any stipulated for this purpose. V. Contents of Valuation report shall contain information as contained in Form 17.3
  • 55.
    Registered Valuers (Forms)– Contents of Valuation report 1) Description of valuation engagement (a) Name of the client: (b) Other intended users: (c) Purpose for valuation: (2) Description of business/ asset / liability being valued (a) Nature of business or asset / liability (b) Legal background (c) Financial aspects (d) Tax matters (3) Description of the information underlying the valuation (a) Analysis of past results (b) Budgets, with underlying assumptions (c) Availability and quality of underlying data (d) Review of budgets for plausibility (e) Statement of responsibility for information received 20/12/2013 Corporate Valuations – Techniques & Application
  • 56.
    Registered Valuers (Forms)– Contents of Valuation report (4) Description of specific valuation of assets used in the business: (a)Basis or bases of value (b) Valuation Date (c) Description of the procedures carried out (d) Principles used in the valuation (e) The valuation method used and reasoning (f) Nature, scope and quality of underlying data and (g) The extent of estimates and assumptions together with considerations underlying them (5) Confirmation that the valuation has been undertaken in accordance with these Rules (6) Further it is certified that valuation has been undertaken after taking into account relevant conditions/regulations/rules/notifications, if any, issued by the Central/State Government(s) from time to time. (i)The valuation report must clearly state the significant assumptions upon which the value is based. When reporting there may be instances, where there are confidential figures, these must be summarized in a separate exhibit (ii)In his valuation report, the registered valuer must set out a clear value or range of values along with the reasoning (ii)In case the valuer has been involved in valuing any part of the subject matter of valuation in the past, the past valuation report(s) should be attached and referred to herein. In case a different basis has been adopted for valuation (than adopted in the past), the valuer should justify the reason for such differences
  • 57.
    Part – C Macro I ssues of V aluation in M ERGERS & A CQUISITION
  • 58.
  • 59.
    Capital Market Valuation Particulars SurplusAssets [including Cash] Excess Debt in Capital Structure Excess Trading Business in Manufacturing Sector Diversified Business Model Excess Business in Subsidiary Company Company Performance [Operating Profits; Net Profits; New Products; Capacity Expansion] Increasing Cash Flows of Business Better Corporate Governance Better Disclosures [Investor, Analysts & Stakeholders Communication] Regular Dividends / Bonus / Buyback Corporate Re-organisation / M&A Joint Ventures / Acquisitions Market Perception 20/12/2013 Corporate Valuations – Techniques & Application Effect Market Cap
  • 60.
    Types and Modesof M &A M&A Mergers Acquisitions NON - COURT PROCESS COURT PROCESS Companies Act Asset Purchase Stock Purchase SEBI [TAKEOVER CODE] (only if Listed Co. is involved) Slump Sale 20/12/2013 Itemized Sale Corporate Valuations – Techniques & Application
  • 61.
    Key Drivers forRe-organization Unlocking of Value and its Sustainability Restatement of Balance Sheet Business clarity to Investors and Analysts Improving Governance Processes Positioning the businesses to be more competitive Making Businesswise Fund raising possible Business Risk Management Stock & Credit Rerating Investor Relations 20/12/2013
  • 62.
    Regulatory aspects undervarious statues Takeover Regulations Competition Commission of India Companies Act, 2013 SEBI and Stock Exchanges Income Tax (DTC) Indirect Tax (GST) FEMA 20/12/2013 Stamp Duty Corporate Valuations – Techniques & Application
  • 63.
    M&A objectives –What it means? Synergies & Economies of Scale Gain access to new markets, customers, products Diversification of Risks Access to New Technology and Knowledge Ability to limit competition / gain market share M&A is primarily driven with motive of achieving Inorganic growth and Synergy i.e. the potential additional value gain from combining two firms, either from operational or financial sources. However, certain studies have shown that most – but not all – M&A fail to deliver value and bridge the price-value gap One of the reasons is that the aggressive promoters in consultation with eager advisors may result in pushing up the acquisition price; Resultantly, the value often get transferred from acquirer’s shareholders to target company’s shareholders; 20/12/2013 Corporate Valuations – Techniques & Application
  • 64.
  • 65.
    Valuation for Merger “Valuationis generally the Starting Point of the M&A process” Judicial Pronouncements; WHETHER VALUATION IS REQUIRED FOR MERGER? In the matter of Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. the Regional Director (RD) raised an objection that no valuation report has been filed and that the exchange ratio for amalgamation has not been worked out by an independent valuer. “The Hon’ble High Court of Rajasthan overruled this objection and sanctioned the scheme of amalgamation by holding that there was no legal or factual impediment to grant sanction to the scheme of amalgamation.” Tool for planning Stamp Duty ? WHETHER ANY VALUATION METHODOLDY IS REQUIRED FOR MERGER? Though there are no specific methodology prescribed for valuation under Merger, however In Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others, Bombay High Court “accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the valuation was based.” 20/12/2013 Corporate Valuations – Techniques & Application
  • 66.
    Valuation for Merger..Contd.. APPLICABLE LAW FOR VALUATION FOR MERGER INVOLVING LISTED COMPANY: 1.Companies Act, 1956 [Section 391- 394]; 2.Fairness Opinion [Clause 24 (h) of the Listing Agreement]; 3.SEBI Notification [CIR/CFD/DIL/5/2013], dated 4 th February, 2013 and 21st May 2013 Circular VALUATION REQUIREMENT UNDER SEBI NOTIFICATION Valuation by independent chartered account mandatory other than those specifically exempted. ''Valuation Report from an Independent Chartered Accountant'' is not required in cases where there is no change in the shareholding pattern of the listed company / resultant company. After the SEBI notification, Valuation by Independent CA is required if shares are issued under the merger and there is change in shareholding pattern.
  • 67.
    Why is therea Mismatch between Buyer & Seller expectations? 1. Differences in Risk Assessment arising from  Company Specific Risk • Management capability • Future Cash Flows  Industry Risk - Business Cycles, Industry Outlook 2. Intangible Asset Valuations 3. Unproductive, high value fixed assets housed in target company 4. Cash and Stock Payout ratio 5. Ability to raise funding on buyer’s or target company’s b/s 6. Estimation of synergies (cost and revenue) Need for Restructuring 20/12/2013 Corporate Valuations – Techniques & Application
  • 68.
    Swap Ratio Valuation • Incase of a merger valuation, the emphasis is on arriving at the relative values of the shares of the merging companies to facilitate determination of the swap ratio – Hence, the purpose is not to arrive at absolute values of the shares of the companies • The key issue to be addressed is that of fairness to all shareholders – This is particularly important where the shareholding pattern and shareholders vary between the two companies • There are established legal precedence for merger valuation methodologies – Valuer’s role is to incorporate case specific factors and use appropriate methodologies so as to determine a fair ratio – Usually, best to give weight ages to valuation by all methods – Market price method and Earnings methods dominate. 20/12/2013 Corporate Valuations – Techniques & Application
  • 69.
    Impact of SwapRatio Valuation • If the exchange ratio is set too high, there will be a transfer of wealth from the bidding firm’s stockholders to the target firm’s stockholders. • If the exchange ratio is set too low, there will be transfer of wealth from the target firm to the bidding firm’s stockholders. 20/12/2013 Corporate Valuations – Techniques & Application
  • 70.
    CASE STUDY Calculation of ExchangeRatio in M&A and Independent Buyer-Seller perspective 20/12/2013 Corporate Valuations – Techniques & Application
  • 71.
    Merger of aUnlisted Power Company into Listed Steel Manufacturing Company Features of Steel Company* o Frequently Traded Listed Company o Low Profit Margin, due to high Power Cost o Running in Low Capacity Utilization due to poor supply of Power Features of Power Company* o Unlisted Company o Company is implementing the Power Plant of 9.5 MW , The Production is expected to start with in Year Acquisition Rationale o Location Advantage, both companies have their unit in same Location o Synergistic benefits- (Captive Power Plant will reduce the Operating cost, because Steel Industry is energy consuming) o Tax benefit from the unabsorbed losses of Power Company o Up the value chain o Capacity utilization will increase in existing steel business, due easy availability of Power 20/12/2013 Corporate Valuations – Techniques & Application *Common Promoter Group
  • 72.
    Merger of aUnlisted Power Company into Listed Steel Manufacturing Company EXCHANGE RATIO & VALUATION –MERGER • Valuation on Steel Company Valuation Method Rs Crores Weights Value of Company Weighted Value Market Cap 2 100 200 Income Method 2 95 190 NAV 1 150 150 Fair Value of Company 108 • Valuation on Power Company Valuation Method Rs Crores Weights Value of Company Weighted Value Market Cap 2 NA NA Income Method^ 2 90 180 NAV 1 50 50 Fair Value of Company 20/12/2013 ^ considering 3 years forward earnings and 80-90% Capacity utilization basis 76.67
  • 73.
    Pre and PostShareholding Pre Merger Shareholding of Steel Company Category Promoter No of shares Independent Perspective % Holding 5,000,000 50% Public 5,000,000 50% Total 10,000,000 100% Pre Merger Shareholding of Power Company Category Promoter No of shares 5,000,000 100% - - 5,000,000 100% Public Total % Holding Post Merger Shareholding of Steel Company Category Promoter No of shares % Holding 12,099,074 71% Public 5,000,000 17,099,074 Valuation of Power business on as is basis – Rs.55 crores Assets Method Earnings Method (Includes premium for the license) Valuation of Power business taking into account synergies – Rs. 70 crores An independent Buyer would bid an amount in excess of valuation on standalone basis (Rs. 55 crores) and below Synergy valuation (Rs.70 crores). 29% Total Buyer-Seller 20/12/2013 Acquisition Price finally depend Corporate Valuations – Techniques & Application negotiations. 100% would on
  • 74.
    Part – D SomeSpecific Tricky Issues
  • 75.
    Tricky issues inDFCF  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.  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.  Projection Validation via-a-vis Industry: Need to have Sanity check of the projections with the trend of the industry.  Beta of Unlisted Company: It is calculated on relative basis by adjusting the average beta of its comparable companies for differences in Capital Structure of the unlisted company with the listed peers.  Risk Free Rate: Yield of a Zero Coupon Bond or Long Term government Bond yield should be taken as the risk free rate since it does not have any reinvestment risk . 20/12/2013 Corporate Valuations – Techniques & Application
  • 76.
    Tricky issues inDFCF (Cont.)  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  Investments: Investments should be valued separately based on their Independent Cash Flows  Surplus Assets: The Value of Surplus Assets (not being utilized for Business purposes) should be added separately and their cash flows should be ignored while computing the Free Cash Flows. Corporate Valuations – Techniques & 20/12/2013 Application
  • 77.
    Discounts Discounts & Premiumscome 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 • Discount for Entity Level Key Person Discount Discount for Contingent Liability Global Studies over the years on diversified Discount for diversified company Discount for Holding Company that companies trade at a discount in the range companies and holding companies has shown of 20%. to 40% each. Tax Payout •Discount for Shareholders Level – Impact on specific ownership interest Discount Lack of Control (DLOC) Discount Lack of Marketability (DLOM) •% stake & special rights DLOM: As per CCI Guidelines, 15% discount has been prescribed; however practically DLOM and DLOC depends upon following factors: 20/12/2013 •Size of distribution or dividends •Dispute •Revenue / Earning – Growth / Stability •Private Company •Shareholders Agreement caveats
  • 78.
    Premium “Beauty lies inthe eyes of the beholder; valuation in those of the buyer” • An investor seeking to acquire control of a company is typically willing to pay more than the current market price Financial Year No. of Transactio ns Median Premium 2006 25 37% 2007 29 20% 2008 38 26% 2009 44 29% 2010 22 31% 2011 42 32% Total 228 30% 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. • Control can be direct (shareholding or Authority to appoint Board) or indirect (veto power, casting vote etc) • Research has shown that the control premium in India has ranged from 20% to 37% in the past few years having median of 30%. 20/12/2013 Corporate Valuations – Techniques & Application
  • 79.
    Excess Cash andNon 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 ? 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. 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. What is an asset is not yielding adequate returns ? 20/12/2013 Corporate Valuations – Techniques & Application
  • 80.
    Cross Holding andInvestments Holdings in other firms can be categorized into: Types of Cross Holding Minority, Passive Investments Meaning 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 Ways to value Cross Holding and Investments: Investment Value By way of Dividend Yield Capitalization or DCF based on expected Agreement dividends Separate Valuation (Preferred) holding 20/12/2013 Corporate Valuations – Techniques & Application Shareholders even may control value less % command
  • 81.
    Accounting Practices andTax issues Most of the information that is used in valuation comes from financial statements. which in turn Accounting are practices 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 20/12/2013 Corporate Valuations – Techniques & Application made on certain considered
  • 82.
    Intangible Valuation Identification ofIntangible 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. 20/12/2013 Corporate Valuations – Techniques & Application
  • 83.
    Intangible Valuation Cont. PurchasePrice 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”; Tangible Assets Consideration paid for acquisition Allocated to Intangible Assets Goodwill 20/12/2013 In Proportion to Fair Value Corporate Valuations – Techniques & Application Balancing Figure
  • 84.
    Private Company Valuation Valuationof Unlisted Company.. Some Data Issues: • 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. 20/12/2013 Corporate Valuations – Techniques & Application
  • 85.
    Company Specific Factors Itis the alignment of Company’s value via-avis to its external environment • Management, Promoter Group • 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 20/12/2013 Corporate Valuations – Techniques & Application
  • 86.
    Valuation Methodologies andValue Impact Major Valuation Methodologies Ideal for Result Net Asset Value Net Asset Value (Book Value) Minority Value Net Asset Value (Fair Value) Control Value Equity Value Comparable Companies Multiples (CCM) Method Price to Earning , Book Value Multiple EBIT , EBITDA Multiple Minority Value Equity Value Enterprise Value Comparable Transaction Multiples (CTM) Method Price to Earning , Book Value Multiple EBIT , EBITDA Multiple Control Value Equity Value Enterprise Value Discounted Cash Flow (DCF) Equity Control Value Firm 20/12/2013 Equity Value Enterprise Value Corporate Valuations – Techniques & Application
  • 87.
    Demerger resulted inincreased shareholders value Reliance Group Market prices (In Rs) Pre demerger Post demerger Reliance Industries 702 698 Reliance Capital Ventures - 23 Reliance Communication Ventures - 292 Reliance Energy Ventures - 43 Reliance Natural Resource “That is what learning is, you suddenly 18 understand something you have understood all 702 your life, but in a 1074 new TOTAL way” …………………………….. Doris Lessing 20/12/2013 Corporate Valuations – Techniques & Application
  • 88.
    Chander Sawhney, VicePresident Corporate Professionals Capital Pvt. Ltd. SEBI registered merchant banker Email : chander@indiacp.com Mobile: 9810557353; Direct: 40622252 www.corporateprofessionals.com; D-28, South Extension, Part-I, New Delhi-110049