BUSINESS VALUATION

1
BUSINESS VALUATION

• A quantitative representation of monetory values
  inherent in a business/enitity, built by the past
  efforts, capable of generating economic benefits
  in the future.
• Enteprise value is the value of the financial
  instruments representing the ownership interests
  in an entity plus net financial debt of the
  enitity
• Fair value is an amount for which an asset could
  be
• exchanged between willing and knowledgable
  parties in an arms length transaction.
• Value of an entity is a sum of parts of a
  business together adding up resulting the streams
  of economic returns and value of an enterprise
  can be more than sum of parts.

2
Value defined

• Depends on who is asking and why
• Generally an economic concept where what a buyer
  is willing to pay and what a seller is willing to
  take overlap
• Implies transferability
• Implies it is agreeable to both parties
• In the real world it is a range, not a point

3
VALUATION

• Part art, part science
• A process to arrive at an estimate of value for a
  company involving
• An analysis of the economic environment
• An analysis of the industry
• An understanding of the historical, current and
• future operations of the company
• An analysis of the financial history and
• prospects of the company and
• Applying acceptable valuation methods

4
Why valuation?

• Transaction pricing
• (mergers, acquisitions)
• Privatization/post privatization
• Financing
• Tax and audit support
• ESOPs
• Management buyouts
• Joint venture
• investments
• Bankruptcy,
• reorganization and restructuring
• Allocation of purchase price
• Litigation
• Planning
• Value based management
• Other

5
Value Creators?

• Cash Flow
• Investors assign value based on the cash flow
• they expect to receive in the future
• Dividends/distributions
• Sale or liquidation proceeds
• The value of a cash flow stream is a function of
  The timing of cash receipts
• The risk that less cash than expected will be
  received

6
WHAT CREATES Contd.)

• Assets
• Operating assets
• Those assets used in the operation of the
  business including working capital, property,
  plant and equipment and intangible assets
• The value of operating assets is generally
  reflected in the cash flow generated by the
  business
• Non-operating assets are those assets not used in
  the operations including excess cash balances,
  and assets held for investment purposes, such as
  vacant land and securities
• Non-operating assets are generally valued
  separately and added to the value of the
  operations

7
How value is measured?

• Income approach
• Estimates value based on the present value of
  future earnings or cash flow
• Asset approach
• Estimates value based on the fair market value of
  the business assets less the fair market value
  of its liabilities
• Market approach
• Estimates value based on the market price of
  similar companies

8
What is measured?

• THE VALUATION BALANCE SHEET
• TOTAL ASSETS
• CURRENT
• ASSETS
• PLANT,
• PROPERTY EQUIPMENT
• OTHER ASSETS
• INTANGIBLE ASSETS
• INVESTED CAPITAL
• EQUITY
• CURRENT LIABILITIES
• LONG TERM DEBT
• OWNERS EQUITY
• Market, Not Book Basis

9
Standards of value

• Value, like beauty, is in the eyes of the
  beholder
• Purpose determines standard
• Three common standards of value
• Fair market value
• Investment value
• Liquidation value

10
Fair Market Value

• The amount at which property would change hands
  between a willing seller and a willing buyer when
  
• neither is acting under compulsion and when both
  have reasonable knowledge of the relevant facts
• Fair market value encompasses
• Hypothetical cash exchange price
• A willing buyer and a willing seller
• Both parties being knowledgeable of the relevant
  facts
• Neither party acting under compulsion
• Typically used in compliance-related assignments

11
Investment Value

• The specific value of goods or services to a
• particular investor (or class of investors) for
• individual investment reasons
• The value to a particular investor
• Based on that investors requirements and
• expectations, including potential synergies
• Can include psychological factors, the joy of
  ownership or the value of a long tradition of
  family ownership

12
Liquidation Value

• The net amount the owner can realize if the
  business is terminated and the assets sold off
  piecemeal
• The seller is compelled to sell
• The time frame is either immediate (forced
  liquidation) or with adequate exposure to the
  market (orderly liquidation)
• Implies the business is worth more dead than
  alive

13
Liquidation value (contd.)

• Considers the costs incurred to sell the assets
  and shut down operations, such as brokerage
  commissions and severance
• Businesses are typically valued under the
• premise of a going concern (i.e., the business is
  a viable operating entity and the assemblage of
  assets contributes to the value)

14
Financial Analysis

• Importance to the valuation analysis
• Key factor in assessing the risk of investing in
• the business
• Provides a basis to analyze trends and identify
  unusual items for further analysis
• Provides a basis for developing a reasonable
  forecast or estimate of normalized earning power
• Provides a basis for comparison to industry data
  or similar company data
• Key factor in selecting the appropriate valuation
  multiple in the market approach

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F A -contd

• The process
• Financial statement adjustments to normalize
  financial position and performance
• Ratio analysis asset management, leverage,
  liquidity, and profitability
• Common size balance sheets and income statements
• Comparison to industry financial data
• Analysis of trends and unusual items

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F A

• Ratio analysis
• Asset management ratios
• A measure of how efficiently assets are being
  used including total assets, inventory and
  receivables
• Leverage ratios
• The ability of the company to pay its debt
  obligations
• If there is incremental risk because of excessive
  debt
• Whether there is any additional debt capacity
• Liquidity ratios
• The ability of the company to pay its current
• obligations
• If the company has adequate working capital

17
F A

• Ratio analysis
• (contd)
• Profitability ratios
• The ability of the company to convert sales into
  profit
• The return earned on assets
• The return provided to investors
• Common size balance sheets and income
• statements provide a basis for trend and
  comparative analysis

18
F A

• Comparison to industry
• Provides a measure of the companys financial
  performance and condition relative to its peers
• Common size balance sheets
• Common size income statements
• Ratio analysis
• Productivity statistics, such as sales per
  employee

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F A

• Conclusion key factors to consider
• Focus on the issues affecting the value of the
  company
• Are any adjustments required to reflect the true
• earnings potential of the company?
• Is the overall trend in the business (sales,
  profits, etc.) improving, stable or declining?

20
F A

• Does the company have adequate liquidity? Is
  working capital well-managed?
• Does the company have too much debt? Does the
  company have the ability to borrow in the future
  if needed?
• Are the returns on equity acceptable?
• Is asset utilization acceptable?
• Are there any non-operating assets?

21
F A

• How does the company compare with the industry?
• Your conclusions are a key factor in
• Assessing the risk of investing in the company
• Developing forecast assumptions for the company

22
INCOME APPOACH
23
INCOME APPROACH

• Key inputs to income approach
• The required rate of return
• The estimate of future cash flow or
• normalized earnings
• An estimate of normalized expected earnings is
  capitalized based on the required
• rate of return and growth prospects

24
Discounted Cash flow

• Theoretically correct method
• Based on future cash flows
• Considers the timing of cash flows
• Potentially dangerous
• Reasonable inputs, unreasonable results
• Easily manipulated
• Not directly linked to market
• Typically gives a control value

25
D C F

• Forecasting revenues
• Revenue forecast considerations
• Forecasting units and prices, or overall growth
• Production capacity
• Impact of capital investment
• What growth will the buyer pay for?
• Historical growth
• The economic outlook
• The outlook for the industry, including
  competition
• Demand for the product
• Expected product price increases
• Product mix
• Management plans

26
D C F

• Steps
• Analyze capital requirements and prepare a
  forecast
• Calculate cash flow for each year
• Determine the appropriate discount rate
• Calculate the terminal value
• Calculate the present value of the future cash
  flows and
• terminal value and sum
• Make any final adjustments
• Perform review procedures

27
Discounted Cashflow

• VALUATION DATE
• FORECAST PERIOD
• Years one through ..n
• Represents the value of all cash flows beyond the
  forecast period
• TERMINAL PERIOD
• TERMINAL VALUE

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Discounted Cashflow

• Terminal value analysis
• The discrete forecast period ends when cash flows
  have stabilize
• stabilized and expected growth is moderate and
  sustainable
• Methods of calculating terminal value include
• Gordon Model
• Assumed Sale
• Gordon Model assumes continued ownership of
  business
• The Assumed Sale method is based on a multiple of
  a measure of financial performance applied at the
  end of the forecast period
• Key assumptions for the Gordon Model
• Depreciation and capital expenditures should be
  equal or at a steady state differential in the
  residual period
• Forecast period should be as long as necessary
  for a stable level of growth to be achieved the
  terminal period must assume a long-term stable
  growth rate

29
D C F

• Discount rate analysis
• Since the cash flow forecast is based on
  debt-free cash flows the
• Weighted Average Cost of Capital (WACC) must be
  used to discount
• the future cash flows
• The WACC is based on
• The cost of equity and debt for the industry or
  firm, and
• The proportion of the firms capital structure
  comprised
• of equity and debt
• WACC Ke ( equity) Kd ( debt)
• Where
• Ke Required rate of return on equity capital
• equity equity as a percent of total
  capitalization
• Kd after tax required rate of return on debt
  capital
• debt debt as a percent of total capitalization

30
Discounted Cashflow(contd)

• Cost of equity - capital asset pricing model
• Formula Ke Rf ß(Rm-Rf)
• Where
• Ke the investors required rate of return
  (equity)
• Rf the risk free rate
• ß beta
• Rm return from the equity market
• Rm-Rf the market premium
• In addition to these variables, there are
  adjustments to
• consider in applying this method to closely held
  companies
• Small company risk
• Specific company risk

31
Discounted Cashflow

• Components of CAPM
• is the risk free rate, either nominal or real. It
  is typically the yield from long-term government
  bonds
• It represents an alternative rate of return to
  the investor
• that is risk-free and has liquidity
• Beta is a risk measure that is based on the
  volatility of the
• price of the shares of a company compared to the
  volatility of
• the market as a whole
• A company whose share price is volatile has more
  risk
• for an investor. Thus, the higher the beta, the
  higher the
• risk
• Betas are typically calculated for an industry to
  provide a to provide a
• measure of risk for that particular industry

32
D C F

• Cost of debt
• Typically based on industry data
• Should be a long term rate to match the DCF
  horizon
• Should be calculated after tax since interest is
  tax
• Should be calculated after tax since interest is
  tax
• deductible
• Formula
• Formula
• Kd D(1-t)
• Where
• Kd after tax required rate of return on debt
  capital
• D debt holders required return on debt
• t corporate marginal tax rate

33
D C F

• Capital structure
• Typically based on industry data
• Should be based on market value
• As a practical matter debt is often considered at
  face value

34
Discounted Cashflow

• Review procedures
• Math check/peer review
• Reasonableness checks
• Compare forecast revenue growth to forecast
  industry growth
• Compare forecast margins to historical
• Compare forecast margins to similar companies
• Compare old forecasts to actual results
• Compare old forecasts to current forecasts for
  the same period
• Calculate valuation multiples implied by DCF
  results and compare
• to industry or overall market multiples

35
ASSET APPROACH

• Asset based methods
• Discrete revaluation of assets and liabilities
• Collective revaluation of assets and liabilities
• Value is based on fair market value of assets
  less fair market value of liabilities

36
ASSET APPROACH
37
Asset Based

• Asset based methods are primarily used for
  holding companies or if liquidation is a
  consideration. They have limited applicability
  for operating entities
• Other situations where asset approach may apply
  include companies with significant tangible
  assets and start ups

38
Asset Based

• Steps to Discrete Revaluation Method
• Obtain balance sheet as of valuation date
• Restate balance sheet for accounting adjustments
• Restate financial assets to net realizable value
• Appraise and record tangible property at fair
• market value
• Identify, value and record intangible assets
• Restate liabilities to current value and add any
• unrecorded liabilities
• Calculate equity value by subtracting current
• value of all liabilities from FMV of total assets

39
Asset Valuation

• Valuation of tangible assets
• Valuation of real estate and improvements
• Based on cost, market and income approaches
• Considers highest and best use of the property
• Should be performed by a qualified real estate
  appraiser
• Valuation of machinery and equipment
• Based primarily on cost and market approaches
• Consideration should be given to physical
  depreciation and to
• the functional, technical and economic
  obsolescence that may exist in the business
• Should be performed by a qualified equipment
  appraiser

40
Asset Valuation

• Liquidation analysis should be considered when
  the value of the business, on a control basis as
  determined by the income or market approaches, is
  Low relative to the net asset value
• Application of the liquidation approach must
  consider the expenses associated with
  liquidation, including taxes, selling expenses
  and plant closing costs, and the risk and timing
  related to the procee

41
Market Approach and Reaching a Conclusion
Market Approach and
Reaching a Conclusion
42
MARKET APPROACH

• Valuation multiples, such as price/earnings
  ratios, are the basis of the valuation
• Valuation multiples are adjusted for differences
  between the subject and similar public companies
• or mergers and acquisitions (MA) activityRisk
  factors - size, operating performance, other
  Growth Prospects

43
M A

• Key Inputs
• Selection of Similar Companies/Transactions
• Publicly Traded Companies
• MQA Transactions
• Adjustment to Multiples
• Controllability Discounts
• Lack of Marketability Discount

44
M A

• Public companies - based on prices paid for
  shares of similarcompanies traded in the public
  market
• Merger acquisition (MA) activity - based on
  prices paid for
• acquisitions of controlling interests in similar
  companies Level of value must be analyzed. Do
  public company multiple
• key advantage of market approach is that it is
  based on actual
• transactions
• Key disadvantage is difficulty in finding similar
  public companies and MA transactions

45
M A

• Steps
• Selection of similar public companies and
  transactions
• Financial analysis and comparison
• Selection and calculation of valuation multiples
• Application to the company being valued
• Final adjustment

46
Market Approach

• valuation multiples, such as price/earnings
  ratios, are the basis of the valuation
• Valuation multiples are adjusted for differences
  between the subject and similar public companies
• or mergers and acquisitions (MA) activity
• Risk factors - size, operating performance, other
  Growth Prospects

47
M A

• Key inputs
• Selection of similar companies and transactions
• Publicly traded companies
• MA transactions
• Adjustments to the multiples viz Control Premium
  and Lack of Marketability Discount

48
CONCLUSION

• Final adjustments
• The value of non-operating, or excess assets,
  must be added to the value of the business
  operations as determined by market approach
• Consideration should be given to significant
  working capital differences
• Consideration should be given to environmental
  liabilities and other contingent liabilities
• Debt must be subtracted from the results of
  applying enterprise value multiples to arrive at
  the value of equity

49

• Selecting the final value
• Subjective weighting
• Mathematical weighting
• Professional judgement
• In mathematical weighting specific weights are
  assigned to each approach and the weighted
  average calculated
• In professional judgement the conclusion is
  based on
• experience and judgment given the quality of
  information and the approaches applied
• Both methods require subjectivity since the
  weights selected in mathematical weighting are
  subjective

50
THE FINAL TEST IS COMMON SENSE AND
REASONABLENESS.Thank YOU
51
M A

• Selection of guideline companies and
  transactions
• Management
• Identification - SIC code and key words
• Data sources
• Business similarity
• Similar industry and products
• Maturity of operations
• Geographic considerations
• Size considerations
• Operating strategies
• Financial characteristics (profitability, growth,
  etc.)
• Trading characteristics
• Volume
• Share price trends
• What is an appropriate sample size

52
M A

• Comparable company and transaction analysis
• Gather appropriate data - SEC filings, analyst
  reports,
• press releases, etc...
• Comparative analysis is used to benchmark the
  company
• against similar companies or transactions in the
  areas of
• asset management, leverage, liquidity,
  profitability, risk
• and growth
• The company can be compared to individual
  companies, or to an average for the industry
• Adjustments may be required to place companies on
  a Comparable basis

53
M A

• Selection and calculation of the valuation
  multiples
• Market Value of Invested Capital to earnings
  before interest,
• taxes, depreciation, and amortization
  (MVIC/EBITDA)
• Application results in enterprise value
• To arrive at equity value, interest bearing debt
  must be
• subtracted
• Other common MVIC multiples include MVIC/Revenue
  and
• MVIC/EBIT
• Price-to-earnings (P/E) ratio application
  results in the value of
• the equity. Sometimes used with pretax earnings
• Price-to-book value application results in the
  value of the equity,
• but is based on net asset value rather than
  earnings or cash flow

54
M A

• Selection and calculation of the valuation
  multiples
• The multiples applied to the company are based on
  the
• relative risk and growth assessment versus the
  companies
• Multiples should show a pattern of correlation
  with measures of cash flow across comparables

55
M A

• Application to the subject company
• multiples should be applied to the appropriate
  financial data of
• the subject company
• consistent with the way the multiple for the
  public companies
• or transaction was calculated
• A price-to-pretax earnings ratio should not be
  applied to
• pretax earnings ratio should not be applied to
• the after tax earnings of the company being
  valued
• In some cases, multiples are calculated based on
  an
• average of several years the multiple should be
  applied
• to the average of the same period for the company
  being valued

56
M A

• Final adjustments
• The value of non-operating, or excess assets,
  must be
• added to the value of the business operations as
• determined by market approach
• Consideration should be given to environmental
  liabilities
• and other contingent liabilities
• Debt must be subtracted from the results of
  applying
• enterprise value multiples to arrive at the value
  of equity
• enterpri

57
M A

• Comparable company and transaction analysis
• Gather appropriate data - SEC filings, analyst
  reports,
• press releases, etc...
• Comparative analysis is used to benchmark the
  company
• Comparative analysis is used to benchmark the
  company
• against similar companies or transactions in the
  areas of
• against similar companies or transactions in the
  areas of
• asset management, leverage, liquidity,
  profitability, risk
• and growth
• The company can be compared to individual
  companies,
• The company can be compared to individual
  companies,
• or to an average for the industry
• Adjustments may be required to place companies on
  a comparable basis

58
M A

• Application to the subject company
• multiples should be applied to the appropriate
  financial data of the subject company
• consistent with the way the multiple for the
  public companies or transaction was calculated
• A price-to-pretax earnings ratio should not be
  applied to
• the after tax earnings of the company being
  valued
• In some cases, multiples are calculated based on
  an average of several years the multiple should
  be applied to the average of the same period for
  the company being valued