International Valuation Newsletter

Transcription

1 International Valuation Newsletter Q2 20 kpmg.at/dealadvisory

2 Dear reader The first few months of 20 gave rise to some remarkable geopolitical events and consequences. First, we were witness to an apparent diplomatic success story in Asia. But then we observed short-sighted introductions of new trade barriers including tariffs and counter-trade reprisals. The latter measures could lead to undesirable trade wars between some of the world s largest economies, generating uncertainty and possibly even a global economic downturn. Besides the capital markets we, of course, followed the FIFA Football World Cup with all its surprising results, stars and stories. A good time to look at the value of football players in the aftermath. In this, our second International Valuation Newsletter of 20, we look back 12 months and present recent capital market data that are pertinent to any valuation analysis in these times of growing disruptions: Major stock market performances: NASDAQ s rally EURO STOXX 600 sector multiples: Recovery in Q2 20 Current risk-free rate Current market risk premium Recent country risk premiums and risk-free rates for the BRICS countries: Lowest risk premiums for China In addition, we share our insights into three topics of use to valuation practitioners: Towards a level playing field: the independent valuation of football players European utilities: valuing companies in a transforming industry Valuing growth and discounting risk: The valuation of start-ups We wish you a pleasant late summer and look forward to discussing with you any questions you might have regarding valuation trends and practices. Yours faithfully Jens Kaden Partner Head of Advisory T jkaden@kpmg.at Klaus Mittermair Partner Head of Deal Advisory T kmittermair@kpmg.at Victor Purtscher Partner Deal Advisory, Valuation T vpurtscher@kpmg.at

3 Towards a level playing field: the independent valuation of football players International Valuation Newsletter Q2/20 3

4 It s over: the FIFA Football World Cup, one of the largest global sporting events that combines big emotions and big business. The question of footballer values following some outstanding performances on the pitch is now of even greater focus for fans and football clubs management teams. KPMG has developed an objective valuation method for football players, which has already been used in practice. KPMG s method for determining the market values of football players supports accounting-based valuations. It also significantly improves the transparency required for the use of innovative financing instruments, and enhances internal asset management. Balance sheet relevance of football players As football clubs and other sports enterprises often have low and in some cases negative equity capital, individual players are hugely important as potential carriers of hidden reserves and liabilities or for establishing an over-indebtedness status. As a result, accounting and valuation play key roles in three particular areas: Internal economics such as for control purposes, determination of transaction prices, and the disclosure of hidden reserves, for instance upon the sale of a player. External economics such as lending and collateralization, leasing, and insurance. Accounting, including impairment tests, examination of overindebtedness status, and conversion to IFRS financial reporting. Due to the impacts on such a broad range of issues, there is a need among all stakeholders for an objective valuation method for football players, given their role as key value drivers with a considerable balance sheet and financial impact. Accounting for football players According to IFRS and many local GAAPs, acquired players represent an intangible asset/value that can be capitalized. This comprises the transfer compensation paid plus related costs such as consulting and brokerage fees. By contrast, nonacquired players are internally produced and ineligible for capitalization. Transfer compensation means that a new club is willing to pay for the economic benefits associated with the player s commitment to the new club. In this context, the capitalized intangible asset value of the transfer fee, transfer compensation or the football player as an asset includes the usage or possibility of utilizing the player and the related cash flow generation, as well as a possible resale. International Valuation Newsletter Q2/20 4

5 The following figure shows the value development over time of the two possible elements of transfer compensation from an economic point of view. The straight-line depreciation of the football player over the term of his or her contract is based entirely on the usage component. The illustration shows that the resale opportunities, which depend on the intrinsic value of the player and market conditions, do not necessarily decline with the usage of the player. A divergence is quite possible and means that one must distinguish between the value of the player from the club s perspective and the value of the player from the player s point of view. Value of player from club s perspective Economically interesting timeframe for exploitation Intrinsic value of player Usage of player Source: KPMG Remaining contract term (in months) International Valuation Newsletter Q2/20 5

6 Valuation of football players from the club s perspective Players must generally be valued according to the same theoretical principles and methods as other assets. In general, values are determined on the basis of historical acquisition and production costs as well as development costs (cost approach), using the discounted cash flow method (income approach) and using different market price methods (market approach). However: The income approach is generally not practicable for team sports, as not all of a club s cash flow such as income from spectators can be broken down to individual player level. The cost approach is also not suitable, as the respective costs cannot be reliably allocated to individual players. A player who has had more training would be worth more than a player with less training. The cost level cannot therefore be a valid criterion for the player s value. This means that in practice, only the market approach is relevant, and is based on historical market prices that have been realized between third parties. By defining criteria or characteristics (e.g. age, playing position, nationality, playing characteristics, weighted performance criteria), similarities can be established in the context of a cluster analysis or a scoring model between the valuation subject (the player) and comparable players for whom a transaction has already taken place in the market. The realized transfer prices of the comparable players must be adjusted to the current market situation. In addition, individual characteristics that affect the value of the player such as long-term injury must be taken into account in the form of discounts or surcharges as well as the individual transfer probability, depending on the remaining term of the contract. The derivation of a value is based on the market approach by forming a representative industry average of observable market prices, thus forming a market consensus on the valuation level of comparable players. The market approach therefore reflects the value concept of a large number of market participants in a large number of transactions and comes close to the valuation principle (within the framework of the market approach). The market approach can lead to distortions in cases where a substantial share of the paid price for a very young player is justified by presumed future potential and not by performance to date. These are players for whom a socalled talent bonus, i.e. an advance on expected future performance and results, has been paid. The chart illustrates this characteristic of future potential without an observable history. Composition of the transfer fee Portion of future potential Portion of past performance Source: KPMG Age of player International Valuation Newsletter Q2/20 6

7 This future potential will only be reflected in future performance. Against this background, a classification on the valuation date based on a scoring model must lead to a very low number of scoring points, although any transfer compensation paid implies a higher value. This does not necessarily mean that the price paid is too high, but that there is a higher risk of realization through the player s future performance. In cases where a talent bonus is paid, clubs tend to award contracts of longer duration in order to participate in realizing the expected performance potential of young players, thereby receiving compensation for potential value increases in the event of a resale. Outlook Players are a central asset for football clubs, not only because of their share of the balance sheet. Related accounting and valuation topics must be seen in the context of transfer regulations and national and international regulations. While uniform standards exist and are applied in practice for accounting for typified assets, the valuation of players is not uniformly implemented. However, the accounting and valuation of players was and always will be an important role in accounting and financing questions of football clubs and associated federations. Industry knowledge is becoming increasingly important for all stakeholders when valuing collateral. The uncertainties on the part of investors and lenders can be actively managed or reduced by football clubs, for example by introducing an objective valuation model for players. The valuation of players was and always will be an important role in accounting and financing questions of football clubs and associated federations. Transfer compensation for an older player, on the other hand, is also paid for his future performance. In this case, however, it is a reflection of the performance he has already demonstrated in the past and therefore focuses more on the usage component than on the resale possibility component. International Valuation Newsletter Q2/20 7

8 European utilities: valuing companies in a transforming industry International Valuation Newsletter Q2/20 8

9 Valuations of utility companies are particularly challenging at the moment. The energy industry is suffering a structural problem whereby integrated energy suppliers must convert their generation plants to renewable energy sources. Investments cannot easily be passed on to customers via higher electricity prices, however. Future prospects and valuations depend on how the regulatory framework develops and which technologies are adopted by utility companies in response. The European energy sector is undergoing a fundamental transformation. The legal framework, regulatory environment, and changes in the competitive landscape are changing business models along the value chain. In light of governmental climate protection goals, this transformation process is likely to take decades. This produces numerous reasons to carry out valuations of utility companies: mergers and acquisitions, profitability analyses, financial controlling, accounting and reporting, capital structure considerations, cash flow forecasts, and insolvency risks, among others. Impacts on capital intensity and profitability The phasing out of nuclear energy in a number of European countries will start soon. This poses various challenges and results in changes how capital-intensive energy businesses will operate in the future. This comes at a time of reduced profitability due to inefficiencies in the subsidy mechanisms for renewable energies. Green electricity with its priority feed-in tariffs is pushing conventional power plants out of the market. New construction projects for conventional power plants are not currently profitable and will not be financed. Companies are responding with cost-cutting programs and by realigning their strategy away from capital-intensive, capital-binding businesses. The aim is to become efficient energy service providers with a balanced generation portfolio and a sales strategy tailored to customers needs. Unfortunately, this leads to lower margins from the generation and sale of energy as companies increasingly advise on energy efficiency and contracting solutions. At the same time there are very few opportunities to pass on the costs of investments to end customers. This results in rising electricity prices. The relevance of value management is reflected in the value adjustments suffered by the industry: since 2009, the industry has lost around EUR 500 billion in market capitalization across Europe. International Valuation Newsletter Q2/20 9

10 Forecast inconsistencies, risk equivalence and scoring models These considerations raise questions regarding the reliability of forecasting and how to deal with uncertainties. Longterm value drivers can be determined only by making assumptions regarding the future regulatory regime and political framework. For example, marginal or full cost calculations must be used when simulating the operating times of a conventional generation plant. The decisive factor is the extent to which a so-called capacity market mechanism 1 compensates for the availability of generation capacities. Many energy suppliers expect such a scenario to be probable. The combination of these considerations leads to a medium to long-term energy mix from which electricity prices as well as operating and financing expenses can be derived. The fact that financing and operation are often separated leads to a lively M&A market. With regard to risk equivalence and the cost of capital, valid comparisons are required. While integrated utility companies of a certain size are listed on the stock exchange and risk parameters such as beta factors can be derived, this is only possible to a limited extent for smaller regional utilities or municipal utilities. Such suppliers often do not have their own generation capacities. Rather, they procure electricity and gas through long-term contracts. The ownership structure and debt capacity also differ from those of large energy companies. In valuation practice, regulatory capital costs are a helpful anchor point in many cases, enabling the risk profile of the entire cash flows to be depicted on the basis of appropriate weighting or scoring considerations. Another aspect with regard to risk equivalence is the cost of capital in renewable energies, especially for new construction projects. The fact that financing and operation are often separated leads to a lively M&A market in each phase of such projects. In addition to operational risks, the individual phases take account of licensing uncertainties, delays, construction risks or financial risks. This lacks a transparent market, again raising the question of whether it is possible to make comparisons against a background of subjective risk appetite and assessment. Here too, scoring models are sufficient to measure and weight risks, allowing their inclusion in the calculation of the project value. This can be done, for example, on the basis of comparable projects such as the observation of project delays. The starting point would be the cost of capital of an operational investment. Utility companies are currently dealing with the question of cost of capital. For all investment decisions, questions can arise as to whether an impairment problem will occur during an impairment test or at what level of sensitivity this could occur. With the extent of transformation in the European markets, and with signs that this will only accelerate, getting to grips with the intricacies of valuation methods in this industry has never been so important. 1 In the capacity mechanism, not the production but the availability of power plant capacity is remunerated. This ensures that sufficient capacities are available even in situations of great scarcity and that no power supply failures occur. The most important characteristic of capacity markets, however, is the goal of (re)investing. For this purpose, investors must be given a certain degree of security through multi-year contracts. International Valuation Newsletter Q2/20 10

11 The valuation of start-ups Valuing growth and discounting risk International Valuation Newsletter Q2/20 11

12 Over the last years Austria has experienced a significant rise of startups in various sectors of the economy. Along these lines the Austrian chamber of commerce estimates that nowadays 500 to 1,000 start-ups are founded each year in Austria representing an important source of growth and innovation. Here, start-ups are regarded as newly established companies with a substantial growth projection operating on an innovative business model or applying a novel technology. Most founders are facing the same challenges when starting their own business ranging from product development and customer acquisition to setting up an efficient organizational structure. However, in almost all cases, raising urgently needed capital in order to finance all these vital activities is a top priority. For this purpose entrepreneurs will have to convince potential investors not only of their unique business idea but also that they will be able to transform it in to commercial success. On the other side, investors have to asses both the potential to succeed and the risk to fail. Thus, the valuation of start-ups profoundly differs from established companies considering the lack of history, missing benchmarks and the inherent uncertainty in terms of future developments. Against this background there is a great variety of different valuation methods specifically tailored for the characteristics of start-ups. However, since the underlying principles of business valuation applies to newly founded as well as to well established companies likewise, we argue not only that the traditional DCF approach can be equally properly applied for valuing startups but also that this approach should be preferred especially by corporate investors. When performing a DCF valuation two parts are essentially needed: on the one hand future cash flows have to be estimated and on the other hand risk adjusted cost of capital have to be determined. In traditional business valuation, the projection of future cash flows can be based on the underlying business plan since it presumably captures future expectations and envisaged developments. Furthermore, cost of capital can generally be derived according to the Capital Asset Pricing Model based on current capital market data. In start-up valuation, in order to account for the idiosyncratic risk and uncertainty, the projection of cash flows can be flexibly adapted by incorporating a probabilistic scenarios analysis of possible future outcomes: In practice two scenarios - eg management case and insolvency case - can be simulated and subsequently weighted according to the ascribed probabilities. Here, survival and default rates based on empirical studies can present valuable reference points. Based on this approach the resulting range will factor in not only the potential of future success but also the possibility of failure and therefore transparently represent the start-up s value. Especially in the case of corporate venture capital the presented approach can be advantageous compared with alternative methods. Firstly, since the approach fully complies with national as well as international valuation standards and guidelines it also meets tax and legal requirements that are relevant for corporations. Secondly, other than methods such as the Berkus-Method, the Scorecard- Approach or the Risk-Factor-Summation, the presented approach is based on transparent assumptions and projections that can be intersubjectively assessed as required by corporations in respect to the internal decision making process. Nonetheless, critics might argue that the DCF approach can principally not be applied for start-up valuations since it lacks the flexibility and capacity to account for the risk inherent in venture capital. However, considering that the commonly suggested alternatives such as the Venture Capital Method or the First Chicago Method are just another adaption of the DCF approach and that by applying the scenario analysis the risk of default will also be considered, this argument can easily be dismissed. In addition, the DCF approach is often criticised for requiring an integrated business plan as a basis for the valuation and that such a plan won t be available in case of a typical startup enterprise. Again, not only that most of the non-traditional valuation methods will also base their calculation on any future projection of the envisaged business development, but a consistent and comprehensive business plan can be regarded as a major prerequisite for raising capital in the first place. More than that, it will serve as a valuable tool for entrepreneurs in guiding and steering the young company. Against this background we developed a specific valuation model for start-ups based on the presented DCF approach and scenario technique. With this established model we supported our clients in analysing the potential and the risk of the targeted start-up and thus understanding the true value of their venture. As y Meeker, former managing director of Morgan Stanley, once claimed: the true value of an enterprise is the present value of future cash flows, always has been, always will be, we are convinced that as this was true during the time of the dot.com bubble - when she made the claim it is equally true as of today. International Valuation Newsletter Q2/20 12

13 Capital market data International Valuation Newsletter Q2/20 13

14 In this section we provide a selection of key financial market data, covering: Comparison of major stock market performances for the 12 months ending e 20 EURO STOXX 600 sector multiples Current risk-free rate Current market risk premium Recent country risk premiums and risk-free rates for the BRICS countries Major stock market performances: NASDAQ s rally The NASDAQ Index performed extremely well over the past 12 months, at +22.3%. The S&P 500 Index (+12.2 percent) and the Nikkei 225 Index (+11.3 percent) also demonstrated outstanding performances with double-digit growth rates. European stock indices clearly lagged behind their counterparts in other parts of the world, however. For example, the Spanish Ibex 35 and the Swiss SMI even demonstrated negative growth rates over the past 12 months, with the Ibex 35 closing at minus 7.9% and the SMI at minus 3.3%. The FTSE 100 Index outperformed its peers globally by posting quarterly growth of 8.2% in Q2 20, followed by NASDAQ s growth of 6.3% in the same quarter. The two major indices that performed negatively in Q2 20 were the MSCI Emerging kets Index at minus 8.7% and the SMI Index at minus 1.5% although the MSCI Emerging kets Index performed positively overall during the past 12 months. Performance of leading indices e 20 e % Index performance (%) 1.1% 9.0% 5.8% 2.4% 0.1% 8.2% 4.4% 1.7% 4.0% 3.0% 0.2% 2.9% 12.2% 6.3% 5.4% 11.3% (0.2)% (1.5)% (3.3)% (8.7)% (7.9)% MSCI World MSCI Emerging kets STOXX Europe 600 FTSE 100 DAX CAC 40 Ibex 35 SMI S&P 500 NASDAQ Nikkei 225 QoQ YoY Source: Capital IQ, KPMG analysis International Valuation Newsletter Q2/20 14

15 EURO STOXX 600 sector multiples: Recovery in Q2 20 The enterprise value (EV) multiple states the market value of the business in relation to an appropriate base metric. Commonly used EV multiples are revenue and EBITDA. The numerator (EV) and denominator (revenue, EBITDA) represent all investor claims on the business. European stock indices clearly lagged behind their counterparts in other parts of the world. The Euro STOXX 600 sector overview of trading multiples showed no significant outliers or other extremes based on EV/ revenue and EV/EBITDA in Q2 20 compared to Q1 20. However, quite a few sectors recovered in Q2 20 compared to Q1 20 and again reached Q4 20 multiple results. 1 Consumer Discretionary Median.0x 15.0x 12.0x 9.0x 6.0x 1.7x 1.8x 1.8x 1.8x 10.7x 10.2x 9.8x 1 EV/EBITDA 2 Consumer Staples Median.0x 15.0x 12.0x 13.1x 12.7x 11.8x 12.1x 9.0x 6.0x 2.4x 2.2x 2.2x 2.2x EV/EBITDA Energy (Oil and Gas) Median.0x 15.0x 12.0x 9.0x 6.0x 1.1x 1.2x 1.1x 1.2x 7.7x 7.9x 7.7x 8.0x EV/EBITDA Note: 1 The sector Consumer Discretionary contains goods and services that are considered non-essential (but desirable) by consumers. Note: 2 The sector Consumer Staples contains essential goods and services, such as food, beverages, household items or tobacco. International Valuation Newsletter Q2/20 15

16 Financials Median 1 Healthcare Median 2.0x 1.7x 1.8x 1.5x 1.4x 1.2x 1.2x 1.1x 1.1x.0x 15.0x 12.0x 9.0x 15.5x 14.8x 14.5x 15.0x 1.0x 6.0x 3.6x 3.6x 3.5x 3.8x P/B EV/EBITDA Industrials Median Information Technology Median.0x 15.0x 12.0x 12.2x 11.7x 11.4x 11.6x.0x 15.0x 12.0x 16.4x.1x 14.6x 16.5x 9.0x 9.0x 6.0x 1.6x 1.6x 1.4x 1.4x 6.0x 4.4x 4.2x 3.9x 3.8x EV/EBITDA EV/EBITDA Materials Median Telecommunication Services Median.0x.0x 15.0x 15.0x 12.0x 9.0x 6.0x 1.6x 1.7x 1.6x 1.6x 9.9x 9.6x 9.9x 9.9x 12.0x 9.0x 6.0x 2.2x 2.3x 2.4x 2.2x 8.8x 8.7x 7.7x 7.5x EV/EBITDA EV/EBITDA Utilities Median.0x 15.0x 12.0x 9.0x 6.0x 1.6x 1.7x 1.6x 1.5x 9.9x 1 8.1x 9.3x Source: Capital IQ, KPMG analysis Note: 1 Financial services companies differ from many other companies in how they operate. Debt acts more like raw material than operational capital for financial services companies. A common valuation metric used by analysts evaluating such firms is the price to book (P/B) ratio. EV/EBITDA International Valuation Newsletter Q2/20 16

17 Risk-free rate: Stabilization of the interest rate? The risk-free rate can generally be broken down into two key components that seek to compensate the investor: the first for expected inflation and the second for deferred consumption. The risk-free rate is considered to be free of risks except for risks embedded in the underlying currency and risks related to investments in the particular country (including general political, legal, regulatory and tax risks, as well as the risk of a moratorium). As no investment is truly risk-free, the risk-free rate is typically approximated by reference to the yield on long-term debt instruments issued by presumably financially healthy governments. As a risk-free rate we recommend to use the spot-rate of zerobonds, denominated in Euro with a maturity of years applying the Svensson-yield curve and data from Deutsche Bundesbank, as of the valuation date. This approach is also in conformity with the Austrian Professional Guidelines for the Valuation of Businesses (KFS/BW 1). The graph below summarizes the development of the above mentioned riskfree rate (zerobonds) over the past two years. There was a slight decline in the risk-free rate in Germany (as well as in the other Eurozone countries) in the first months of 20. As of 29 e 20 the risk-free rate ( year spot-rate of German zerobonds) was 1.12 percent, as of July percent. Risk-free-rate - Y spot rate ( Jul 20) Source: Deutsche Bundesbank, KPMG Analysis International Valuation Newsletter Q2/20

18 ket risk premium According to the new recommendation of the Expert Group on Business Valuation of the Austrian Chamber of Tax Advisors and Auditors, the market risk premium should be based on (implied) market returns. The Expert Group recommends a range for the expected market return between 7.5 percent and 9.0 percent. The market risk premium should be consistent with the current level of the market return and the current level of the risk-free rate. In light of the low level of the risk-free rate (see above) and our models on the current level of implied market returns, we currently recommend to use a market risk premium of 7.25 percent for the Austrian capital market as of e 20 as well as of July 20. The table below summarizes our recommendation for the risk-free rate (going concern case), the corresponding market risk premium and the resulting market return for the past six months in Austria. The mentioned parameters are a recommendation for valuations within the Austrian market. Recommended risk-free rate and market risk premium Date Implied market return Risk-free rate Implied MRP Recommended MRP Feb 28, 20 8,27% 1,36% 6,91% 7,00%, 20 8,% 1,24% 7,08% 7,00% Apr, 20 8,33% 1,% 7,03% 7,00% May, 20 8,73% 1,% 7,56% 7,25%, 20 8,52% 1,12% 7,40% 7,25% Jul, 20 8,91% 1,15% 7,76% 7,25% Source: Expert Committee on Business Administration and Organization of the Institute for Business Economics and Organization, Thomson-Reuters, CIQ, Deutsche Bundesbank, KPMG Analysis Note: 1: We adjusted the approach how the consensus estimates regarding future dividends and earnings are retrieved in July 20 resulting in a smaller data pool and a higher implied market return. Note 2: A theoretical market return (calculated by the recommended MRP plus the risk-free rate) is a calculated figure representing the underlying assumption by applying the mentioned risk-free rate and market risk premium. The observed implied market return is different to this figure due to rounding and by smoothing of market movements to protect from short-term fluctuations. Country risk premium in the BRICS countries The country risk premium is a measure of risk faced by businesses when investing in sovereign states. It reflects a number of risks including economic, financial, political and institutional. The country risk premium is effectively the risk of low probability, high impact events that could lead to significant losses in investment values. These types of risk are at the forefront of many investors thinking now more than ever due to a number of major economic and geopolitical events such as the Eurozone sovereign debt crisis and events in the Middle East and North Africa, all of which have led to previously stable countries becoming much riskier. KPMG s Valuation practice has been analyzing and measuring country risk for 15 years and covers more than 150 sovereign states in a proprietary KPMG analyst model. Our recommendations for the riskfree rate ( year spot-rate of German zerobonds plus inflation difference of the respective country compared to Germany) and the country risk premiums for Brazil, Russia, India, China and South Africa are set out below as of e 20. The country risk premium for China is substantially lower than that for Brazil, Russia, India or South Africa. Higher inflation rates are expected for Brazil, Russia, India and South Africa compared to China. Recommended risk-free rate and country risk premium e, 20 Risk-free rate Country risk premium Brazil 3,22% 3,60% Russia 3,32% 2,85% India 4,32% 2,70% China 1,82% 1,20% South Africa 4,72% 4,05% International Valuation Newsletter Q2/20

19 KPMG Advisory GmbH Porzellangasse Wien Kudlichstraße Linz Jens Kaden Partner, Head of Advisory T jkaden@kpmg.at Klaus Mittermair Partner, Head of Deal Advisory T kmittermair@kpmg.at Victor Purtscher Partner, Deal Advisory, Valuation T vpurtscher@kpmg.at kpmg.at/dealadvisory The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received, or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. The scope of any potential collaboration with audit clients is defined by regulatory requirements governing auditor independence. 20 KPMG Advisory GmbH, Austrian member of firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Austria. KPMG and the KPMG logo are registered trademarks of KPMG International. All rights reserved.