Introduction to Valuation

Transcription

1 Introduction to Valuation Romesh Vijay CA, ICAI Certified Valuer

2 Contents Introduction Overview of Methods Used Case Studies Relative Method of Valuation

3 Introduction Valuer A valuer is a fellow who lends you an umbrella when the sun is shining, but wants it back the minute it begins to rain..mark Twain Value The monitory worth of something. Valuation 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.

4 Who can do valuation??? (Valuation Rules, Companies Act 2013) Currently Chartered Accountants Merchant Bankers Going forward Only a Registered member of the regulatory body. Who all can be a member of regulatory body? Member of professional institute Graduate with 5 years of experience Post graduate with 3 years of experience

5 Chartered Accountants and Valuation We are not new to valuation Only the principles and basis of valuation changes CA s most aptly suited for business valuations Our understanding of businesses across multiple industries Our intricate knowledge of financials and its interlinkage to businesses across industries

6 Why Valuation??? Transactions- Decision Making Accounting Regulatory Mergers Acquisitions/ Investments Fund Raising Sale of Businesses Voluntary Assessment Fair Value (Ind AS) ESOP Purchase Price Allocation Impairment/ Diminution Income Tax SEBI RBI Stock Exchanges Companies Act Courts/ CLB

7 Valuation Approaches 01 Income Based Capitalization of Earnings Method (Historical) Discounted Cash Flow Method (Projected Time Value) Asset Based Book Value Method Liquidation Value Method Replacement Value Market Based Comparable Companies Market Multiple Method (Listed Peers) Comparable Transaction Multiples Method (Unlisted Peers) Other Contingent-Claim Valuation (Option Pricing) First Chicago Method Venture Capital Rule of Thumb Fundamental Methods Relative Method Other Methods

8 Turnover / Profits STAGES OF DEVELOPMENT Growing Companies Turnover / Profits : Increasing still low Proven Track Record : Limited Method of Valuation : Substantially on Business Model Cost of Capital : Quite High Start-Up Companies Turnover / Profits : Negligible Proven Track Record : None Method of Valuation : Entirely on Business Model Cost of Capital : Very High TIME Mature Companies Turnover / Profits : Saturated Proven Track Record : Widely Available Method : More from existing assets Cost of Capital : May be high Declining Companies Turnover / Profits : Drops Proven Track Record : Substantial operating history Method of Valuation : Entirely from existing assets Cost of Capital : N.A. High Growth Companies Turnover / Profits : Good Proven Track Record : Available Method of Valuation : Business Model with Asset Base Cost of Capital : Reasonable

9 SUITABLE METHODS OF VALUATION Methods START Up RAPID EXPANSION HIGH GROWTH MATURE GROWTH DECLINE Income Approach Discounted Cash Flow (DCF) Market Based EBIDTA Multiple Sales Multiple Cost Based Cost to Date Net Assets / Liquidation Value

10 CASE STUDIES

11 The client is a auto component player incurring losses for past 2-3 years. Apart from inventory, it has a large piece of land on a prime location in NCR. As per latest annual filings, the business follows a going concern assumption and the management neither has any intention to shut down its operations nor there is any foreseeable certainty for the same. Considering current circumstances the value of business as per DCF method is half the current market value of its land holding. Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

12 The client is a new player in the real estate sector who wants to develop luxury apartments in Bangalore. It acquired a large piece of land on super prime location in one of Bangalore. The development activity was in full swing and around 30% work has been completed when state government announced Metro line to be passed through the middle of this project. The 40% of the land was compulsorily acquired by the government at a significantly lower price. The existing project design cannot be executed in these circumstances. Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

13 The client is solar power project owner and has entered in PPA for 25 years Due to its business model the client is able to generate a steady stream of cash with significant certainty. It has no further plans to reinvest in new projects Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

14 The client is auto component player who proposes to buy a Germany based manufacturing plant from a non-resident Company. At one hand client seeks to identify the intrinsic value of such business as well as have to comply with the regulatory valuation guidelines issued by RBI. We are exposed to foreign exchange risk and a highly matured financial market. We have gathered comparable transaction data and hope to consider other relevant factors into our valuation. Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

15 The client has invested in non-core business where it holds around 17% of the business making it minority shareholder. Now the client is planning to divest this non-core strategic investment and therefore seeks to obtain fair market value of its share. We have gathered comparable transaction data and calculated cost of equity on the basis of industry average. However one of the valuation experts has advised to do some adjustments. Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

16 The client is in the business of owning luxury hotels throughout India. Currently they are planning to sell 4-Star hotel based out of central business district Gurugram, Haryana. Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

17 The client is a large steel company incurring huge operational losses for many years. Currently under stress due to high outstanding debt and is referred to Insolvency and Bankruptcy Board for Insolvency The Company is currently operating at 80% of its capacity and has got several long term customer contracts to operate as a going concern. Which valuation approach should be used? What factors are to be considered before reaching to final conclusion?

18 Valuation Myth Myths around valuation profession The myth is X Valuation is objective. X Valuation gives precise number X A single valuation servers more than one purpose. X A complex financial model gives better valuation X Valuation is worthless as it involves lot of assumptions The truth is It is subjective Valuation only gives an estimate That the value will change if the purpose is changed That it doesn t give better valuation That it is useful in decision making

19 RELATIVE VALUATION

20 The Value of an asset is compared to the values assessed by the market for similar or comparable assets. Relative Valuation Is Pervasive Identify Comparable Assets Obtain Market Values Convert Market values into Standardized Values Research Analyze Compare

21 Relative Method of Valuation Value of assets is compared to value assessed by market for comparable assets Most equity research report / Investment banking use relative method of valuation c75%+. Many DCF valuation use relative valuation to determine terminal value (See Example on Next Slide)

22 Terminal Value Calculation (INR Million) Particulars Terminal Value Revenue 77,801 FY-21 Revenue x EV / Sales multiple (4.6 X) Free cash flow to firm 357,885 Discounting factor 0.37 Present value of free cash flow to firm 132,417

23 Why Relative method of valuation? Easy to sell and easy to value Requires less information Easy to defend valuation

24 Comparable Companies multiple Method Group of companies comparable with respect to: Size Products Recent trends and future prospects Key ratios are calculated for each company and are averaged for group. Average ratios applied to absolute data for company of interest and indicated market values obtained from each ratio based on which valuation judgments are made.

25 Comparable Transactions Method Valuation based on companies involved in the same kind of merger transactions Market value refers to transactions in a completed deal which is more directly applicable than company comparisons May be difficult to find truly similar transactions within a relevant time frame

26 The valuation ratio typically expresses the valuation as a function of a measure of Key Financial Metrics Price Earning EV/ EBITDA EV/ Sales Earning Multiples Revenue Multiples Revenue/Room Industry Specific Multiples Book Value Multiples Price/Book Value

27 Price Earnings Ratio (PE Multiple) Method of determination of equity value Price Earnings ratio is the ratio of company's current share price to its earnings per share. Have to use very carefully

28 EV / EBITDA Multiple EV is enterprise value EV = Market Capitalization + Outstanding Debt Cash & Bank balances EBITDA is earnings before interest, tax, depreciation and amortization. It is a proxy for CASH Most widely accepted multiple for valuation

29 Example: Ashok Leyland EV = Market Capitalization + Outstanding Debt Cash & Bank balances = 24, , = INR 25,295 crore EBITDA = Earning before interest, tax, depreciation and amortization. = INR 2,003 crore EV / EBITDA = times

30 The value of a firm in stable growth could be derived as under: FCFF1 Value of Firm = V0 k g Dividing both sides by the expected free cash flow to the firm yields the Value/FCFF multiple for a stable growth firm: V 0 1 FCFF 1 k c g n The value/ebitda multiple, for instance, can be expressed as follows: c n Value EBITDA = (1 - t) k c - g + Depr (t)/ebitda k c - g - CEx/EBITDA k c - g - Working Capital/EBITDA k c - g

31 Tax Lower / Higher Key driver- EV / EBIDTA Cost of capital Growth rate Lower / Higher Lower / Higher Reinvestment rate Lower / Higher

32 EV / SALES Multiple It takes into account the enterprise value and then compared with the sales of the company. Generally used in high growth young companies with loss / low profitability Generally, the lower the ratio, the lower value of the company is. However should be concuded with operating method

33 Example: Ashok Leyland EV = Market Capitalization + Outstanding Debt Cash & Bank balances = 24, , = INR 25,295 crore Net Sales = 20,478 EV / Net Sales = 1.24 times

34 Key driver EV / Sales method Operating Margin Examples Luxury goods & Retail

35 Current - EV / EBIDTA multiples and EV / Sales multiple EV EBITA EV Sales Average Median Average Median Chemicals Auto Ancillary Auto LCV / HCV Auto Passenger car Hotel Engineering Airconditioner Cigarettes

36 Price to book The price-to-book ratio (P/B Ratio) is a ratio used to compare a stock's market value to its book value. Can be used to value bank financial service companies

37 Comparison of public and private sector banks Particulars Average Median PSU Banks Private Sector Banks

38 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. USE WITH CAUTION Industry Hospital Engineering Mutual Fund Oil Print Media Entertainment & Media Metals Airlines Valuation Parameters EV/ROOM Market Cap / Order Book Asset under management EV / Barrel of Equivalent EV / Subscriber EV / Per Screen EBIDTA / Ton, EV / Metric Ton EV / Plane or EV / Per Passenger Textiles EBIDTA depend upon capacity utilization %

39 Rules for using Relative valuation Identification of comparable company Comparable similar growth and margin Multiple consistently defined Equity / Enterprise value Uniformly estimates for all companies Gap differences, trailing, forward, extra ordinary items Sample size small / large

40 Investments and Cross Holdings Types of Holding Meaning Minority, Passive Investments If the securities or assets owned in another entity represents less than 20% of the overall ownership of that entity without any active role in management of that entity. Minority, Active Investments Majority, Active Investments If the securities or assets owned in another entity represents 20% - 50% of the overall ownership of that entity with an active role in management of that entity. If the securities or assets owned in another entity represents more than 50% of the overall ownership of that entity. Ways to value Investment in Cross Holdings:- Investment Value Dividend Yield Capitalization or DCF based on expected dividends Separate Valuation (Preferred)

41 Excess cash is defined as : Less : Total Cash (As appearing in Balance Sheet) Operating Cash (Minimum cash required to sustain operations and manage contingencies) Key Issues : 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. However, when valuing a non controlling ownership interest under the income approach, the value of any non operating asset, non operating liabilities, or excess or deficient operating assets may or may not be used to adjust the value of the operating entity depending on the valuer s assessment of the influence exercisable by the non controlling interest (ICAI Business valuation standard).

42 Selection of comparable Most of the information used in valuation comes from financial statements. So select like companies with similar accounting and financial data : Ind AS vs IGAAP Accrual vs Cash Accounting Presumptive vs Actual Tax Companies paying MAT Treatment of Intangible assets Treatment of Tax Benefits and Losses

43 Thank You! CA. Romesh Vijay rv@felixadvisory.com