Indé Global knowledge sharing presents

Transcription

1 Indé Global knowledge sharing presents

2 Valuing multi-business, multi-national companies Presenter: Purvesh Kapadia

3 About the Presenter Purvesh Kapadia Assistant Manager Financial Reporting and Valuation Services Indé Global Inc. Purvesh Kapadia has experience in assisting clients with the valuation of companies, carrying out purchase price allocation and setting-up deferred tax balances as on the opening date balance sheet Valuation of companies Understanding the company, analysing the prospective financial information and valuing the company using the income and market approaches. Derive the equity value from the firm value and allocate the equity value to various classes of shares based on the rights and obligations of each class of share. Purchase price allocations Reading the share purchase agreement and understand the important terms of the agreement relevant to the purchase price allocation exercise. Identify various intangibles assets that needs to be valued and value the intangible assets using approaches like multiperiod excess earnings method, relief from royalty method, distributor method, with or without method etc. Valuation of contingent consideration using monte carlo simulation and probability weighted expected return method Understanding the differences in the treatment of intangible assets and other assets for book and tax purposes and determining the deferred tax balances as on the opening date balance sheet. Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 2

4 Presentation outline 1 Introduction 2 Attributes of multi-business, multi-national companies 3 Approaches to valuation 4 Issues in valuation of multi-business, multi-national companies 5 Valuation of multi-business, multi-national companies 6 Oversights in valuation of multi-business, multi-national companies Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 3

5 Introduction When companies enter multiple businesses and many markets, valuation of such companies brings special challenges. The different risk, growth and cash flow profiles of the cash flow streams generated by multi-national firms requires appraisers to reconsider how we estimate discount rates and approach valuation. These firms can be valued on a consolidated basis and also on a disaggregated basis using the sum of the parts to value the businesses. Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 4

6 Attributes of multi-business, multi-national companies Many different countries/markets Complex holding structures Risk parameters available for the aggregate but not for the pieces Intra-company transactions Taxes reflect mix of marginal tax rates and jurisdictions Large centralized costs Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 5

7 Approaches to multi-national companies valuation Income approach Market approach Cost approach Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 6

8 Issues in valuation of multi-business, multi-national companies DCF valuation Existing assets Diversified earnings Capital expenditures and investments Presence of intra company transactions Growth assets Reinvestment amounts Returns generated on capital investment Discount rates Cost of capital Financial leverage Multiple currencies Terminal value Varied growth Restructuring Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 7

9 Steps in discounted cash flow valuation STEP 1: Decide on whether to use aggregated or disaggregated numbers STEP 2: Make a currency choice STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in STEP 4: Estimate future cash flows and value STEP 5: Get from firm value to equity value per share STEP 6: Decide whether you want to adjust the value of equity for other factors Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 8

10 STEP 1: Decide on whether to use aggregated or disaggregated numbers Availability of information If management gives business/region wise information, else use industry averages Differences across businesses/ regions Significant differences across businesses/regions may call for disaggregated valuation Number of businesses/ regions Determine how practical it is to consider a disaggregate valuation considering number of businesses and presence in different regions Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 9

11 STEP 2: Make a currency choice Aggregated valuation One currency as a base currency for valuation Domestic currency or foreign currency depending on: 1)Availability of inputs in domestic currency 2)Financial reports in a foreign currency maybe more comprehensive Disaggregated valuation Value each of the businesses located in different regions in different currencies and do the conversion of values at the final step Single currency for all the valuations and estimating cash flows and discount rates in that currency Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 10

12 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Aggregated valuation Disaggregated valuation Betas Use a weighted beta for each industry/ country the company operates in on basis of its revenue or earnings Risk premium Compute the equity risk premium for each region and use a weighted risk premium based on its revenues or earnings from each of the regions Cost of debt Risk free rate of the currency used for estimating cash flows. Credit spread to be based on the overall rating of the company Debt ratios Debt equity ratio to be based on the entire company s debt and total market value of equity Betas There is no need to calculate Beta on a weighted average basis, it can be done by using sector betas for each of the businesses of the company. Risk premium Equity risk premiums to be calculated individually for each of the regions in which the company operates Cost of debt Wherever available, use separate credit spreads for each region/ industry and individual risk free rates based on currency used to prepare cash flow projections. Debt ratios In case individually units borrow money, individual debt ratios can be used. Incase of debt at a consolidated level 1)Basis of total assets 2)consolidated debt ratios 3)Industry average debt ratio Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 11

13 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Aggregated basis Betas Division Business Country Operating Income Weights Unlevered Beta Carrier Refrigeration systems USA 1, Pratt & Whitney Defense UK 2, Otis Construction Brazil 2, UTC Fire & Security Security Bangladesh Hamilton Sundstrand Manufacturing Canada 1, Sikorsky Aircraft Mexico Total $8, Marginal tax rate: 38% Debt/Equity ratio: Debt/Capital ratio: Levered beta = (1+[(1-0.38) x ]) = 1.16 Disaggregated basis Division Country Unlevered Beta Debt/Equity Ratio Levered beta Carrier USA % 0.99 Pratt & Whitney UK % 0.96 Otis Brazil % 1.42 UTC Fire & Security Bangladesh % 0.77 Hamilton Sundstrand Canada % 1.24 Sikorsky Mexico % 1.39 Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 12

14 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Betas Use a weighted beta for each industry/ country the company operates in on basis of its revenue or earnings Risk premium Compute the equity risk premium for each region and use a weighted risk premium based on its revenues or earnings from each of the regions Cost of debt Risk free rate of the currency used for estimating cash flows. Credit spread to be based on the overall rating of the company Debt ratios Aggregated valuation Debt equity ratio to be based on the entire company s debt and total market value of equity Betas Disaggregated valuation There is no need to calculate Beta on a weighted average basis, it can be done by using sector betas for each of the businesses of the company. Risk premium Equity risk premiums to be calculated individually for each of the regions in which the company operates Cost of debt Wherever available, use separate credit spreads for each region/ industry and individual risk free rates based on currency used to prepare cash flow projections. Debt ratios In case individually units borrow money, individual debt ratios can be used. Incase of debt at a consolidated level 1)Basis of total assets 2)consolidated debt ratios 3)Industry average debt ratio Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 13

15 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Risk premium The three commonly used approaches for computing CRP: 1. Bond default spread: The default spread on a dollar denominated bond issued by the country. Brazil s 10 year $ denominated bond at the start of 2017 was trading at an interest rate of 6.09 %, a default spread of 3.64% over the US treasury bond rate of 2.45%. 2. Sovereign ratings spread: Brazil s sovereign local currency rating is Ba2. The default spread for a Ba2 rated sovereign is about 3.47%. 3. Relative standard deviation approach The country equity risk premium is based upon the volatility of the market in question relative to the US market. i. Assume that ERP of US is 6.94% ii. Assume that the standard deviation in Brazilian equity is 30% and that the standard deviation for S&P 500 is 18% iii. Therefore, total ERP for Brazil = 6.94% x (30%/18%) = 11.57% iv. Country risk premium for Brazil = 11.57% % = 4.63% Sovereign ratings spread: In this approach, the country equity risk premium is set equal to the default spread for the country: Sovereign local currency rating Rating based Countries S&P rating Moody's rating default spread USA AAA Aaa 0.0% UK AA+ Aa1 0.5% Brazil BB Ba2 3.5% Bangladesh BB- Ba3 4.2% Canada AAA Aaa 0.0% Mexico A- A3 1.4% This default spread is added on to the mature market premium to arrive at the total equity risk premium for each of the countries, taking a mature market premium of 6.96%. Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 14

16 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Risk premium Country Mature ERP (D&P yearbook) CRP Total ERP USA 6.94% 0.0% 6.94% UK 6.94% 0.5% 7.44% Brazil 6.94% 3.5% 10.44% Bangladesh 6.94% 4.2% 11.14% Canada 6.94% 0.0% 6.94% Mexico 6.94% 1.4% 8.34% Country Revenues Weight Equity risk premium USA 14,944 25% 6.94% UK 12,965 22% 7.44% Brazil 12,949 22% 10.44% Bangladesh 6,462 11% 11.14% Canada 6,207 11% 6.94% Mexico 5,368 9% 8.34% Company 58, % 8.41% Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 15

17 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Cost of equity Cost of equity = Rf + β x (Erp) = 3% x (8.41%) = 12.74% Aggregated basis Disaggregated basis Division Country Levered beta Rf ERP Cost of equity Carrier USA % 6.94% 9.86% Pratt & Whitney UK % 7.44% 10.18% Otis Brazil % 10.44% 17.18% UTC Fire & Security Bangladesh % 11.14% 11.63% Hamilton Sundstrand Canada % 6.94% 11.60% Sikorsky Mexico % 8.34% 14.62% Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 16

18 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in Betas Use a weighted beta for each industry/ country the company operates in on basis of its revenue or earnings Risk premium Compute the equity risk premium for each region and use a weighted risk premium based on its revenues or earnings from each of the regions Cost of debt Risk free rate of the currency used for estimating cash flows. Credit spread to be based on the overall rating of the company Debt ratios Aggregated valuation Debt equity ratio to be based on the entire company s debt and total market value of equity Betas Disaggregated valuation There is no need to calculate Beta on a weighted average basis, it can be done by using sector betas for each of the businesses of the company. Risk premium Equity risk premiums to be calculated individually for each of the regions in which the company operates Cost of debt Wherever available, use separate credit spreads for each region/ industry and individual risk free rates based on currency used to prepare cash flow projections. Debt ratios In case individually units borrow money, individual debt ratios can be used. Incase of debt at a consolidated level 1)Basis of total assets 2)consolidated debt ratios 3)Industry average debt ratio Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 17

19 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in Cost of debt Cost of debt (Kd) = (Rf + credit spread) x (1-t) = (3% %) x (1-0.38) = 2.95% Varies across different currencies Varies across different borrowings of the firm Varies across different countries 3 ways in which we can deal with different tax rates I st Use a Weighted Average of the marginal tax rates, with the weights based upon the income derived by the firm from each of these countries. The problem with this approach is that the weights will change over time if income is growing at different rates in different countries. (This is generally used while valuing company on a consolidated/ aggregated basis) II nd Use the marginal tax rate of the country in which the company is incorporated, with the implicit assumption being that the income generated in other countries will eventually have to be repatriated to the country of origin, at which point the firm will have to pay the marginal tax rate. This assumes that the home country has the highest marginal tax rate of all other countries. III rd The third and safest approach is to keep the income from each country separate and apply a different marginal tax rate to each income stream. (This is generally used while valuing company on a stand-alone/ disaggregated basis) Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 18

20 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in Betas Use a weighted beta for each industry/ country the company operates in on basis of its revenue or earnings Risk premium Compute the equity risk premium for each region and use a weighted risk premium based on its revenues or earnings from each of the regions Cost of debt Risk free rate of the currency used for estimating cash flows. Credit spread to be based on the overall rating of the company Debt ratios Aggregated valuation Debt equity ratio to be based on the entire company s debt and total market value of equity Betas Disaggregated valuation There is no need to calculate Beta on a weighted average basis, it can be done by using sector betas for each of the businesses of the company. Risk premium Equity risk premiums to be calculated individually for each of the regions in which the company operates Cost of debt Wherever available, use separate credit spreads for each region/ industry and individual risk free rates based on currency used to prepare cash flow projections. Debt ratios In case individually units borrow money, individual debt ratios can be used. Incase of debt at a consolidated level 1)Basis of total assets 2)consolidated debt ratios 3)Industry average debt ratio Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 19

21 STEP 3: Estimate risk parameters, allowing for the multiple businesses/ regions that the firm operates in. Calculation of WACC Debt: $12,919; Equity: $41,904 Aggregated basis WACC = 12.74% x [41,904/(12,919+41,904)] % x [12,919/(12,919+41,904)] = 10.43% Division Country Unlevered Beta Debt/Equity Ratio Levered beta Rf ERP Cost of equity Disaggregated basis After-tax cost of debt Debt to Capital Carrier USA % % 6.94% 9.86% 2.95% 23.56% 8.23% Pratt & Whitney UK % % 7.44% 10.18% 2.95% 23.56% 8.47% Otis Brazil % % 10.44% 17.18% 2.95% 23.56% 14.30% UTC Fire & Security Bangladesh % % 11.14% 11.63% 2.95% 23.56% 9.58% Hamilton Sundstrand Canada % % 6.94% 11.60% 2.95% 23.56% 9.56% Sikorsky Mexico % % 8.34% 14.62% 2.95% 23.56% 11.87% WACC Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 20

22 STEP 4: Estimate future cash flows and value Aggregated valuation Growth based on combined reinvestment rate Return on capital for the entire firm Disaggregated valuation Growth rates for each business/location independently Return on capital for each business/location Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 21

23 STEP 4: Estimate future cash flows and value Aggregated valuation Year Total EBIT (1-t) 5,579 5,925 6,292 6,682 7,096 Minus: Reinvestment (2,266) (2,407) (2,556) (2,715) (2,883) FCFF 3,312 3,518 3,736 3,967 4, % 2,999 2,885 2,774 2,668 2,566 13,891 For terminal value calculation: ROC: 11% Expected long term growth rate: 3% Stable period re-investment rate: 27.3% (3%/11%) EBIT: Growth rate of 6.2% YoY Reinvestment rate of 40.62% Expected free cash flow to the firm Terminal value = (7,096 x 1.03 x (1-27.3%))/ ( ) = $71,527 Value of operating assets = 13,885 + [71,339/( ) 5 ]= $57,442 Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 22

24 STEP 4: Estimate future cash flows and value Aggregated valuation Growth based on combined reinvestment rate Return on capital for the entire firm Disaggregated valuation Growth rates for each business/location independently Return on capital for each business/location Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 23

25 STEP 4: Estimate future cash flows and value Disaggregated valuation Total capital invested (TIC) in the firm is $28,287 million and total reinvestment for the firm is $2,134 million. Computation of after tax return on capital and reinvestment rate: Division Country Total Assets c TA % Allocated TIC e Capex Capex % g Allocated Reinvestment h EBIT (1-t) Return on capital j = i/e Reinvestment Rate k = h/i a b d f i Carrier USA 10,810 21% 6, % % 43.28% Pratt & Whitney UK 9,650 19% 5, % 762 1, % 57.89% Otis Brazil 7,731 15% 4, % 277 1, % 18.06% UTC Fire & Security Bangladesh 10,022 20% 5, % % 52.28% Hamilton Sundstrand Canada 8,648 17% 4, % % 38.29% Sikorsky Mexico 3,985 8% 2, % % % Total $50,846 $28,287 $1,154 $2,134 To estimate the expected growth rate, we assume that these reinvestment rates and returns on capital can be maintained for the near term. The resulting expected growth rates are summarized in table below Division Country Cost of capital Return on capital p Reinvestment Rate q Expected growth r=p*q Length of growth period Stable growth rate Stable ROC (assumed) Carrier USA 8.23% 13.57% 43.28% 5.87% % 8.25% Pratt & Whitney UK 8.47% 24.51% 57.89% 14.19% % 12.00% Otis Brazil 14.30% 35.71% 18.06% 6.45% % 14.00% UTC Fire & Security Bangladesh 9.58% 6.03% 52.28% 3.15% % 9.24% Hamilton Sundstrand Canada 9.56% 14.15% 38.29% 5.42% % 9.58% Sikorsky Mexico 11.87% 13.35% % 13.76% % 12.11% Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 24

26 STEP 4: Estimate future cash flows and value Disaggregated valuation We have assumed that all of the divisions, other than UTC Fire and Security, will be able to maintain their current returns on capital and reinvestment rates for the next five years. With UTC Fire and Security, we assume that the firm is already in stable growth, since its growth rate (3.15%) is close to the stable growth rate (3%) and that its return on capital will be equal to the cost of capital. Equipped with these expected growth rates and costs of capital, we first compute the expected free cash flows, by division, for the high growth phase/ Business Country EBIT (1-t) Expected growth rate Reinvestment Rate Present value WACC Carrier USA % 43.28% , % Pratt & Whitney UK 1, % 57.89% ,076 3, % Otis Brazil 1, % 18.06% 1,340 1,426 1,518 1,616 1,720 5, % UTC Fire & Security Bangladesh % 52.28% % Hamilton Sundstrand Canada % 38.29% , % Sikorsky Mexico % % (10) (12) (13) (15) (17) (48) 11.87% Note that there are no high growth cash flows for UTC, since it is assumed to be in stable growth. We then estimate the value at the end of the high growth phase for each firm Business Country EBIT (1-t) Stable growth rate Stable ROC Stable Reinvestment rate (g/roc) Terminal value Carrier USA 1, % 8.25% 36.36% 13,597 Pratt & Whitney UK 2, % 12.00% 25.00% 36,053 Otis Brazil 2, % 14.00% 21.43% 15,037 UTC Fire & Security Bangladesh % 9.24% 32.47% 3,551 Hamilton Sundstrand Canada % 9.58% 31.32% 9,563 Sikorsky Mexico % 12.11% 24.77% 4,926 Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 25

27 STEP 4: Estimate future cash flows and value Disaggregated valuation The final estimates of value for operating assets, by each location: Business Country Cost of capital PV of FCFF PV of terminal value Value of operating assets Carrier USA 8.23% 2,167 9,155 11,322 Pratt & Whitney UK 8.47% 3,241 24,005 27,245 Otis Brazil 14.30% 5,109 7,708 12,817 UTC Fire & Security Bangladesh 9.58% - 3,551 3,551 Hamilton Sundstrand Canada 9.56% 1,875 6,058 7,933 Sikorsky Mexico 11.87% (48) 2,811 2,763 Total 65,631 Treatment of corporate overheads Value of Corporate Expenses = Corporate Expenses x Current (1 t)(1+ g) / (Cost of capital Company g) = 408(1 0.38)(1.03) / ( ) = $3,506 million Reducing the cumulative value of the operating assets from table above ($68,317 million), by this amount ($3,682 million), generates a value for the operating assets of the firm of $62,126 million. This is about 8% higher than the value that we obtained for the operating assets in the last illustration, where we valued IACC on an aggregated basis, of $57,442 million. Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 26

28 STEP 5: Get from firm value to equity value per share Add cash Subtract out debt Add in values of cross holdings Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 27

29 STEP 6: Decide whether you want to adjust the value of equity for other factors Discount on estimated value Apply a conglomerate discount Estimate the discount at which the complex firms trade at in the market place relative to simpler firms. Measure complexity directly and estimate a discount based on complexity Use a complexity scoring system and relate the score to the size of the discount. Positive adjustment to estimated value Determine whether the firm would be worth more if it were broken up into independent businesses. Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 28

30 Oversights in valuation of multi-business, multi-national companies DCF valuation Multi-country- Incorporation versus Operations Choice of discount rates Non adjustment of discount rates Multi-business- The averaging argument Choice between consolidated and individual inputs Changing weights over time Ignoring Centralized Costs and Intra-Company Transactions Ignoring vs Incorrect valuation Adjusting intra company transactions Cross Holding Valuations Minority holdings Minority interest in majority holdings Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 29

31 Knowledge repository Valuation handbook Guide to cost of capital: Duff & Phelps Business Valuation: Discounts and Premiums Shannon P. Pratt Valuing a business: The analyses and appraisal of closely held companies Shannon P. Pratt Valuations for Mergers, Buyouts and Restructuring Enrique R. Arzac Damodaran on Valuation Aswath Damodaran S&P database Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms. 30

32 Questions? id

33 Thank you Our offices: Amsterdam WTC Amsterdam, Strawinskylaan 925, 1077XX Amsterdam Atlanta One Lakeside Commons, Suite 850, 990 Hammond Drive NE, Atlanta, GA Geneva Rue du Rhone 114, 1204 Geneva Hyderabad 402, Moghul's Court, Basheerbagh, Hyderabad London Kajaine House, High Street, Edgware, Middlesex, HA8 7DD Lyon 74 Rue Maurice Flandin Lyon Mumbai 303, OIA House, 470 Cardinal Gracious Road, Andheri East, Mumbai, Maharashtra New Delhi 220 & 221, Square One Building, Saket, New Delhi Singapore 71 Ubi Crescent, Excalibur Center, #08-0, Singapore Toronto 55 York Street, Suite 401, Toronto, Ontario, M5J 1R7 W: E: admin@igapl.com Indé Global Inc. is the US independently owned member firm of KNAV International Limited, a network of international accounting firms.