The ESOP Association California Western States Annual Conference October 3-5, 2018

Transcription

1 The ESOP Association California Western States Annual Conference October 3-5, 2018 Valuation Basics Presented By Josh Edwards Managing Director Eureka Valuation Advisors (949) Richard Joseph Managing Director Chartwell Financial Advisory (714)

2 Agenda Process and Standard of Value Value Drivers and Influencing Factors Methodologies Conclusion Premiums, Discounts and Other Considerations Questions 2

3 PROCESS AND STANDARD OF VALUE 3 3

4 Valuation Theory Value is determined by an assessment of the relationship between the future returns generated on an investment and the risk of attaining those returns THEORY The art of business valuation is to: Understand the potential returns to shareholders Assess the risk of attaining those returns Convert the concept into a value using various financial models and tools ART 4

5 Standard of Value Guidance & Regulatory Agencies Internal Revenue Service (Revenue Ruling 59-60) Department of Labor (DOL) Title I of the Employee Retirement Income Security Act ( ERISA ) and the Proposed Regulation Relating to the Definition of Adequate Consideration (Prop. Reg. Section (b)(2)(i)) Fair market value: The price at which an asset would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and both parties are able, as well as willing, to trade and are well-informed about the asset and the market for the asset. 5

6 Enterprise & Equity Value Enterprise Value Enterprise Value = Market Value of Operating Assets Equity Value = Market Value of Shareholders Equity Equity Value = Enterprise Value + Cash -Debt 6

7 Levels of Value ACQUISITION / STRATEGIC VALUE Premium for Strategic Synergies (increased revenue and/or cost reductions) CONTROL VALUE Control Premium Minority Interest Discount MINORITY, MARKETABLE VALUE Discount for Marketability MINORITY, NON-MARKETABLE VALUE 7

8 Valuation Process DUE DILIGENCE DOCUMENT REVIEW MANAGEMENT INTERVIEW & COMPANY VISIT INDUSTRY & MARKET RESEARCH FINANCIAL ANALYSIS VALUE DETERMINATION & PRESENTATION FINAL REPORT DELIVERY 8

9 VALUE DRIVERS AND INFLUENCING FACTORS 9

10 Financial Metric -EBITDA EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization EBITDA = Net Income + Taxes + Interest Expense + Depreciation/Amortization EBITDA is value to the Enterprise Net income is value to shareholders Interest is value to debt holders For valuation purposes, should exclude one-time, nonrecurring items 10

11 Value Drivers Profitability Goal is to increase profit Increasing sales and cutting expenses increases profit Cash Flow Value is a function of future cash flow and risk Takes into account capital expenditures, working capital changes, etc. Goal is to increase future cash flow Higher future cash flow Higher value 11

12 Value Drivers Risk Higher risk Lower value, and vice versa Influencing Factors: External Factors Economic Condition Industry Condition Regulatory Environment Competitive Landscape Internal Factors Key Person / Bench Strength Financial Performance / Outlook Products/ Services Customer Concentration Supplier Concentration 12

13 13 METHODOLOGIES

14 Commonly Used Appraisal Methodologies Comparable Public Company Analysis Comparable M&A Transaction Analysis Discounted Cash Flow Analysis ( DCF ) Tangible Asset Method Market Approach Comparable Public Company Valuation technique estimates the value of a company by comparing it to similar public companies Market Approach The primary focus of the Comparable Transactions method is to examine prices found in relevant transactions Income Approach The Discounted Cash Flow valuation technique values a company based on the present value of future cash flows plus a terminal value Asset Approach The primary focus of the Tangible Asset Method is to determine a market value of the assets less a company s liabilities (limited application) 14

15 Comparable Public Company Analysis Process: Select comparable public companies Analyze peer group and compare to subject company Review market multiples Select appropriate multiples Apply to subject company financial data Advantages Excellent data based on current market pricing Known market value Disadvantages Size Business mix Geography 15

16 Comparable M&A Transaction Analysis Process: Select comparable transactions Analyze acquired companies and compare to subject company Review transaction multiples Select appropriate multiples Apply to subject company financial data Advantages Actual business sales, both private and public Size and business risk comparisons Disadvantages Less publicized data Synergistic premiums 16

17 Discounted Cash Flow Analysis Value is determined by projecting a company s future cash flow and converting the cash flow to a present value through the application of an appropriate discount rate Free cash flow is projected over a finite period (5 to 10 years) Projections should be developed by management Appraiser to vet and analyze the projections Terminal value: To recognize that a company has value beyond the projected period, a terminal value is determined EBITDA multiple Gordon growth method Once terminal value is determined, is it discounted to a present value by utilization of the discount rate 17

18 Discount Rate Represents the expected rate of return (or yield) that an investor would have to give up by investing in the subject investment instead of in available alternative investments that are comparable in terms of risk and other investment characteristics * The weighted average cost of capital (WACC) can be determined using the Build-Up Method (example below) or Capital Asset Pricing Method (CAPM) Cost of Equity + Risk Free Rate of Return 3.5% + Equity Risk Premium 5.5% + Small Stock Premium 3.7% + Company Specific Premium 5.0% = Cost of Equity 17.7% WACC: Calculation Detail After Tax Cost of Debt 2.7% % Debt to Enterprise Value 40.0% Cost of Equity 17.7% % Equity to Enterprise Value 60.0% WACC 11.7% WACC Midpoint Utilized in DCF 11.5% *(Valuing a Business, The Analysis and Appraisal of Closely Held Companies, Shannon Pratt, Robert Reilly, Robert Schweihs) 18

19 Tangible Asset Method The tangible asset method valuation is a function of examining the net assets of the company Assets & liabilities restated to market value May require use of asset appraisers if certain asset categories are truly material e.g.; Real Estate, Machinery May not be a suitable method for ESOPs or going concern valuations 19

20 CONCLUSION PREMIUMS, DISCOUNTS AND OTHER CONSIDERATIONS 20

21 Arriving at a Value Conclusion Methods utilized are reviewed to determine a selected enterprise value No industry standard appraiser specific Factors taken into consideration: Quality of the data Quantity of available data (detailed industry information, number of public companies or M&A transactions) Overall reliability of the value conclusions 21

22 Other Considerations Synthetic equity Various other stakeholders (preferred stock) Excluded assets Excluded liabilities 22

23 Premiums and Discounts Control premium or discount for lack of control A controlling interest has more rights than a minority interest (i.e., lack of control) Lack of marketability Closely held equity interests do not have the same liquid market as publicly traded stock do; therefore, they are worth less Internal Revenue Code (IRC) Section 409(h)(1)(B) Participants are granted a put right exercisable against the employer upon leaving the company; Upon exercise, they receive fair market value for their vested shares per the terms of the employers Plan document 23

24 Questions? Josh Edwards, Managing Director Eureka Valuation Advisors Los Altos, Suite 240 Mission Viejo, CA Phone: (949) Richard Joseph, Managing Director Chartwell Financial Advisory 535 Anton Blvd., Suite 810 Costa Mesa, CA Phone: (714)