VALUATION OF UNQUOTED COMPANIES

Transcription

1 VALUATION OF UNQUOTED COMPANIES Fifth Edition Christopher G. Glover MScFCA CCH a Wolters Kluwer business Wolters Kluwer (UK) Ltd 145 London Road Kingston upon Thames Surrey KT2 6SR Tel: +44 (0) Fax: +44 (0) customerservices@cch.co.uk

2 Preface list of figures and tables list of abbreviations vii xix xxiii Chapter 1: Valuation theory Introduction The comparative value judgement Opportunity cost Anticipated opportunity cost Satisfaction of common demand Law of equilibrium Exterior values Interior values and price determination Price and market value Valuation of shares Some characteristics of value Conclusion 18 Chapter 2: Concepts of property value Introduction Value to the owner or owner value Deprival value Fluctuations in owner value Owner value and market value Market value or exchange value Elements of a market Basis of market value Practical considerations Fair value Investment value Investment-based owner value Liquidation value Liquidation value as a limit to risk Going concern value Valuing the going concern as a break-up Personalised goodwill Intrinsic value Definitions considered Intrinsic value versus market value Intrinsic value not a valid concept Conclusion 44 IX

3 Chapter 3: The legal framework Introduction Limited company Nature of a company Separate legal personality Perpetual succession Ultra vires rule Articles of association Articles of association as a contract Model articles Distinction between a public and a private company Division of power between the shareholders and the directors Powers of management Sanctions available to shareholders Legal nature of a share Importance of the articles of association Stock market investor versus the private company shareholder Ownership and control of the company Classes of security Ordinary shares Preference shares Debentures Purchase by a company of its own shares Redeemable shares Distributable profits Degrees of control Types of resolution Statutory minority rights Conclusion 65 Chapter 4: The rights of minorities Introduction Unfairly prejudicial conduct petition Prerequisites for a petition under section What constitutes unfairly prejudicial conduct? Obligation to make use of available solutions O'Neill v. Phillips Powers of the court Winding up petition on the 'just and equitable' ground Circumstances in which a winding-up order may be made Derivative action Conclusion 82 Chapter 5: The influence of the Stock Exchange Introduction Quoted company comparisons Commercial valuations 87 x

4 5.2.2 Fiscal valuations Objections to quoted company comparisons Effect of lack of marketability Main indicators of comparability The London Stock Exchange Main Market versus AIM PLUS Selection of comparable companies Published share and bond price information Stock Market indices FTSE All Share Index FTSE 100 Index Share Index FTSE Gold Mines Index Fixed Interest Indices Efficient capital markets and portfolio theory Efficient market hypothesis Modern portfolio theory Conclusion 101 Chapter 6: The efficient market hypothesis Introduction Weak form Semi-strong form The theory and its implications Generalised hypothesis incapable of conclusive proof Academic evidence in support of the hypothesis FFJR study examined in detail Critique of FFJR's findings Other academic studies. t Strong form Academic test of the strong form Indirect tests - the United States Indirect tests - the United Kingdom, Jensen's mutual funds study Review of findings Conclusion 126 Chapter 7: Risk and rate of return Introduction Nature of risk Risk measurement Variability of future returns Pay-back period Sensitivity/scenario analysis Risk premium Relationship between risk and the rate of return Utility function for wealth Capital Asset Pricing Model Notion of diversifiable risk 150 XI

5 7.6.2 Beta co-efficient Calculating betas Critique of the CAPM/MPT Conclusion 157 Appendix 7.1 Calculation of the standard deviation of returns for Company A and Company B 160 Appendix 7.2 Calculation of the revised 'expected' rate of return and standard deviation for Company A and Company B 161 Appendix 7.3 Calculation of the standard deviation of returns for QRS pic and ABC pic 162 Chapter 8: The dividend basis of valuation Introduction General remarks Fundamental significance of dividends Relationship of dividends to earnings and asset backing Valuations not for portfolio investment purposes Basic approach Assuming a fixed annual dividend Assuming a dividend increasing at a constant annual rate Derivation of die dividend discount model Adjusting the DDM for temporary abnormal growth Relationships between the DDM and the PE ratio Required rate of return Two elements of the required rate of return Assessing the degree of risk The Stock Exchange risk premium Risk premium on individual stocks Initial yield method Non-dividend paying companies Hypothetical dividend yield method Valuation for portfolio investment purposes. : Valuation for other purposes Discount for lack of marketability The need for a discount Empirical studies in the United States Position in the United Kingdom Dividend cover Its significance and calculation Dividend cover for valuations prior to April Conclusion 188 Chapter 9: The earnings basis of valuation Introduction Meaning of control Composition of the board Reflecting the degrees of control in a valuation Deadlock companies, ie whose equity is held 50: XII

6 9.2.4 Value of voting rights with no equity entitlement Earnings Nature of profit Estimating future profits Discounted earnings method Present value of future earnings Importance of retained profit Allowing for retained profit A formula for the present value of future earnings Selecting the rate of return PE ratio PE ratio and the earnings yield Problems with the PE ratio Use of the PE ratio in valuing unquoted shares Pretax profits yield Conclusion 212 Appendix 9.1 Derivation of the discounted earnings formula 215 Chapter 10: Discounted Cash Flow technique and other valuation methods Introduction Discounted Cash Flow method Investment projects versus company valuations Net present value and price Information required Treatment of financing needs Allowing for a minority interest Terminal value Discount rate Cost of capital : Some cautionary remarks Assets basis General rule Winding-up Suitability of fixed assets for their purpose Formal net asset valuations Minority shareholdings in property companies Stock market's focus on asset backing Dividends nevertheless are important Asset backing and risk Weighted-average techniques Rules of thumb Conclusion 241 Chapter 11: Choosing the appropriate valuation basis Introduction Controlling shareholdings Manufacturing, trading or commercial companies Investment / property companies When break-up value is relevant 247 Xlll

7 11.3 Minority shareholdings The basic rule Many exceptions to the basic rule Some further points Dividend irrelevance proposition Effect of dividend policy with perfect markets, rational behaviour and perfect certainty What does the market 'really' capitalise? Earnings, dividends and growth rates Effects of dividend policy under uncertainty Dividend policy and market imperfections Conclusion 263 Chapter 12: Goodwill and other intangibles Introduction Tangible and intangible assets Goodwill Its nature As defined by the courts Super-profits definition As defined in accounting standards 'Positive' and 'negative' goodwill Goodwill - a non-separable asset Intellectual property rights Patents Trademarks Registered designs Copyright Brands Valuation techniques Royalty method Premium pricing technique Earnings basis : An illustrative brand valuation, Deferred revenue expenditure Conclusion 282 Chapter 13: Options, warrants and convertibles Introduction Share options Traditional options Traded options Market terminology Pricing of options Uses of share options Options used to hedge risks Options used as highly-geared investment Options as speculative devices Stock Exchange warrants Introduction Gearing ratio 294 XIV

8 Conversion premium Capital fulcrum point Volatility factor Intrinsic or formula value An illustrated example Covered warrants Quoted convertibles Basic characteristics Value on the income differential basis Implied value of conversion rights Unquoted share options A suggested valuation approach Cross-checking the results of the valuation Unquoted convertibles Income differential method of valuation Valuing the straight debt and conversion rights separately Conclusion 302 Chapter 14: Fixed interest securities and miscellaneous valuation topics Introduction Fixed interest securities General characteristics Required rate of return Inverse relationship between yield and value Flat yield Yield to redemption Published yields Valuation technique illustrated Participating preference shares Deferred shares General characteristics...' Valuation considerations An illustrative valuation, Non-voting ordinary shares Valuations cum div and ex div Prior sales Purchase by a company of its own shares General considerations Controlling interests Effect of the buy-back on the other shareholders Conclusion 317 Chapter 15: Legal or binding valuations Introduction Binding force of the valuation Fraud or collusion An erroneous principle Speaking certificate Valuer's liability for negligence Representations to the expert valuer 327 XV

9 15.5 Interpreting the terms of reference Identifying the value concept 'Net assets including goodwill' formula Discounted or full pro rata basis Fair value Distinction between fair value and market value Fair value as interpreted in Dean v Prince Procedure Accepting the engagement Obtaining information Valuation summary Form of certificate Conduct during and after the valuation Conclusion 348 Chapter 16: Fiscal valuations: Statutory open market value Introduction Requirement for fiscal valuations Inheritance tax Capital gains tax Stamp duty Income tax Statutory open market value Interpreting the valuation hypothesis Information available Share transfer restrictions Purchaser orientation of the valuation hypothesis Open market Special purchaser Effect on price As illustrated in IRC v Clay As illustrated in Glass v IRC And other cases Dicta in the Grossman and Lynall cases Conclusions to be drawn from the case law General conclusions Hindsight inadmissible Combined holdings Expenses of sale not deductible Time of hypothetical sale ; 369, Consideration in cash Conclusion 369 Chapter 17: Fiscal valuations: some practical points Introduction Relevance of case law The influence of The Stock Exchange Minority shareholdings Controlling interests Non-dividend paying minority shareholdings Valuation in commercial, ie non-fiscal, situations XVI

10 Institutional investors Private individual as investor Relating commercial practice to fiscal open-market value A suggested approach An illustrative example Hypothetical dividend yield basis Shareholder with other roles in the company Relevance to going-concern value Effect of the statutory valuation hypothesis More significant for the controlling shareholding Thin capitalisation Valuations as at 31 March High marginal saving in tax Premium for control - a perceived unfairness Advisability of a fully reasoned report Relevance of prior sales and previously agreed values Fully taxed PE ratios Goodwill Conclusion 389 PRACTICAL INFORMATION 393 Section A: Valuation questionnaire/checklist 395 Section B: Engagement letters 407 Section C: Form of report 417 Section D: Financial analysis 419 Section E: Case studies 433 Section F: Selected statistics and data for 31 March 1982 valuations 481 Bibliography 539 Books 539 Articles 540 Other.542 Table of Cases 543 Index 547 xvn