Valuation Insights. Third Quarter Inside. 02 Feature SEC Issues Staff Paper on Incorporating IFRS into the U.S.

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1 Third Quarter 2011 Valuation Insights Inside 02 Feature SEC Issues Staff Paper on Incorporating IFRS into the U.S. Financial System 03 Technical Notes Realizing Value from Worthless Stock Deductions 04 International in Focus A Return to Dealmaking: 2011 Transatlantic Private Equity Survey 05 Spotlight FASB Proposed Accounting Standards Update on Testing Goodwill for Impairment 06 North American Industry Market Multiples 07 European Industry Market Multiples 08 About Duff & Phelps In this edition of Valuation Insights we discuss a Staff Paper recently issued by the Securities and Exchange Commission (SEC) which discusses a possible approach for incorporating International Financial Reporting Standards into the U.S. financial system. Subsequent to the release of the paper the SEC held a roundtable, in which Duff & Phelps participated, to continue discussions on this topic. In our Technical Notes section we explore worthless stock deductions, a tax benefit that is potentially available to companies that have insolvent subsidiaries. Our International in Focus section discusses the Duff & Phelps 2011 Transatlantic Private Equity survey and observations of interest for corporations. Finally, our Spotlight article discusses the proposed Accounting Standards Update on Testing Goodwill for Impairment. In every issue you will find Industry market multiples which are useful for benchmark valuation purposes. We hope that you will find this and future issues of this newsletter informative and reliable resources. Read this issue to find out more. Contact us at:

2 SEC Issues Staff Paper on Incorporating IFRS into the U.S. Financial System The Securities and Exchange Commission (SEC) has yet to announce whether and how the U.S. financial reporting system will converge with global standards. However, in May 2011, the SEC offered a few details about how the convergence process might unfold if they should decide to adopt International Financial Reporting Standards (IFRS). A Staff Paper issued by the SEC s Office of the Chief Accountant described an endorsement protocol for the Financial Accounting Standards Board (FASB) to incorporate new or amended versions of IFRS into U.S. Generally Accepted Accounting Principles (GAAP) over a defined transition period of five to seven years. In addition to the Staff Paper, the SEC held a roundtable discussion on this topic in July. The Commission and its Staff have previously proposed several possible approaches to achieve a single set of globally accepted accounting standards. These include: (1) Full adoption of IFRS on a specified date, without any endorsement mechanism, (2) Full adoption of IFRS following a staged transition over several years, (3) an option for U.S. issuers to apply IFRS, and (4) continued convergence of U.S. GAAP with IFRS. The SEC Staff Paper proposes a framework in which U.S. GAAP would be retained, however the FASB would incorporate IFRS into U.S. GAAP over a defined period of time through an endorsement protocol. The endorsement protocol would enable the commission and the FASB to modify or supplement IFRS when in the public interest and necessary for the protection of investors. Under this proposed approach, differences between IFRS and U.S. GAAP would be eliminated over time through joint standard setting efforts. The SEC believes that this approach to incorporation of IFRS would minimize cost and effort of U.S. issuers. Pursuant to this framework, the Staff has proposed that the FASB would remain the standard-setting body responsible for promulgating U.S. GAAP, principally through endorsement of standards promulgated by the IASB. However, the FASB s primary role would shift towards participation in the development of IFRS, providing input and support to the IASB and advancing U.S. perspectives of new global accounting standards. The framework proposes a transition period during which current U.S. GAAP would be replaced with IFRS and discusses three categories of standards as follows: MoU Projects (Category 1) The Memorandum of Understanding (MoU) projects include joint FASB and IASB projects in connection with financial instruments, revenue recognition, leases, presentation of other comprehensive income, fair value measurement, balance sheet netting of derivative and other financial instruments, and the consolidation of investment companies. The Boards target 2011 for completion of all of these projects. Assuming these projects are completed this year, these new standards would likely be incorporated into U.S. GAAP and IFRS subject to their effective dates in advance of U.S. transition to IFRS. IFRSs Subject to Standard Setting (Category 2) Pursuant to the transition plan, the FASB would identify IFRSs that are subject to or anticipated to be modified and would retain the corresponding U.S. GAAP until such time that the new or modified IFRSs are issued. Upon issuance of the new or modified IFRSs, the FASB would assess how to incorporate them into U.S. GAAP. IFRSs Not Subject to Standard Setting (Category 3) The FASB would review and assess IFRSs that are not subject to standard setting to determine how and when they should be incorporated into U.S. GAAP. These would be identified for earliest incorporation into U.S. GAAP as they are not subject to any standard setting. Transition plans for these IFRSs could also allow for prospective application. SEC Roundtable Discussion On July 7, the SEC hosted a roundtable on the potential for adopting IFRS for use in the U.S. David Larsen, Duff & Phelps Managing Director, participated on the first panel on Investor Understanding and Knowledge of IFRS. This panel discussed U.S. investors current knowledge of IFRS and preparedness for potential incorporation, education requirements and timing, and potential methods of incorporation. Other panel discussion topics included the impact of IFRS on smaller public companies, steps and timing required to undertake changes to regulation as a result of changes in accounting standards, benefits and challenges of potential transition to IFRS and implementation cost mitigation. The roundtable provided an open forum to specifically address key questions and concerns from a number of perspectives. There was fairly clear consensus among participants that a single set of uniformly applied, high quality accounting standards will benefit investors, said Larsen. However, questions remain as to whether IFRS represents the best option for that single set of accounting standards and whether they can be uniformly applied, given differences in regulatory regimes around the world. Additional thought and analysis will be required. The SEC s decision will impact financial reporting and investors for years to come. Duff & Phelps 2

3 Technical Notes Realizing Value from Worthless Stock Deductions In today s economic environment, companies that have insolvent subsidiaries may be able to unlock a valuable tax benefit by claiming a worthless stock deduction in conjunction with making a check-the-box election. In Rev. Rul , the Internal Revenue Service ruled that the sole shareholder of an entity that converted from a corporate entity type to a disregarded entity type for federal income tax purposes was entitled to a worthless stock deduction where the fair market value of the entity s assets (including intangibles such as goodwill and going concern value) did not exceed its liabilities on the date of the conversion. A taxpayer is entitled to a capital loss if it holds stock that becomes worthless. The loss may only be claimed if the loss is evidenced by a closed and completed transaction, fixed by an identifiable event, and actually sustained during the taxable year. Moreover, ordinary loss treatment may apply if the taxpayer is a domestic corporation and the stock is of a corporation that is affiliated. A corporation is treated as affiliated if: y At least 80% of the voting power and value of all classes of the corporation s stock is owned directly by the taxpayer; and y More than 90% of the corporation s gross receipts historically consist of operating income, rather than dividends, royalties, and similar passive income. If the tax basis in the stock of the subsidiary is significant, a meaningful tax benefit may result. A corporate taxpayer may use this loss to (1) offset ordinary and capital gain income in the tax year of the loss, (2) carry back the loss up to two prior tax years for a refund, or (3) carry forward the loss up to twenty years. If the loss were treated as capital, on the other hand, the loss would be available by a corporate taxpayer to offset only capital gain income with a more limited carry forward period of five years. The opportunity to claim an ordinary worthless stock loss is principally applicable to domestic corporations with wholly owned foreign subsidiaries. An identifiable event, often evidenced by a liquidation of the subsidiary, must occur to claim a worthless stock loss. As long as the subsidiary is insolvent at the time of its liquidation, the tax treatment would be subject to whether all of the tests have been met for an ordinary deduction for worthless stock loss purposes. The subsidiary must be insolvent to pass this threshold test. Insolvent for federal income tax purposes generally means that the fair market value of the assets of the subsidiary does not exceed the sum of its liabilities. This standard becomes somewhat more difficult to establish in the context of a worthless stock loss: it must be demonstrated that there is neither a present value nor a future value as to the assets of the subsidiary. This is where independent, well qualified valuation experts come to the fore. The check-the-box rules generally provide that if an eligible entity has one owner, it is treated as a disregarded entity unless it makes an election to be treated like a corporation. If an entity that elected to be treated like a corporation later elects to be a disregarded entity, it is deemed to distribute all of its assets to its shareholder in a liquidation. If a wholly owned corporation is merged into a single-member limited liability company, it is deemed to distribute all of its assets to its owner in a liquidation. These events are identifiable events for worthless stock loss purposes, provided that the subsidiary is insolvent. If a taxpayer has a wholly owned subsidiary to which the check-the-box rules do not apply, it may still avail itself of like kind opportunities to claim a worthless stock loss. One advantage of the check-the-box election is that it may be retroactive: an election may be applied up to 75 days prior to the date on which the election is filed. This affords a grace period to consider it as a possibility after the end of a tax year during which the subsidiary became insolvent. For a corporate shareholder to establish a worthless stock loss with regard to a wholly owned subsidiary, it must be shown that at the time of an identifiable event (say, a deemed liquidation), the shareholder received no value for its subsidiary stock. Matching identifiable events with the determination of a lack of both the present value and future value of a company for federal income tax purposes often presents significant tax value for taxpayers. For more information contact Michael Williams at or Myron Marcinkowski at Duff & Phelps 3

4 International in Focus A Return to Dealmaking: 2011 Transatlantic Private Equity Survey Optimism prevails on both sides of the Atlantic, as the private equity community sets its sights upon a return to dealmaking. According to respondents of the 2011 Transatlantic Private Equity Survey, this is the year when investors will put their massive war chests to work. The return to dealmaking is driven, respondents say, according to a few macro-level conditions present across both North America and Europe: the ongoing recovery from the financial crisis, improved access to credit, and corporates seeking to put cash on the balance sheet to work. In Europe, 96% of respondents expect private equity activity to increase or increase significantly in their region. Slightly less bullish, 84% of respondents in North America expect to similarly increase or increase significantly the private equity activity in the region. The Survey data reveals that investors across the board believe the financing climate will turn the corner in More than half took the view that financings would improve by the first half of While 20% of European respondents believe it will be well into 2012 until significant improvements are seen. Methodology for the Survey The research methodology for the Survey, carried out by mergermarket, involved a series of interviews among private equity practitioners in North America and Europe. Respondents provided valuable insight into financing structures, geographies and industries they anticipate will experience activity, exit strategies and other issues that impact their investment strategies. Industries Healthcare and energy stand above all other industries as being the most ripe for activity in the next 12 to 24 months, among European and North American investors. Industrials, chemicals and engineering follow closely behind, with regard to the expected levels of deal activity in both regions. North American investors expect to see deals across every industry identified, while Europeans stand likely to avoid financial services, internet and e-commerce companies. Deal Activity by Region North American respondents are equally split between North America and Asia- Pacific as offering investment opportunities, but none identify Europe. In contrast, European respondents are more diverse in their views on which regions offer them opportunities. 58% of European respondents view North America as having potential for new investments perhaps driven by distressed opportunities and 17% view Asia-Pacific as having opportunity perhaps driven here by the enormous growth prospects in the region. Finally, one quarter of European respondents view their own region as being ripe for the greatest opportunities for new investments. Implications for Corporations What are the implications for large corporates in the midst of this renewal of private equity investing? First, corporates will have to compete with private equity investors for deals and likely demonstrate to targets the value of a strategic acquirer over a financial buyer. In addition, public companies may become targets for private equity buyouts. According to Survey respondents, a small yet meaningful percentage of North American investors do see public company acquisitions as a viable strategy over the next year, while European investors will focus on growth, distressed and minority interest transactions. Lastly, as private equity investors seek liquidity events over the coming year, a large percentage will look to sell their portfolio companies to public companies. A common theme among North American and European private equity firms is the need to shed portfolio companies as they gear up for new rounds of fundraising and show returns to their LPs. As such, 70% of European respondents and 90% of North American respondents expect an increase in the likelihood of the sale of a portfolio company to a public company just behind an IPO as the most likely liquidity event in the next 12 months. The conclusion is that public companies and the public markets will have a healthy appetite for the private equity portfolio companies coming onto the market. Tax and Regulatory Considerations More than three quarters of both European and North American respondents say their exit strategies will not be impacted by potential tax and regulatory changes. Only a small percent of Europeans admitted to reviewing their options to re-domicile to a more tax and regulatory favorable jurisdiction. There was a clear push to complete deals in the US by the end of 2010 to take advantage of the 15% capital gains/dividend rate. As a result of Congress extending the beneficial rates for an additional two years, and the credit markets still remaining very accommodating, deal activity in the U.S. has continued its upswing. China and Mexico remain popular jurisdictions for manufacturing subsidiaries, though both jurisdictions have recently changed their tax laws to make them less attractive. Visit transatlanticpesurvey to read the complete survey. Duff & Phelps 4

5 Valuation Insights - Third Quarter 2011 Spotlight FASB Proposed Accounting Standards Update on Testing Goodwill for Impairment The FASB recently issued an Accounting Standards Update (Update) titled Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The proposal was issued in response to private company preparers concerns about the cost and complexity of performing the first step of the two-step goodwill impairment test; however, FASB decided to expand the scope of the project to public companies as well. Under the proposed amendments, an entity would have the option to first assess qualitative factors to determine whether it is more likely than not (greater than a 50% likelihood) that the fair value of a reporting unit is less than its carrying amount; the outcome of this assessment could render the quantitative two-step goodwill impairment test unnecessary. As of June 16, 2011, the FASB received a total of 89 comment letters. In the comment black and white answers letters, a number of accounting firms expressed concerns about their ability to audit an entity s qualitative impairment assessment. As a result, the Board directed the staff to conduct workshops over the near-term with accounting firms, preparers, and regulators to discuss implementation concerns. A final Update is expected to be issued in the third quarter of ,000 shades of grey the sweet spot As a leading global independent provider of financial advisory and investment banking services, Duff & Phelps delivers added value and tailored advice to our clients, principally in the area of valuation, transaction and restructuring & financial performance. We find the right balance between analysis and instinct that sweet spot that powers sound decisions. Learn more at poweringsounddecisions.com Investment banking services in the United States are provided by Duff & Phelps Securities, LLC. Investment banking services in the United Kingdom and Germany are provided by Duff & Phelps Securities Ltd. Duff & Phelps Securities Ltd. is authorized and regulated by the Financial Services Authority. Investment banking services in France are provided by Duff & Phelps SAS. Member FINRA/SIPC Duff & Phelps, LLC. All rights reserved. Duff & Phelps 5

6 North American Industry Market Multiples As of June 30, 2011 MVIC to EBIT MVIC to EBITDA Industry U.S. Canada U.S. Canada U.S. Canada Energy Energy Equipment & Services Integrated Oil & Gas Materials Chemicals Diversified Chemicals Specialty Chemicals Construction Materials Metals & Mining Paper & Forest Products Industrials Aerospace & Defense Industrial Machinery Commercial Services & Supplies Road & Rail Railroads Consumer Discretionary Auto Parts & Equipment Automobile Manufacturers Household Durables Leisure Equipment & Products Textiles, Apparel & Luxury Goods Restaurants Broadcasting Cable & Satellite Publishing Multiline Retail MVIC to EBIT MVIC to EBITDA Industry U.S. Canada U.S. Canada U.S. Canada Consumer Staples Beverages Food Products Household Products Health Care Health Care Equipment Health Care Services Biotechnology Pharmaceuticals Information Technology Internet Software & Services IT Services Software Technology Hardware & Equipment Communications Equipment Computers & Peripherals Semiconductors Telecommunication Services Integrated Telecommunication Services Wireless Telecommunication Services Utilities Electric Utilities Gas Utilities of Equity/ Book Value Industry U.S. Canada U.S. Canada Financials Commercial Banks Investment Banking and Brokerage Insurance An industry must have a minimum of 5 company participants to be calculated. For all reported multiples in the U.S. and Canada, the average number of companies in the calculation sample was 80 (U.S.), and 50 (Canada); the median number of companies in the calculation sample was 26 (U.S.), and 29 (Canada). Source: Data derived from Standard & Poor s Research Insight and Capital IQ databases. Reported multiples are median ratios (excluding negatives). MVIC = of Invested Capital = of Equity plus Book Value of Debt. EBIT = Earnings Before Interest and Taxes for latest fiscal year. EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization for latest 12 months. Sample set includes all U.S.-based, publically-traded companies. Duff & Phelps 6

7 Europe Industry Market Multiples As of June 30, 2011 Industry MVIC to EBIT MVIC to EBITDA Industry MVIC to EBIT MVIC to EBITDA Energy Energy Equipment & Services Integrated Oil & Gas Materials Chemicals Diversified Chemicals Specialty Chemicals Construction Materials Metals & Mining Paper & Forest Products Industrials Aerospace & Defense Industrial Machinery Commercial Services & Supplies Road & Rail Railroads Consumer Discretionary Auto Parts & Equipment Automobile Manufacturers Household Durables Leisure Equipment & Products Textiles, Apparel & Luxury Goods Restaurants Consumer Staples Beverages Food Products Household Products Health Care Health Care Equipment Health Care Services Biotechnology Pharmaceuticals Information Technology Internet Software & Services IT Services Software Technology Hardware & Equipment Communications Equipment Computers & Peripherals Semiconductors Telecommunication Services Integrated Telecommunication Services Wireless Telecommunication Services Utilities Electric Utilities Gas Utilities Broadcasting Cable & Satellite Publishing Industry of Equity to of Equity to Book Value Multiline Retail Financials Commercial Banks Investment Banking and Brokerage Insurance An industry must have a minimum of five company participants to be calculated. For all reported multiples in Europe, the average number of companies in the calculation sample was 97 and the median number of companies in the calculation sample was 42. Source: Data derived from Standard & Poor s Research Insight and Capital IQ databases. Reported multiples are median ratios (excluding negatives). MVIC = of Invested Capital = of Equity plus Book Value of Debt. EBIT = Earnings Before Interest and Taxes for latest fiscal year. EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization for latest 12 months. Duff & Phelps 7

8 For more information about our global locations and expertise, or to subscribe to Valuation Insights, visit: Valuation Insights Contributors Lisa Gonzalez James Harrington David Larsen Myron Marcinkowski Sherri Saltzman Michael Williams About Duff & Phelps As a leading global provider of financial advisory and investment banking services, Duff & Phelps balances analytical skills, deep market insight and independence to help clients make sound decisions. The firm provides expertise in the areas of valuation, transactions, financial restructuring, alternative assets, disputes and taxation, with more than 1,000 employees serving clients from offices in North America, Europe and Asia. Investment banking services in the United States are provided by Duff & Phelps Securities, LLC. Investment banking services in the United Kingdom and Germany are provided by Duff & Phelps Securities Ltd. Duff & Phelps Securities Ltd. is authorized and regulated by the Financial Services Authority. Investment banking services in France are provided by Duff & Phelps SAS. For more information, visit (NYSE: DUF) Copyright 2011 Duff & Phelps Corporation. All rights reserved. DP111220