Valuation Importance and Issues. Chamber of Tax Consultants, Seminar on Corporate Restructuring 20 January 2017 Pinkesh Billimoria

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1 Valuation Importance and Issues Chamber of Tax Consultants, Seminar on Corporate Restructuring 20 January 2017 Pinkesh Billimoria

2 Investing in India An Easy Difficulty Valuation expectations / Mismatch in valuation Corporate governance Families giving up control Tax and regulatory Issues Management information systems Quality of second tier management Transparency of financial information and reporting standards Understanding the group structure and the role of the entity Lack of homework on partners Cultural Differences Less emphasis on the non-transactional area 34% Biggest challenges and barriers to growth for the Indian PE 20% 17% 14% 11% 11% 11% 9% 6% 6% 6% 6% 6% 6% 23% Regulatory environment/hurdle s Insufficient liquidity/access to capital Obtaining the right valuations Human capital deficiencies Difficult exit market Corporate governance/transpa rency Pressure on returns Portfolio company challenges/recoupin g value Sorting the quality groups from the bad Economic slowdown Poor quality of industry advisors Macro factors (inflation, foreign exchange) Shortages of quality investment opportunities Lack of acceptance of PE/investment mentality *Other Other includes: liberalisationof the market, political instability, lack of debt finance, enforceability of contracts, cross-border growth, uncertainty caused by forthcoming elections, reduced appetite of foreign investors, fundraising problems Source: Deloitte PE Survey

3 Valuation

4 What is a Valuation? Value is an economic concept where what a willing buyer is willing to pay and what a willing seller is willing to take overlap. Valuation means the procedure and technique of estimating the value of a specific Asset/ Liabilityatastatedtimeandplaceandforaspecificpurpose. Valuation is not just a SCIENCE, but an ART. Though quantitative in nature, the valuation methods require inputs that are based on subjective judgment. Hence, any preconception or bias of the valuer gets reflected in the value. Fusion of Art & Science Valuation involves application of different methodologies some being used as primary and some as corroborative depending on the facts and circumstances of each case. 4

5 Valuation A Perspective Valuation is relative to a specific point in time What is being valued Whyitisbeingvalued Secure definition of value Going concern vis-à-vis liquidation Premium for control, efficiency and synergy Timing Context Basis Extent of control Forward looking andcash flows key Premise Asset Method Earning Method Market Method 5

6 What is a Valuation? Principles of valuation Business value vs Asset value Business value more than assets Absolute value vs Relative value Value hovers within a range not a precise number Valuation v/s price "Price is what you pay. Value is what you get." - Warren Buffett Value Seller s subjective value line 3 key points to remember: Valuation involves informed subjectivity Price is different from value Deal is made at a Negotiated Price Buyer s subjective value line Perspective (set of assumptions) Area in which a market exists 6

7 Valuation Methodologies Asset based Earnings based Net Asset Value More than one right way to value Approaches are not exclusive; but complement each other Value of Business / Equity / Intangibles Discounted Cash Flow Earnings Capitalisation Royalty Relief method Contribution/ Excess earnings method Incremental Cashflows method Market Price Market based Comparable Companies Multiples Comparable Transaction Multiples 7

8 Valuation Methodologies Methods throw a range of values Consider relevance of each methodology depending upon the purpose & premise of valuation decide on primary and corroborative methods Selecting the final value/ range of values Subjective weighting: In professional judgement the conclusion is based on experience and judgment given the quality of information and the approaches applied Mathematical weighting In mathematical weighting specific weights are assigned to each approach and the weighted average calculated Both methods require subjectivity since the weights selected in mathematical Final Recommendation common sense and reasonableness 8

9 Importance of Valuation

10 What requires a Valuation the Purpose Business Valuation Regulatory Intangibles Financial Reporting Private Equity Restructuring of Companies FEMA issue/ transfer of shares Brand or Trade Names, Non Compete Agreement Purchase Price Allocation Entry Purchase/ Sale/ Merger/ Acquisition Transaction Transfer Pricing / Tax withholding tax/ capital gains tax Customer Contracts & Relationships Impairment Testing Financial reporting - Private Equity IPEVC Valuation guidelines Litigation/ Dispute / Family Settlements Valuation under SEBI Regulations Software and Technology Financial Instruments Options, ESOPs, Derivatives Subsequent rounds of funding Fund raising The Companies Act requirement Intellectual Property Ind AS reporting Exit CORPORATE RESTRUCTURING ~ M&A 10

11 Valuations and the Deal Cycle Target Identificatio n Negotiations and Term Sheet Post Diligence Adjustments Transaction Structuring and Closure Post Transaction Formalities Exit Lender Compliance and Financial purposes Asset Valuation Tax and Regulatory Valuations Buyout / Exit / Dispute Valuation Entry valuation FMV Valuations FMV Valuations and Pre deal PPA for Management / Board Consideration For Merger and Demerger PPA Portfolio Valuation Valuation an integral part of the deal 11

12 Issues in Valuation

13 Triangulating value perceptions Why deals fail Market Value What is it worth to someone else VALUE / DEAL VALUE Economic Value What it is worth to the current owner? Investment Strategic Value What could it be worth? 13

14 Where is the value What underpins the cash flows of this business -fixed assets, people (or one person), know-how? People business Asset business Once you have worked out what drives the value make sure that it is still there after you have acquired the business! Brands Identifying key value drivers & key risk areas 14

15 Value Drivers show me the money Qualitative Value Drivers Financial Value Drivers Quality Image Competition Market Share Customer Relation/ Contract Production Cost Price Per Unit Margin on Units Sold Sales Growth Investment in working capital EBITDA Margin Future Investments in Assets Free Cash Flows Discount Rate (Cost of Capital) Sustainable Growth Rate Shareholders Value Delivery Time Taxes IPRs 15

16 Valuation in Real life Start-up or Idea Companies Rapid Expansion High Growth Mature Growth Decline Revenues / Earnings Revenues Earnings Time Revenue / Current Operations Operating History Non-existent or low revenue /negative operating income Revenue increasing/income still low or negative Revenue in high growth/operating income also growing None Very limited Some operating history Revenue growth slows/operating income still growing Operating history can be used in valuation Revenue and operating income growth drop Substantial operating history Comparable Firms Source of Value None Entirely future growth Some, but in same stage of growth Mostly future growth More comparables, at different stages Portion from existing assets/growth still dominates Large number of comparables, at different stages More from existing assets than growth Declining number of comparables, mostly mature Entirely from existing assets 16

17 Valuation - Issues & Challenges Availability of information Sustainability of business model Scalability of business model Profitability of core operations Timing isitatapeakoratroughofaindustrycycle? Issues in forecasting Capex required to maintain the business Surviving the commercial test Loss making companies Valuation of start-up companies(i.e. e-commerce companies) Tax and Transfer Pricing tax breaks, amortisation rules, DTAA etc. DD Issues Valuation exercise reflects the VUCA of the underlying business being valued Volatility, Uncertainty, Complexity and Ambiguity 17

18 Valuation - Issues & Challenges Selection of methods Difficulty in obtaining Comparable companies and Transactions Thinly traded / Dormant Scrip - low floating stock, unusual fluctuations in market price Pre money or Post money valuation Discountrate -SCRP /Hurdlerate International valuation: Country/ political Risk Legal environment Different accounting policies and varied tax and corporate laws Relying on technical valuer s report putting a value to surplus assets 18

19 Valuation - Issues & Challenges Deal Structure- Merger/ Demerger/ Slump Sale/ Intangible Structuring a deal- emerging sectors- Healthcare, Education unorganized Funding structure and Forex movements Exotic instruments optionally convertible/ differential voting rights RBI/ FEMA Regulations Valuation giving minimum/ maximum price. SEBI guidelines Takeover/ Preferential pricing, Takeover- Direct/ Indirect, Delisting/ Open offer/ Reverse Book Building Synergies Premium/ Discount Accounting different GAAPs Jurisdiction different regulations, settlement mechanism 19

20 Conclusion

21 In Summary Valuation Practical issues and challenges in valuation especially in M&A Best practices to navigate Wear blinkers It is impossible to eliminate uncertainty in valuation. However, imperative to reduce / de-risk uncertainty as much as possible. 21

22 Valuations - Pitfalls Confusing Value with Price Confusing strategic value for a buyer with fair market value Interpreting Goodwill Asserting that a valuation is always a scientific fact, not an opinion Valid for any valuation date A valuation is valid for everybody It is important to avoid pitfalls. 22

23 In Summary Of late, valuations have been soft targets for dispute / litigation of listed companies Valuer to keep in mind fairness to all stakeholders Instances of minority shareholders delaying the restructuring process Balance needs to be achieved through transparency, fairness and best Corporate Governance practices Feel the deal -Don t look for precision. Accept that there is a reasonable possibility of erring Always remember the basics Keep it simple Scenario analysis Don t ignore black swan events Long term averages mean reversion Don t blindly follow the experts Herd mentality may not always help Keep a check on bias Smell test - common sense and reasonableness Wear blinkers Focus Get back Value to basics All in all, its hard to build assets competitively, but its harder to value them... 23

24 THANK YOU This document discusses various methods and process of valuation. The style contained herein is intended to make aware the valuation process in relation to general issues and concerns. The approach might be different in light of specific issues that are in nature different in context and character. Further, the information contained in this document is intended only to provide a perspective on valuation methods and the processfollowedinrelationtosuchandrelatedengagements. Itshouldbeinnowayconstruedtobeanopinionoradviseof any character and is in no way represented as such. The information provided herein should not be used and reproduced and should be considered privileged and only for the intended recipients.