Buying and selling companies: what Corporate Counsel should understand

Transcription

1 Asset Valuations: Buying and selling companies: what Corporate Counsel should understand Yves Heijmans, Lead European Counsel, Chevron Phillips Chemicals Int NV Alessandro Macri, Legal Counsel, GMAC Financial Services Mathias Schulze Steinen, Partner, K&L Gates LLP

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3 Introduction / Scope of session Asset Based Valuation Income Based Valuation Market Based Valuation Case Study

4 Value & Valuation Value is an economic concept, an estimate of likely prices to be concluded by a buyer and a seller, not a fact. Valuation is the process of determining the Economic Worth of an asset or company under certain assumptions and limiting conditions and subject to the data available on the valuation date.

5 Purposes for Valuation Strategic Planning Dispute Resolution Regulatory Mandate Public Offerings Compensation schemes Mergers & Acquisitions

6 Objectives of Valuation Mediation: results in arbitration award value (e.g., stock swap) Reasoning: argument is backed up by value (e.g., in unfriendly takeover) Counseling: decision is based on value (e.g., minimum / maximum price for seller / buyer)

7 Key facts of Value & Valuation Price is not the same as value Value varies with person, purpose and objective Valuation is hybrid of art & science Transaction concludes at negotiated prices

8 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

9 Asset Based Methods Commonalities: Companies' value lies basically in its balance sheet. Business is a set of assets and liabilities that are used as building blocks to construct the picture of business value. The difference of these assets and liabilities is the business value. Different Approaches: (adjusted) book value liquidation value replacement value

10 Critics to Asset Based Methods (1/2) Viable method for companies having reached the mature or declining growth cycle, property and investment companies having strong asset base, evaluation of entry barrier that exists in a business.

11 Critics to Asset Based Methods (2/2) Method not a true indicator of the fair business value, as value reflected in books is historical in nature and does not usually include intangible assets and earning potential, static viewpoint that does not take into account temporary effects such as evolution of the company, money s temporary value, industry s current situation, human resources, organizational problems, it does not cover impact by accounting policies which may be discretionary at times.

12 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

13 Asset Based Methods: Book Value (1/2) Form of valuation that is based on company s book value (i.e., net worth) = shareholders equity stated in the balance sheet (capital and reserves). It is also the difference between total assets and liabilities, i.e., the surplus of the company s total goods and rights over its total debts with third parties.

14 Asset Based Methods: Book Value (2/2) Example (Beta Inc. Official Balance Sheet in Million Euros): Assets Liabilities Cash 5 Accounts payable 40 Accounts receivable 10 Bank debt 10 Inventories 45 Long-term debt 30 Fixed assets 100 Shareholders' equity 80 Total assets 160 Total liabilities 160 Method entirely dependent on the accounting criteria which are subject to a certain degree of subjectivity and differ from market criteria. Book value almost never matches the market or fair value.

15 Adjusted Book Value (1/2) Net worth is obtained when the values of assets and liabilities match their market value. Example (Beta Inc. Official Balance Sheet in Million Euros): Assets Liabilities Cash 5 Accounts payable 40 Accounts receivable 8 Bank debt 10 Inventories 52 Long-term debt 30 Fixed assets 150 Shareholders' equity 135 Total assets 215 Total liabilities 215

16 Adjusted Book Value (2/2) Method seeks to overcome the shortcomings that appear when purely accounting criteria are applied in valuation. To be factored in also contingent liability, tax shields on accumulated losses, impact of auditors qualification and due diligence, money to be received from warrants, stock options, impact of corresponding shares.

17 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

18 Liquidation Value Company s value if it is liquidated = its assets are sold and its debts are paid off Value is calculated by deducting the business s liquidation expenses (redundancy payments to employees, tax expenses and other typical liquidation expenses) from the adjusted net worth. Method s usefulness limited to a highly specific situation. BUT: Always represents the company s minimum value as a company s value, assuming it continues to operate, is greater than its liquidation value.

19 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

20 Replacement Value Investment that must be made to form a company having identical conditions as those of the company being valued. Does not include assets that are not used for the company s operations, e.g. unused land, holdings in other companies. Three types of replacement value are usually defined: - gross substantial value: asset s value at market price, - net substantial value: gross subst. value less liabilities, - reduced gross substantial value: gross substantial value reduced only by value of the cost-free debt. Not relevant in case of a valuation for a going concern.

21 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

22 Market Based Methods (1/2) Value is determined by comparing the subject, company or assets with its peers or transactions happening in the same industry and preferably of the same size and region. This method is easiest to use when - large number of assets comparable to the one being valued, - assets are priced in the market, - there exist some common variable that can be used to standardize the price.

23 Market Based Methods (2/2) Whereas no publicly traded companies provides an identical match to the operations of a given company, important information can be drawn from the way similar enterprises are valued by public markets.

24 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

25 Comparable Companies Market Multiples Method Market Multiples of Comparable Listed Companies are computed and applied to the Company being valued to arrive at a multiple based valuation. Most valuations in stock markets are market based. The difficulty is the selection of a comparable company, since it is rare to find two or more companies with the same product portfolio, size, capital structure, business strategy, profitability and accounting practices.

26 Understanding the CC Method (1/2) Identify comparable firms and determine values from market data (peer) Adjust values for different accounting methods Calculate the multiple based on the peer group's base and values Estimate the base of the multiple for the subject business unit or company Apply the multiple from the peer group to the subject business unit or company

27 Understanding the CC Method (2/2) Identifying relevant comparables (examples): Price / Earnings ratio: market value of equity on the basis of net income of the company Price / Book ratio: market value of equity on the basis of book value of the company EV / Sales ratio: enterprise value on the basis of company's net sales EV / EBITDA ratio: enterprise value on the basis of operating efficiency

28 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

29 Comparable Transaction Multiples Method Mostly used for valuing a company for M&A: acquisitions or divestitures are identified that have taken place in the industry which are similar to the transaction under consideration. The multiples implied by their purchase prices are used to assess the subject company s value. Greatest impediment in finding truly comparable transactions: absence of available information on private transactions based on which such transactions took place. The more recent the transaction, the better this technique.

30 Comparable Transaction Multiples Method: Market Data for 2012

31 Main Valuation Methods Asset based / Balance Sheet Income based Market based Others Book Value Capitalization of Earning Comparable Companies Market Multiples Contingent Claim Valuation Liquidation Value Discounted Free Cash Flow Comparable Transaction Multiples Price of Recent Investment Replacement Value Market Value (for Quoted Securities) Rule of Thumb

32 Market Value Method (for Quoted Securities) Most preferred method in case of frequently traded shares of companies listed on Stock Exchanges having nationwide trading.

33 Reconciliation and Value Conclusion Different methods show different range of values. Valuer has to consider relevance of each method depending upon the purpose and premise of each valuation. While selecting the final value: - Mathematical weighting assigns specific weights to each approach and weighted average is calculated. - Conclusion is based on experience and judgment given the quality of information and the approaches applied.