19 NOVEMBER 2011 DRUSHTI DESAI

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1 19 NOVEMBER 2011 DRUSHTI DESAI

2 PRESENTATION OVERVIEW Purpose of Valuation Steps in Valuation Analysis of Company Principal Methods of Valuation Fair Value Other Value Drivers Issues

3 Purchase / Sale of Business Merger/ Demerger Private Equity Buyback of Shares Test of Impairment/ IFRS Why Valuation? IPO/ FPO Family Separation Litigation PPA Regulatory Approval Portfolio Value of Investments

4 STEPS IN VALUATION Obtaining information Reviewing data provided Selecting a method Applying Method Conducting sensitivities on assumptions Assigning Weights Determining Fair Value Reporting

5 SOURCES OF INFORMATION Historical data such as audited results of the companies being valued Future projections Stock market quotations Discussion with the management of the companies involved Representation by the management Data on comparable companies Market surveys, news paper reports

6 ANALYSIS OF COMPANY SWOT Analysis Profitability Analysis past and vis-à-vis industry Ratio Analysis P&L Ratio Expense & Profitability ratio Balance Sheet Ratio Quick Ratio/Current Ratio Turnover Ratios Liquidity Ratio Debt Equity of Company & Industry

7 PRINCIPAL METHODS OF VALUATION Asset Based Approach Net Assets Method Replacement Value/Realisable Value Earning based Approach Price Earnings Multiple Method Discounted Cash Flow EBIDTA Multiple Method Sales Multiple/Revenue Multiple Method Market Approach Market Price Market Comparables

8 NET ASSETS METHOD FORMULAE The Value as per Net Asset Method is arrived as follows: Total Assets (excluding Miscellaneous Expenditure and debit balance in Profit & Loss Account) Less: Total Liabilities NET ASSET VALUE OR Share Capital Add: Reserves Less: Miscellaneous Expenditure Less: Debit Balance in Profit & Loss Account NET ASSET VALUE

9 NET ASSETS METHOD Following adjustments may be called for: Accounting Policies Contingent Liabilities Auditors Qualification Sales Tax Deferment Loan Investments & Surplus Assets Inventory & Debtors Contingent Assets Preference Shares ESOPs / Warrants

10 ABC LIMITED VALUATION AS ON 31 MARCH 2011 NET ASSETS METHOD (Rs. in Lakhs) Particulars XYZ Ltd. Net Fixed Assets 1,000 Current Assets 2,450 Current liabilities (1,565) Net Current Assets 885 Investments 500 Deferred Tax liabilities (100) Loan Funds (550) Net Assets 1,735 Adjustments: Appreciation in the value of Investment 350 Preference Share capital (150) Contingent liabilities (20) Other Adjustments **** Adjusted Net Assets 1,915 No. of Equity shares (FV- RS.10 each) Value per Share (in Rs.) 213 MV/BV multiple 2.1 Derived Market Price based on NAV 447

11 NET ASSETS METHOD Situations where Net Assets Method may be used: Manufacturing companies where fixed assets have greater relevance for earning revenues Investment Companies Start up companies(capital intensive in nature) Companies with no sustainable track record of profits Companies with no reliable evidence of future profits due to violent fluctuations/disruption of business Where there is an intention to liquidate and to realize the assets and distribute the net proceeds

12 EARNING BASED APPROACH Price Earnings Multiple Method- Parameters Future Maintainable Profits Appropriate Tax Rate Capitalisation Rate

13 PRICE EARNINGS MULTIPLE METHOD Based on past performance and /or projections Appropriate in case of valuation for going concern Non-recurring& extraordinary items excluded Profits of various years are averaged (simple or weighted). Check for abnormal year, if any. Current profit is accorded the highest weight Projected profits discounted for inflation By applying effective tax rate, maintainable Profit After Tax arrive at Finally appropriate capitalisation rate/pe multiple is appliedto arrive at the value

14 ABC LIMITED CALCULATION OF ADJUSTED PBT (Rs. in Lakhs) Particulars Profit before Tax 910 Less: Non recurring Income Dividend Income 300 Profit on sale of Fixed Assets 120 Profit on Sale of Investments - Interest on Income tax refund 50 Interest Income 30 Total Non recurring Income 500 Add: Non recurring Expenditure Loss on Sale of Fixed Asset VRS paid 20 Others 2 Total of Non recurring Expenditure 22 Adiusted PBT 432

15 ABC LIMITED Valuation as on 31 March 2011 Price Earnings Capitalisation Value Method Particulars (Rs. in Lakhs) Adjusted PBT 432 Tax Rate 32.45% 140 Maintainable PAT 292 PE Multiple 11.5 Capitalised Value 3356 Adjustments Value of Investments 850 Contingent Liabilities (20) Deferred Tax Liabilities (100) Preference Share Capital (150) Other Adjustments **** Adjusted Earning Value 3936 No. of Equity shares (FV-Rs. 10 each) Value per Share(in Rs.) 437

16 DISCOUNTED CASH FLOW (DCF) Considers Cash Flow and Not Profits Cash is King Free Cash Flow ( FCF ) FCFtoFirm FCFtoEquity FCF to Firm Preferred Nominal or Real Cash Flows

17 CASH FLOWS Business Plan Business Cycle Working Capital Capital Expenditure Depreciation Amortization Tax

18 DCF - PROJECTIONS Factors to be considered for reviewing projections: Industry/Company Analysis Dependence on single customer/ supplier Installed capacity Existing policy/ legal framework Capital expenditure increasing capacities Working capital requirements Alternate scenarios / sensitivities

19 DCF - DISCOUNTING Weighted Average Cost of Capital (WACC) WACC={D/(D+E) *kd} + {E/(D+E)*ke} D = Debt E = Equity Kd = Post tax cost of debt Ke = Cost of equity

20 DCF - TERMINAL VALUE Terminal Value is the residual value of business at the end of projection period used in discounted cash flow method. Terminal Value Liquidation Approach Multiple Approach Stable Growth Approach

21 ABC LIMITED Valuation as on 31 March 2011 DISCOUNTED CASH FLOW METHOD (Rs. In Lakhs) Particulars Perpetuity Operating PBT Add: Interest Depreciation Total Inflows Less: Outflows Capital Expenditure Incremental Working Capital Tax Total Outflows Free Cash Flows (FCF) Cash Flow for Growth Rate 3% Capitalised Value for Perpetuity 5,150 Discounting Factor 14.00% Net Present Value of Cash Flows Enterprise Value 4,080 Loan Funds (550) Preference Share Capital (150) Contingent Liability (20) Surplus Funds 250 Value of Investments 850 Adjusted Value for Equity Shareholders 4,380 No of Equitv Shares Value Per Share (FV Rs.10) 496

22 OTHER EARNINGS-BASED METHODS EBITDA Multiple Method: Involves determination of maintainable EBITDA Based on projections or past performance. Weights may be assigned to various years EBITDA Not affected by the pattern of Funding adopted by Company/ Comparable Companies Sales Multiple Method: Compares Enterprise value to Company s Sales

23 CALCULATION OF ADJUSTED EBITDA ABC Limited (Rs. In Lakhs) Particulars Adjusted PBT 432 Add: Interest Expense 40 Add: Depreciation 70 Adjusted EBITDA 542

24 ABC LIMITED VALUATION AS ON 31 MARCH 2011 EBITDA Multiple Method (Rs. in Lakhs) Particulars Adjusted EBITDA 542 EV/EBITDA Multiple 7.5 Enterprise Value 4065 Adjustments: Value of Investments 850 Contingent Liability (20) Loan Funds (550) Preference Share Capital (150) Other Adjustments **** Adjusted Equity Value 4195 No. of Equity Shares (FV-Rs. 10 each) Value per Share (In Rs) 466

25 MARKET PRICE APPROACH Evaluates the value on the basis of prices quoted on the stock exchange Thinly traded / Dormant Scrip Low Floating Stock Significant and Unusual fluctuations in the Market Price Weighted Average of quoted price for past 6 months Regulatory bodies often consider market value as important basis Preferential allotment, Buyback, Takeover Code

26 ABC Limited Valuation as on 31 March 2011 Market Price Method Months Volume Turnover Monthly Average Price April ,95,000 72,61,42, May ,95,000 58,49,22, June ,02,560 58,58,22, July ,26,395 63,78,51, August ,85,424 58,47,13, September ,57,403 41,92,24, Total 82,61,782 3,53,86,76,598 Value per Share (in Rs.)

27 MARKET COMPARABLES Generally applied in case of unlisted entities Estimates value by relating an element with underlying element of similar listed companies. Based on market multiples of Comparable Companies Book Value Multiples Industry Specific Multiples Multiples from Recent M&A Transactions

28 SELECTION OF METHODS Situation Approach Knowledge based companies Manufacturing Companies Brand Driven companies A Matured company Investment/Property companies Company going for liquidation Earnings/Market Earnings/ Market/ Asset Earnings/Market Earnings/Market Asset Asset Generally Market Approach is used in Combination with other methods or as a cross check

29 FAIR VALUE Method Value per Share (In Rs.) Net Assets Method 447 Price Earning Multiple Method 437 EBIDTA Multiple Method 466 DCF Method 496 Market price Method 428

30 OTHER VALUE DRIVERS Distress Sale Alternate Opportunity Strategic Positioning Final Value Emerging Markets Illiquidity discount Control Premium Final Value is a result of negotiations

31 VALUATION ISSUES ARISING IN MERGERS & DEMERGERS Case study on Valuation date A Ltd. and B Ltd. propose to amalgamate. The date of the board meeting for considering the proposal and appointing a valuer is October 7, The Appointed Date fixed for the purpose of amalgamation is April 1, The valuer gives his report on the ratio of exchange as the case may be on November 7, 2011.

32 Issue raised On what date should the fair values be determined? Should it be 1. April 1, 2011 i.e. the appointed date, or 2. September 30, 2011

33 ISSUES FOR SELECTING THE CaseI: APPROACH B Ltd own a prime plot of land from which it is carrying out manufacturing activity. The business of B Ltd is incurring losses. The manufacturing facility of B Ltd is old and the technology obsolete. Revival of the business of B Ltd is not possible. However, the plot has an alternate use, which is highly profitable, viz. real estate development. The existing management of B Ltd does not have the expertise to develop the plot.

34 A Ltd. on the other hand has the necessary expertise for such real estate development and is looking at acquiring B Ltd. To acquire the property for development. The market value of the plot of land is Rs. 150 crores. There are 50 employees working in the facility. The VRS payable to the employees works out on an average to Rs. 5 Lacs per worker. What should be the method of valuation that should be adopted? The business of B Ltd. would be valued on assets backed method. The valuation would be based on the liquidation approach.

35 Since, what is proposed to be acquired is the entire company, all other assets and liabilities, including contingent liabilities should be considered in valuation. All the assets should logically be considered at their realisable values. From the market value of the plot of land the VRS cost of Rs. 2.5 crores should be considered.

36 Case II In the case discussed above if the land was with restricted usage and could not be exploited for real estate development then value of B Ltd may be substantially different. Evidently, a real estate developer would not be interested in undertaking the acquisition. The person interested acquisition had the latest technology that could be used for upgrading the plant and make it viable. The upgradation is expected to cost Rs 15 Crores over a period of 3 years.

37 a. How would the valuation of the business be done in such a case i.e. would it be based on the asset value or on profitability. b. Should the valuation be based on the past profits or only future profits? c. Shouldit be based on cash flows?

38 a. As discussed before, the business at present is not a profitable business. There are no profits available for its past performance. Therefore, valuation based on the past performance will not be feasible. b. Indeed, the business is expected to turn around in the future. However, the cost involved in turning it around is not factored into arriving at its profits. Therefore, merely computing the value based on profits may not be fair to the buyer. c. In this situation it would be appropriate to compute the value based on the future operating cash flows. Such cash flows would be after considering the capital outgo.

39 Case III An enterprise has borrowed funds for its operations. Over a period of three years,it expectsto repay its debts. Should the WACC applicable to the first year be made applicable to each of the projected years? Ideally in a DCF model the WACC should be based on the long term capital structure. However, in the given case the capital structure is not constant for the immediately projected three years. In such a case it would be ideal to consider individually ascertained WACC for the first three years and then a maintainable WACC for the balance period.

40 CONTROL PREMIUM When acquisition of a high stake is involved the acquirer gets a representation in the management of the acquired company; In such a case the acquirer is willing to pay a premium for the control so acquired and this premium is termed as Control Premium

41 Case Group A acquires a 26% stake in B Ltd.,which is a private company. The value per share of B based on profits/ cash-flows is worked out to Rs For the purpose of such working beta or P/E multiple of the industry is adopted. Would the acquisition take place at Rs. 100 or would the seller demand an additional price? B would be justified in asking for a premium on the price as A would get a controlling stake in B. By giving 26% stake B would give up his powerto pass a special resolutionwithout the consent of the A.

42 DISCOUNT FOR LACK OF MARKETABILITY AND CONTROL Discount for Lack of Marketability and Control is applied to the Company s Equity Value to arrive at a reasonable approximation of minority, non-marketable value per share. Case A Ltd.is not a listed company. In valuing its shares based on profits the multiple applicable to the Industry comprising of listed companies is used. Should the multiple of the listed companies be discounted to make it applicableto A Ltd. Yes. The multiple should be discounted before making it applicableto A, as the shares of A are not marketable.

43 SURPLUS ASSETS Non Operating Assets of the Business are referred to here as the Surplus Assets. Case A Ltd has a surplus asset in the form of a property. The property is not put to any business utilisation, nor is it proposed to be. The property is currently let out. 1. Should the valuation of A have a special reference to the surplus property. 2. Should the surplus asset be considered at its full market value?

44 1. Yes. Effect to be given Income earned from the surplus assets is to be reduced from the profits of A. The Market value of the Surplus Asset is to be added to the Final Value arrived at for the business of A. 2. The value of the property could taken net of the cost of disposing it, e.g. tax, stamp duty etc.

45 Valuation is.. A blend of art and science but a disciplined and systematic blend. Thoroughly dependent on all of the explicit and implicit assumptions made. CONCLUSION

CA SUJAL SHAH. 22 nd June 2013

CA SUJAL SHAH. 22 nd June 2013 CA SUJAL SHAH 22 nd June 2013 Value Price Valuation-not an exact science, more an art Value varies with situations Date specific Purchase / Sale of Business Merger/ Demerger Private Equity Buyback of Shares