Valuations

1. Valuations For Merger Acquisitions and Joint Ventures

2. Valuations • An Exercise carried out during • M&A process • Listing • Private Equity • General Purpose Evaluation

3. Objective of Valuation • To Arrive at an approximate value of a going concern • To identify the potential and derivate the value of tangibles and intangibles • To assign monetary aspect to promoters skill, trust and confidence

4. Methods • DCF • FCFE • FCFF • Comparable Companies / Relative Method • Multiples assigned to Sales • Multiples assigned to EBITDA • P/E • Methodology based upon business • Replacement Value • Net Adjusted Asset Values

5. Valuation methods These can be broadly classified into: • Cost based • Income based • Market based www.venturebean.com

6. Income Based methods • Earnings capitalisation method or profit earning capacity value method • Discounted cash flow method (DCF)

7. Earnings capitalisation method • This method is also known as the Profit earnings capacity value (PECV) • Company’s value is determined by capitalising its earnings at a rate considered suitable • Assumption is that the future earnings potential of the company is the underlying value driver of the business • Suitable for fairly established business having predictable revenue and cost models

8. Applicability of DCF method • Cash flow to equity • Discount rate reflects cost of equity • Cash flow to firm • Discount rate reflects weighted average cost of capital

9. Discounted cash flow • Cash flow to equity • Valuation of equity stake in business • Based on expected cash flows • Net of all outflows, including tax, interest and principal payments, reinvestment needs

10. Discounted cash flow • Cash flow to firm • Value of firm for all claim holders, includes equity investors and lenders • Net of tax but prior to debt payments • Measures free cash flow to firm before all financing costs

11. Applicability • Discounted cash flow is based on expected cash flow and discount rates • Sometimes it is difficult to get a reliable estimate for the future and the valuation model may need modification

12. Limitations • Companies in difficulty • Negative earnings • May expect to lose money for some time in future • Possibility of bankruptcy • May have to consider cash flows after they turn negative or use alternate means

13. Limitations • Companies with cyclic business • May move with economy & rise during boom & fall in recession • Cash flow may get smoothed over time • Analyst has to carefully study company with a view on the general economic trends. The bias of the analyst regarding the economic scenario may find its way into the valuation model

14. Limitations • Unutilised assets of business • Cash flow reflects assets utilised by company • Unutilised and underutilised assets may not get reflected in the valuation model • This may be overcome by adding value of unutilised assets to cash flow. The value again may be on assumption of asset utilisation or market value or a combination of these

15. Limitations • Companies with patents or product options • Unutilised product options may not produce cash flow in near future, but may be valuable • This may be overcome by adding value of unutilised product using option pricing model or estimating possible cash flow or some similar method

16. Limitations • Companies in process of restructuring • May be selling or acquiring assets • May be restructuring capital or changing ownership structure • Difficult to understand impact on cash flow

17. Limitations • Companies in process of restructuring • Firm will be more risky, how can this be captured? • Historical data will not be of much help • Analysis should carefully try to consider impact of such change

18. Limitations • Companies in process of M&A • Estimation of synergy benefit in terms of cash flow may be difficult • Additional capex may be calculated based on inadequate information or limited data • Difficult to capture effect of change in management directly in cash flow • Analyst should try to study impact of M&A with due care

19. Limitations • Companies in process of M&A Historically, many M&As have not done as well as expected. Many times this has been attributed to valuation being too high. To minimise this risk of over valuation, a proper due diligence review (DDR) exercise is to be done, with one of the mandates for this being careful review of the value drivers and the business proposition.

20. Limitations • Unlisted companies • Difficult to estimate risk • Historical information may not be indicative of future, particularly in early stage, growth phases • Market information on similar companies can be difficult to obtain

21. MARKET BASED METHOD

22. Market based method • Also known as relative method • Assumption is that other firms in industry are comparable to firm being valued • Standard parameters used like earnings, profit, book value • Adjustments made for variances from standard firms, these can be negative or positive

23. Relative Valuation • Using fundamentals • Valuation related to fundamentals of business being valued • Using comparables • Valuation is estimated by comparing business with a comparable fit

24. Relative Valuation • Using fundamentals for multiples to be estimated for valuation • Relates multiples to fundamentals of business being valued, eg earnings, profits • Similar to cash flow model, same information is required • Shows relationships between multiples and firm characteristics

25. Relative Valuation • Using Comparables for estimation of firm value • Review of comparable firms to estimate value • Definition of comparable can be difficult • May range from simple to complex analysis

26. Applicability • Simple and easy to use • Useful when data of comparable firms and assets are available

27. Limitation • Easy to misuse • Selection of comparable can be subjective • Errors in comparable firms get factored into valuation model

28. VALUATION: What it depends on www.venturebean.com

29. Valuation depends on • Management team • Historical performance • Future projections • Project, product, USP • Industry scenario • Country scenario • Market, opportunity, growth expected, barriers to competition

30. Valuation depends on • Nature of transaction • Whether 1st round or later round • Whether family and friends or other parties • Amount of money required • Stage of company - early stage, mezzanine stage (pre-IPO), later stage (IPO)

31. Valuation depends on • Strategic requirements and need for transaction • Demand / supply position • Flavour of the season Initial ballpark valuation can also be a deal issue

32. VALUATION: Process

33. Process of valuation Consider • Net assets tangible and intangible • Financial data • Historical information • Company info • Industry info • Economic environment

34. Process of valuation • Include elements of cash, costs, revenues, markets • Plan long term not short haul • Use more than one model • Discount for risks, assign probabilities • Arrive at range A valuation range is preferable to a single number

35. Process of valuation Finally after arriving at the value range raise some fundamental questions • Does the value reflect the past performance and the expected future? • Does the value reflect the USP as compared to competition? • Does the value reflect the quality of the management?

36. Process of valuation The last mile… • Does the valuation reflect the picture you have of the business? • Would you be willing to pay this price?

37. Valuation: for investment • Valuation is perception in the eye of the beholder • It is subject to negotiation Investor Value Company Value Function of time

38. Valuation: in M&A • Value of combined business is expected to be more than value of the individual companies Value (A+B) Value A + Value B

39. APPLICATION OF VALUATION MODELS In special cases

40. Multi business models • The entire business is valued as a sum of the parts • Valuation depends on successful management of different units • Strategic decisions usually occur at each business unit level • To understand the company one needs to first understand the opportunities and threats faced by each business unit

41. Multi business models • Valuation of company that is based on valuation of individual business units provides deeper insight • Valuation of individual business units also helps understand whether the company is more valuable as a whole or in parts and to understand where the value is (eg. in some units or in the company as a whole)

42. Multi business models • Particularly useful in restructuring and reworking business and financial strategy of the business going ahead • Helps understand and get a better picture of costs of the corporate office and understand allocation of these costs and whether these can be reduced

43. Multi business models • Identifying business units can be complex • Cash flows projection can be complex and interdependent on different units • Allocation of corporate office costs and other company costs/benefits may be difficult

44. Multi business models • A business unit is identified as one which can be split off as a stand alone unit or sold to another enterprise • Units are to be logically separable • They should not have depend production/sales/distribution etc. • Some joint products may fall under one unit, if there is interdependency which calls for this • If there is limited interdependency, this may be viewed by considering transfer pricing and whether transactions could be considered ‘arms length’

45. Multi business models • Allocation of corporate costs including some or all of these: • Salary and other costs of key management • Board costs • Corporate administration costs • Costs of listing as a public company • Advertising and marketing costs

46. Multi business models • Allocation methods are to be carefully thought through and could be a combination of different methods for different costs, including • Based on time spent (time sheets) • Advertising based on revenue

47. Multi business models • Benefits are also to be incorporated, including • Saving on operational costs • Information/communications • Tax benefits / shields (ie one loss producing unit would provide a shield to another profit making one – important when one is considering a split up / hive off of some units) • Intangible benefits – can these be quantified? (Eg key person in management team / Board)

48. Multi business models • Difficulties and concerns • Partial holdings in units (taken as a percentage of ownership of business unit value) • Double counting may occur • Allocation may pose difficulties • Interdependency may not be easy to separate • Intangibles cannot be easily quantified • Transfer pricing to be viewed in the regulatory context

49. Mergers/Acquisitions • These have become very important as companies try to grow inorganically or network to exploit possible synergies • Most senior executives may be involved in such transactions • Directly or indirectly • In the buy side or target side

50. Mergers/Acquisitions Rationale for the proposed transaction is to be understood • Synergy • Revenues • Costs • Intangibles • Control/ dominance in market • Under valuation perceived (LBOs/LBIs)