Valuation – A Fast Growing Practice Area for CAs

Valuation – A Fast Growing Practice Area for CAs CA Sujal Shah NATIONAL CONFERENCE Rajkot (WIRC) December 28, 2013

Presentation Overview • Valuation Concept • Principal Methods Of Valuation • Discounted Cash Flow Method (DCF) • Enterprise Value/ EBITDA Multiple Method • Market Price Method • Net Assets Value (NAV) Method • Judicial Pronouncements • Opportunities for Professionals • Best Practices • Companies Act, 2013 – Registered Valuer

Valuation Concept Value - Price Not an Exact Science Value varies with situation Subjective More of an Art Date Specific

Principal Methods of Valuation

Discounted Cash Flow (DCF) • Values a business based on the expected cash flows over a given period of time • Involves determination of discount factor and growth rate for perpetuity • Value of business is aggregate of discounted value of the cash flows for the explicit period and perpetuity

Discounted Cash Flow (DCF) • Considers Cash Flow and Not Profits • Cash is King • Free Cash Flow (‘FCF’) • FCF to Firm • FCF to Equity

DCF – Parameters • Cash Flows • Projections • Horizon period • Growth rate • Discounting • Cost of Equity • Cost of Debt • Weighted Average Cost of Capital (‘WACC’)

Earnings Multiple Method Commonly used Multiples

Enterprise Value/EBITDA Multiple Method • Determination of Maintainable EBIDTA • Multiple • Not affected by the pattern of Funding adopted by Company/ Comparable Companies

Maintainable Earnings • Based on past performance and/ or projections • Elimination of Material non-recurring/ non operational items • Adjustment if Capacity is under-utilized or recently added • Profits of various years averaged (simple or weighted)

Multiples • Multiples to be applied represent the growth prospects/ expectations of the Company • Factors to be considered while deciding the multiple: • Past and Expected Growth of the Earnings • Performance vis-à-vis Peers • Size & Market Share • Historical Multiples enjoyed on the Stock Exchange by the Company and its peers

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 • It is prudent to take weighted average of quoted price for past 6 months • Regulatory bodies often consider market value as important basis – Preferential allotment, Buyback, Takeover Code

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

NAV Formula The Value as per Net Asset Method is arrived as follows: OR

Common Adjustments Following adjustments may be called for: • Investments • Surplus Assets • Auditors Qualification • Preference Shares • ESOPs / Warrants • Contingent Liabilities/Assets • Tax concessions • Findings of Due Diligence Reviews

Selection of Methods Generally Market Approach is used in Combination with other methods or as a cross check

Reaching a Recommendation • Methods throw a range of values • Consider the relevance of each methodology depending upon the purpose and premise of valuation • Mathematical weightage • Professional judgment • Subjective Value

Other Value Drivers Strategic Positioning Control Premium Illiquidity Discount Final Value Distress sale Emerging markets Alternate opportunity Final Price is a result of negotiations

Judicial Pronouncements Exchange Ratio not disturbed by Courts unless objected and found grossly unfair” • Miheer H. Mafatlal Vs. Mafatlal Industries (1996) 87 Com Cases 792 • Dinesh v. Lakhani Vs. Parke-Davis (India) Ltd. (2003) 47 SCL 80 (Bom) “Valuation will take into account number of factors such as prospective yield, marketability, the general outlook for the type of business of the company, etc. Mathematical certainty is not demanded, nor indeed is it possible ” • Viscount Simon Bd in Gold Coast Selection Trust Ltd. vs. Humphrey reported in 30 TC 209 (House of Lords)

Judicial Pronouncements (cont.) It is fair to use combination of three well known methods - asset value, yield value & market value • Hindustan Lever Employees’ Union Vs. HLL (1995) 83 Com. Case 30 SC Valuation job must be entrusted to people who know the Company rather than giving to outsiders who will start from scratch • Consolidated Coffee V/s Arun Kumar Agrawal (1999) 21 SCL 11 (Kar)

Opportunities for Professionals Valuation Requirement: • For Transaction Closure • For Regulatory Approval • For Internal Use …Cont.

Opportunities for Professionals (cont.) Valuation for Transactions: • Acquisition/ Sale of Equity stake or Business • Corporate Restructuring (Merger, Demerger, etc.) • Sale/ Purchase of Intangible assets • Joint Venture Partners’ exit • Family Separation • Liquidation of company …Cont.

Opportunities for Professionals (cont.) Valuation as per Regulatory Requirements: • Reserve Bank of India • Securities Exchange Board of India • Income Tax Act, 1961(Sec. 56, Transfer Pricing , etc.) • Stock Exchanges • Companies Act, 2013 • Stamp Duty …Cont.

Opportunities for Professionals (cont.) Internal Use: • Purchase Price Allocation (PPA) • Testing of Impairment • Applying for a loan • Seeking Investors/IPO • Portfolio Value of Investments by Venture Funds / Private Equity Funds

Opportunities for Professionals (cont.) Competence for Valuation • What we are taught in CA course is more than sufficient • Read books on valuation E.g. Damodaran, Mckinsey, etc. • Broad knowledge of economy and industries • Training with a valuation firm • Use of common sense • Be open to new thoughts • Keep your eyes and ears open • Use of Technology

Opportunities for Professionals (cont.) Regular Reading • Newspapers / Business Magazines • Financial Statements • Stock Exchange Announcements • Journals of Professional bodies • Tax Updates • International Magazines / Newspapers • SEBI & Corporate Law Journal

Best Practices • Unreasonable timelines vis-à-vis quality • Rationale for various parameters used in valuation • Arithmetical accuracy of the model • Detailed office notes on valuation • Regular Internal training of employees • Internal peer review • Strict Adherence to Code of Conduct of the Institute …Cont.

Best Practices (cont.) • Internal Code of Conduct at office • Confidentiality • Chinese wall • Restriction of trading in stocks • Appointment of new employees • Data Secrecy • Withholding Client Pressure for unreasonable valuations / timelines • Creating goodwill will take a long time, destroying it will take a second

Companies Act, 2013 Companies Act, 2013 has introduced a new concept ‘REGISTERED VALUERS’ under Chapter XVII • Registration with the Central Govt. or institution or agency notified by the Central Govt. • Form No. 17.1 - Applicant is Individual/ Partnership Firm • Form No. 17.2 - Applicant is Company / LLP • Persons eligible to be valuers • Removal of names from register of valuers • Methods of valuation • Contents of Valuation report [Form no 17.3]

Role of Registered Valuer

Valuation – A Fast Growing Practice Area for CAs