Description
The doc describing on valuation acquisition.
Introduction Valuation is one of the most important aspects that are to be considered in any restructuring exercise. Since various restructuring options necessarily involve exchange of payment/ consideration, valuation assumes great significance. Why value your business? Any restructuring exercise, be it the sale of a unit, investment consideration in a business, acquisition of a business, hiving off an undertaking or buyback of shares, requires a particular value to be assigned to the activity under consideration in order to make for meaningful analysis. Besides undertaking a valuation exercise at the time of restructuring activity it could also be used to value a business in the normal course of its activity or on a periodic basis whereby the valuation outcome acts as a decision making tool to the management. Apart from profitability, value creation is an equally important objective and this aspect should also be given due consideration. There are many cases where the profitability of a business has been increasing however the value creation has been nil or negligible. Valuation Methods: There are various methods adopted across the globe, however we discuss some of the common and widely accepted methods of valuation. 1. Discounted cash flow method: This valuation method based on free cash flow is considered a strong tool because it concentrates on cash generation potential of a business. This valuation method uses the future free cash flow of the company (after providing for changes in working capital and capital expenditures) and discounts it by the firm's weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity) to arrive at the value of the enterprise as a whole. According to the discounted cash flow valuation model, the intrinsic value of a company is the present value of all future free cash flows, plus the cash proceeds from its eventual sale. The presumption is that the cash flows are used to pay dividends to the shareholders. In general, the DCF method is a strong and widely accepted valuation tool, as it concentrates on cash generation potential of a business.
2. Net Asset Value Method: Under this method a business is valued on the basis of the net
assets of business i.e. the total assets less the liabilities and the preferred shareholders claims and dividing the resultant number by the equity shares outstanding as on a particular date. Valuation for this purpose can be done on a number of basis such as a. Book Value b. Net replacement value
c. Net realizable value
NAV method of valuation is rarely used for valuing a going concern as it does not consider the future earnings capacity of the business. However it is a widely used method of valuation in cases where the projections of future profits cannot be made with reasonable accuracy, where there are losses or where the value of the entity is derived substantially from the value of its assets.
3. Comparable company Analysis: Comparable company method of valuation is widely
used to value private firms. It values an asset or firm based on how an exactly identical firm (in terms of risk, growth rate and cash flows) is priced. In this method, price multiples of comparable listed companies are applied to key financials to arrive at the valuation. Commonly used comparables are the PE multiple, EV/EBIDTA multiple, Price/Sales etc. Comparable company analysis method is much likely to reflect the current mood of the market since it attempts to measure the relative value and not the intrinsic value. Even though it is not an independent valuation methodology, comparable company method may be used to support valuations churned out by cash flow and other futuristic valuation methodologies. This is based on the premise that the market multiples of comparable listed companies are a good benchmark to derive valuation. The price earnings ratio expresses the stock price in terms of earnings per share (EPS). The P/E ratio uses the earnings of a company to value that company’s stock. The price to cash flow measure compares the value of a company relative to its cash flow generation. The price to cash flow ratio is based on the actual cash flow generated by the company unlike the PE ratio, which is an accounting measure and is susceptible to manipulation. The price to sales ratio measures the value of the company relative to its revenue. This measure provides a very useful benchmark for companies that are in commodity business with similar margins and operating characteristics. However certain issues like
measurement of revenue and the revenue recognition policy need to be considered while using this ratio.
4. Maintainable Profit Method: Under this method a reasonable estimate of the average
future maintainable operating profits is made by taking past earnings as a base and adjusting it for the trend and the future plans of the company. The resulting profit, after deducting for preference dividend, if any, is capitalized at an appropriate rate, and the resultant figure is the value of the equity shares. The determination of average future maintainable profits and suitable rate of capitalization is a complex task and necessitates subjective evaluation of many factors such as government policies, prospects of expansion, competition, nature of industry, entry barriers in business, technological obsolescence, investors’ perception etc. The capitalization rate could be taken as the aggregate of the long term risk free rate and the additional earnings expected to cover the risk involved in the business. Reliance has also to be placed on the market quotations of shares of the companies in a similar business, after making necessary adjustments for various factors which affect the stock markets. If the company which is being valued has diversified businesses then the future maintainable profits may be capitalized at different rates on account of different risk levels of each business. Special points in relation to acquisition or takeover With more and more companies looking for newer and better ways to grow, takeovers have become the most efficient way of growing rapidly. As far as valuation in a takeover is concerned the following considerations need to be kept in mind: • • • • • • • Long term strategic planning of the acquirer Value of synergies that will be derived after the acquisition Value of intangible assets owned by the company such as brands, patents, marketing network, human resources, goodwill etc. Product profile of the target company Quality and value of fixed assets owned The replacement value of the production facility along with the gestation period involved in setting up of new facilities. Key regulatory approvals held by the companies ( especially in case of telecom, power, LPG companies)
doc_177805089.doc
The doc describing on valuation acquisition.
Introduction Valuation is one of the most important aspects that are to be considered in any restructuring exercise. Since various restructuring options necessarily involve exchange of payment/ consideration, valuation assumes great significance. Why value your business? Any restructuring exercise, be it the sale of a unit, investment consideration in a business, acquisition of a business, hiving off an undertaking or buyback of shares, requires a particular value to be assigned to the activity under consideration in order to make for meaningful analysis. Besides undertaking a valuation exercise at the time of restructuring activity it could also be used to value a business in the normal course of its activity or on a periodic basis whereby the valuation outcome acts as a decision making tool to the management. Apart from profitability, value creation is an equally important objective and this aspect should also be given due consideration. There are many cases where the profitability of a business has been increasing however the value creation has been nil or negligible. Valuation Methods: There are various methods adopted across the globe, however we discuss some of the common and widely accepted methods of valuation. 1. Discounted cash flow method: This valuation method based on free cash flow is considered a strong tool because it concentrates on cash generation potential of a business. This valuation method uses the future free cash flow of the company (after providing for changes in working capital and capital expenditures) and discounts it by the firm's weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity) to arrive at the value of the enterprise as a whole. According to the discounted cash flow valuation model, the intrinsic value of a company is the present value of all future free cash flows, plus the cash proceeds from its eventual sale. The presumption is that the cash flows are used to pay dividends to the shareholders. In general, the DCF method is a strong and widely accepted valuation tool, as it concentrates on cash generation potential of a business.
2. Net Asset Value Method: Under this method a business is valued on the basis of the net
assets of business i.e. the total assets less the liabilities and the preferred shareholders claims and dividing the resultant number by the equity shares outstanding as on a particular date. Valuation for this purpose can be done on a number of basis such as a. Book Value b. Net replacement value
c. Net realizable value
NAV method of valuation is rarely used for valuing a going concern as it does not consider the future earnings capacity of the business. However it is a widely used method of valuation in cases where the projections of future profits cannot be made with reasonable accuracy, where there are losses or where the value of the entity is derived substantially from the value of its assets.
3. Comparable company Analysis: Comparable company method of valuation is widely
used to value private firms. It values an asset or firm based on how an exactly identical firm (in terms of risk, growth rate and cash flows) is priced. In this method, price multiples of comparable listed companies are applied to key financials to arrive at the valuation. Commonly used comparables are the PE multiple, EV/EBIDTA multiple, Price/Sales etc. Comparable company analysis method is much likely to reflect the current mood of the market since it attempts to measure the relative value and not the intrinsic value. Even though it is not an independent valuation methodology, comparable company method may be used to support valuations churned out by cash flow and other futuristic valuation methodologies. This is based on the premise that the market multiples of comparable listed companies are a good benchmark to derive valuation. The price earnings ratio expresses the stock price in terms of earnings per share (EPS). The P/E ratio uses the earnings of a company to value that company’s stock. The price to cash flow measure compares the value of a company relative to its cash flow generation. The price to cash flow ratio is based on the actual cash flow generated by the company unlike the PE ratio, which is an accounting measure and is susceptible to manipulation. The price to sales ratio measures the value of the company relative to its revenue. This measure provides a very useful benchmark for companies that are in commodity business with similar margins and operating characteristics. However certain issues like
measurement of revenue and the revenue recognition policy need to be considered while using this ratio.
4. Maintainable Profit Method: Under this method a reasonable estimate of the average
future maintainable operating profits is made by taking past earnings as a base and adjusting it for the trend and the future plans of the company. The resulting profit, after deducting for preference dividend, if any, is capitalized at an appropriate rate, and the resultant figure is the value of the equity shares. The determination of average future maintainable profits and suitable rate of capitalization is a complex task and necessitates subjective evaluation of many factors such as government policies, prospects of expansion, competition, nature of industry, entry barriers in business, technological obsolescence, investors’ perception etc. The capitalization rate could be taken as the aggregate of the long term risk free rate and the additional earnings expected to cover the risk involved in the business. Reliance has also to be placed on the market quotations of shares of the companies in a similar business, after making necessary adjustments for various factors which affect the stock markets. If the company which is being valued has diversified businesses then the future maintainable profits may be capitalized at different rates on account of different risk levels of each business. Special points in relation to acquisition or takeover With more and more companies looking for newer and better ways to grow, takeovers have become the most efficient way of growing rapidly. As far as valuation in a takeover is concerned the following considerations need to be kept in mind: • • • • • • • Long term strategic planning of the acquirer Value of synergies that will be derived after the acquisition Value of intangible assets owned by the company such as brands, patents, marketing network, human resources, goodwill etc. Product profile of the target company Quality and value of fixed assets owned The replacement value of the production facility along with the gestation period involved in setting up of new facilities. Key regulatory approvals held by the companies ( especially in case of telecom, power, LPG companies)
doc_177805089.doc