VALUATION CA Bhavik Shah 16 May 2015 Presentation Overview - - PowerPoint PPT Presentation

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VALUATION CA Bhavik Shah 16 May 2015 Presentation Overview - - PowerPoint PPT Presentation

Oct 05, 2022 603 likes •1.11k views

VALUATION CA Bhavik Shah 16 May 2015 Presentation Overview Valuation Concept Purpose of Valuation Principal Methods of Valuation Net Assets Value (NAV) Method Price to Book Multiple (P/B) Method Price Earnings

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SLIDE 1

VALUATION

CA Bhavik Shah 16 May 2015

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SLIDE 2

Presentation Overview

  • Valuation Concept
  • Purpose of Valuation
  • Principal Methods of Valuation

 Net Assets Value (NAV) Method  Price to Book Multiple (P/B) Method  Price Earnings Capitalisation (PECV) Method  Enterprise Value/ EBITDA Multiple (CCM) Method  Discounted Cash Flow (DCF) Method  Market Price Method

  • Judicial Pronouncements
  • Conclusion
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SLIDE 3

Valuation Concept

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

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SLIDE 4

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

Wh Why Valuation luation?

Merger/ Demerger

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SLIDE 5

Steps in Valuation

  • Obtaining Information
  • Data analysis & review
  • Discussion with the management of the company
  • Selection of method
  • Conducting sensitivities on assumptions
  • Assigning weights
  • Recommendation
  • Reporting
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SLIDE 6

Sources of Information

  • Historical data such as audited results of the company
  • Management Discussion and Industry Overview
  • Future projections
  • Stock market quotations
  • Representation by the management
  • Data on comparable companies
  • Market surveys, news paper reports
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SLIDE 7

Analysis of Company

  • SWOT Analysis
  • Profitability Analysis- Past and vis-à-vis industry
  • Analysis of P&L Ratios

 Operating margins  EBITDA margins  PBT margins  Expense ratios

  • Balance Sheet Ratios

 Quick Ratio/ Current Ratio  Turnover Ratios  Liquidity Ratios  Debt Equity Ratio of Company & Industry

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SLIDE 8

Principal Methods of Valuation

Asset Based Approach

  • Net Assets Value
  • Price to Book Multiple

Earning Based Approach

  • Earnings Multiple Method
  • Discounted Cashflow Method (DCF)

Market Based Approach

  • Market Price
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SLIDE 9

Common Adjustments

Following adjustments may be called for:

  • Investments
  • Surplus Assets
  • Auditors Qualification
  • Preference Shares
  • ESOPs / Warrants
  • Contingent Liabilities
  • Tax benefits
  • Findings of Due Diligence Reviews
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NAV

  • The Value as per Net Asset Method is arrived as follows:

Total Assets excluding Miscellaneous expenditure & debit balance in Profit & Loss Account Less: Total Liabilities Net Asset Value Share Capital Add: Reserves Less: Miscellaneous Expenditure Less: Debit Balance in P&L account Net Asset Value OR OR

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NAV – An Example

NET ASSETS METHOD (INR lacs) Particulars 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 (930) Net Assets Value 1,355 Adjustments: Add: Appreciation in the value of Investment 350 Less: Preference Share capital (150) Less: Contingent Liabilities (20) Adjusted Net Assets 1,535

  • No. of Equity shares (FV - INR 10 each)

9,00,000 Value per Share (INR) 171 XYZ Ltd.

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Issues in NAV Method

  • Book value may not reflect the true value of assets
  • Earnings potential ignored
  • Profit generating Intangible assets could be understated

 Brand  Patent

  • Value of Human Resource not captured
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SLIDE 13

Price/Book Value Multiple

  • The Price/Book Value Multiple of Comparable Company is

arrived as follows:

Weighted Average Market Price Divide by: Value per share as per Net Assets Value as calculated in the previous slide Price/Book Value Multiple STEP 1: STEP 2: STEP 3:

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SLIDE 14

Price/Book Value– An Example

P/B Multiple Method (INR lacs) Particulars 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 (930) Net Assets Value 1,355 Adjustments: Add: Appreciation in the value of Investment 350 Less: Preference Share capital (150) Less: Contingent Liabilities (20) Adjusted Net Assets 1,535

  • No. of Equity shares (FV - INR 10 each)

9,00,000 Net Asset Value per Share (INR) 171 P/B Multiple 3 Value per Share (INR) 512 XYZ Ltd.

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SLIDE 15

Earnings Multiple Method

  • Commonly used Multiples:

Price to Earnings Multiple Market Cap/ PAT Enterprise Value to EBITDA Multiple Enterprise Value/ EBITDA

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SLIDE 16

Price Earnings Capitalization Method

(PECV) - Parameters

Maintainable Profits Appropriate Tax Rate PE Multiple

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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)
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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

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SLIDE 19

PECV – Example

CALCULATION OF ADJUSTED PBT (INR Lacs) Particulars 2013-14 (A) 2014-15 (A) 2015-16 ( E ) Reported Profit before Tax 540 780 910 Less: Non recurring Income Dividend Income 340 300 300 Profit on sale of Fixed Assets 10

  • 120

Profit on Sale of Investments 50 100

  • Interest on Income tax refund
  • 40

50 Interest Income 10 18 30 Total Non recurring Income 410 458 500 Add: Non recurring Expenditure Loss on Sale of Fixed Asset

  • 10
  • VRS paid

10 15 20 Others 4

  • 2

Total of Non recurring Expenditure 14 25 22 Adjusted PBT 144 347 432 Add: Interest 165 113 56 Add:Depreciation 79 75 70 Adjusted EBITDA 388 535 558

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PECV – Example (CONTD...)

Price Earnings Capitalisation Value Method (INR Lacs) Particulars

  • Adj. PBT

Weight Product 2013-14 144

  • 2014-15

347 1 347 2015-16 432 1 432 Total 2 779 Maintainable PBT 390 Tax Rate 34.61% 135 Maintainable PAT 255 PE Multiple 15 Capitalised Value of Business 3,821 Adjustments Add: Value of Investments 850 Less: Contingent Liabilities (20) Add: Deferred Tax Liabilities (100) Less:Preference Share Capital (150) Adjusted Earning Value 4,401

  • No. of Equity shares (FV - INR 10 each)

9,00,000 Value per Share (INR) 489 ABC Ltd.

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SLIDE 21

Enterprise Value / EBITDA Multiple Method

  • Determination of Maintainable EBIDTA.
  • EV/EBITDA Multiple
  • Not affected by the pattern of Funding adopted by Company/

Comparable Companies

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SLIDE 22

EV/EBITDA – Example

EV/EBITDA Multiple Method (INR Lacs) Particulars

  • Adj. EBITDA Weight

Product 2013-14 388

  • 2014-15

535 1 535 2015-16 558 1 558 Total 2 1,093 Maintainable EBITDA 547 EV/EBITDA Muliple 9 Enterprise Value 4,919 Adjustments: Add: Value of Investments 850 Less: Contingent Liability (20) Less: Loan Funds (930) Less:Preference Share Capital (150) Adjusted Equity Value 4,669

  • No. of Equity Shares (FV - INR 10 each)

9,00,000 Value per Share (INR) 519 ABC Ltd

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Issues in PECV / CCM Method

  • Valuation of:

 Loss making companies  Start-up companies  Finite life project companies

  • Ignores time value of money
  • Calculation of Maintainable Profits

 Adjustment for non-operating / non-recurring items

  • Finding listed comparable companies
  • Difficulty in obtaining comparable multiples
  • Effective tax Rate in PECV Method
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SLIDE 24

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

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Discounted Cash Flow (DCF)

  • Considers Cash Flow and Not Profits
  • Cash is King
  • Free Cash Flow (‘FCF’)

 FCF to Firm  FCF to Equity

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DCF – Parameters

  • Cash Flows

 Projections  Horizon period  Growth rate

  • Discounting

 Cost of Equity  Cost of Debt  Weighted Average Cost of Capital (‘WACC’)

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SLIDE 27

Cash Flows

Business Plan Business Cycle Working Capital Capital Expenditure Depreciation Amortization Tax

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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
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SLIDE 29

Cost of Equity

In CAPM Method, all the market risk is captured in the beta, measured relative to a market portfolio, which at least in theory should include all traded assets in the market place held in proportion to their market value Ke = (Rf + ( x Erp)) Where , Ke = Cost of Equity Rf = Risk free return Erp = Equity risk premium = Beta

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SLIDE 30

Cost of Debt

Kd = (Int x (1-t)) Where , Kd = Cost of Debt Int = Average Interest Rate t = Marginal rate of tax

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DCF – Discounting Rate

  • Weighted Average Cost of Capital (WACC)
  • D = Debt
  • E = Equity
  • Kd = Post tax cost of debt
  • Ke = Cost of equity

D E (D + E) (D + E) Ke WACC = x Kd + x

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DCF – Terminal Value

  • Terminal Value is the residual value of business at the end
  • f projection period used in discounted cash flow method

TERMINAL VALUE LIQUATION APPROACH MULTIPLE APPROACH STABLE GROWTH APPROACH

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The Final Value

Under the FCF to the firm approach - The Value is the summation

  • f:
  • PV of the FCF to Firm during the horizon period
  • PV of the residual value
  • PV of the tax benefit on the WDV of the assets, 80IA, 10A/10B

sales tax, etc. beyond the horizon period

  • Market value of the investments and other non-operating/

surplus assets (net of tax)/ surplus cash as at the valuation date

  • Adjustment for contingent liabilities (net of taxes)
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SLIDE 34

DCF – When to use?

Most appropriate for valuing firms:

  • Limited life projects
  • Large initial investments and predictable cash flows
  • Regulated business
  • Start-up companies
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SLIDE 35

DCF – Example

(INR Lacs) Particulars 2015-16 2016-17 2017-18 Perpetuity Operating PBT 432 518 596 Add: Interest 56 44 46 Depreciation 70 80 86 Total Inflows 558 642 728 Less: Outflows Capital Expenditure 45 45 45 Incremental Working Capital 20 30 30 Tax 158 182 208 Total Outflows 223 257 283 Free Cash Flows (FCF) 335 385 445 Cash Flow for 2019-20 445 Growth Rate 5% Capitalised Value for Perpetuity 5,838.15 Discounting Factor 13.00% 0.88 0.78 0.69 0.69 Net Present Value of Cash Flows 296 301 308 4,046 Enterprise Value 4,952 Less: Loan Funds (930.0) Less: Preference Share Capital (150.0) Less: Contingent Liability (20.0) Add: Value of Investments 850 Adjusted Value for Equity Shareholders 4,702 No of Equity Shares 9,00,000 Value per Share (FV INR 10) 522

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Issues in DCF Method

  • Issues in forecasting cash flows
  • Estimation of Discounting Factor Parameters

 Risk Free Rate  Beta  Market Return  Debt Equity Mix

  • Terminal Growth rate
  • Pre Money or Post Money Valuation
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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, Takeover Code

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Market Price Method – Example

Market Price Method Months Volume Turnover November 2014 16,95,000 7261,42,620 December 2014 14,95,000 5849,22,726 January 2015 15,02,560 7810,96,596 February 2015 13,26,395 9112,16,380 March 2015 11,85,424 8185,98,438 April 2015 10,57,403 4791,13,336 Total 82,61,782 43010,90,096 Value per Share (INR) 520.60

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Issues in Market Price Method

  • Market price mat not capture intrinsic value
  • Thinly traded / Dormant Scrip - Low Floating Stock
  • Unusual fluctuations in Market Price
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Selection of Methods

SITUATION APPROACH Knowledge based companies Earning / Market Manufacturing Companies Earning / Market / Asset Brand Driven Companies Earning / Market A Matured Company Earning / Market Investment / Property Companies Asset Company going for Liquidation Asset NBFC / Banks P/B Multiple

Generally Market Approach is used in combination with other methods or as a cross check

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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
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Fair Value – An Example

Method Value per Share (INR) Weight Product (INR) Net Assets Method 171 1 171 P/B Multiple 512 1 512 Price Earning Multiple Method 489 1 489 EV/EBIDTA Multiple Method 519 1 519 DCF Method 522 1 522 Market price Method 521 1 521 Total 6 2,733 Fair Value per share (INR) 455.49

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Other Value Drivers

Final Value Final Price is a result of negotiations

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Some Issues (Common)

  • Relying on Technical Valuer’s Report
  • Joint Reports
  • Fairness Opinion by Merchant Bankers
  • Engagement Letter
  • Management Representations
  • Reporting
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Judicial Pronouncements

  • Exchange Ratio not disturbed by Courts unless
  • bjected and found grossly unfair.

Miheer H. Mafatlal Vs.Mafatlal Industries (1996) 87 Com Case

792 Dinesh v. Lakhani Vs. Parke-Davis (India) Ltd. (2003) 47 SCL 80 (Bom)

  • It is fair to use combination of three well known methods
  • viz. asset value, yield value & market value

Hindustan Lever Employees’ Union Vs. HLL (1995) 83 Com case 30SC

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Judicial Pronouncements

  • Valuation will take into account number of factors such as

prospective yield, marketability, the general outlook for the type of business of the company. 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)
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Conclusion

  • Valuers must keep in mind fairness to all stakeholders
  • Many instances of minority shareholders delaying the

merger process by challenging valuation

  • Balance needs to be achieved through transparency,

fairness and best governance practices

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