Introduction to Valuation - nirc@icai · Relative Valuation Is Pervasive. Value of assets is...

Introduction to Valuation

Romesh Vijay

CA, ICAI Certified Valuer

Contents

Introduction

Overview of Methods Used

Relative Method of Valuation

Case Studies

Introduction

A valuer is a fellow who lends you an umbrella whenthe sun is shining, but wants it back the minute itbegins to rain. ….Mark Twain

Valuer

Value

The monitory worth of something.

Valuation

Valuation is the process of determining the“Economic Worth” of an Asset or Company undercertain assumptions and limiting conditions andsubject to the data available on the valuation date.

Who can do valuation ???(Valuation Rules, Companies Act 2013)

Currently➢ Chartered Accountants

➢ Merchant BankersGoing forward

Only a Registered member of the regulatory body.

Who all can be a member of regulatory body?➢ Member of professional institute➢ Graduate with 5 years of experience➢ Post graduate with 3 years of experience

Chartered Accountants and Valuation……

Only the principles and basis of valuation changes

We are not new to valuation

CA’s most aptly suited for business valuations

•Our understanding of businesses across multiple industries

•Our intricate knowledge of financials and its inter-linkage to businesses across industries

Transactions-Decision Making

Mergers

Acquisitions/

Investments

Fund Raising

Sale of Businesses

Voluntary Assessment

Accounting

Fair Value (Ind AS)

ESOP

Purchase Price Allocation

Impairment/

Diminution

Regulatory

Income Tax

SEBI

RBI

Stock Exchanges

Companies Act

Courts/ CLB

Why Valuation ???

01Income Based

▪ Capitalization of EarningsMethod (Historical)

▪ Discounted Cash FlowMethod (Projected TimeValue)

02 03 04

Fundamental Methods Relative Method Other Methods

Asset Based

▪ Book Value Method

▪ Liquidation Value Method

▪ Replacement Value

Market Based

▪ Comparable CompaniesMarket Multiple Method(Listed Peers)

▪ Comparable TransactionMultiples Method

(Unlisted Peers)

Other

▪ Contingent-ClaimValuation (Option Pricing)

▪ First Chicago Method

▪ Venture Capital

▪ Rule of Thumb

Valuation Approaches

STAGES OF DEVELOPMENTMature CompaniesTurnover / Profits : SaturatedProven Track Record : Widely AvailableMethod : More from existing assetsCost of Capital : May be high

Declining CompaniesTurnover / Profits : DropsProven Track Record : Substantial operating historyMethod of Valuation : Entirely from existing assetsCost of Capital : N.A.

High Growth CompaniesTurnover / Profits : GoodProven Track Record : AvailableMethod of Valuation : Business Model withAsset BaseCost of Capital : Reasonable

Growing CompaniesTurnover / Profits : Increasing still lowProven Track Record : LimitedMethod of Valuation : Substantially on BusinessModelCost of Capital : Quite High

Start-Up CompaniesTurnover / Profits : NegligibleProven Track Record : NoneMethod of Valuation : Entirely onBusiness ModelCost of Capital : Very High

TIME

Turn

ove

r /

Pro

fits

Methods START – Up RAPIDEXPANSION

HIGH GROWTH MATURE GROWTH

DECLINE

Income Approach

Discounted Cash Flow (DCF)

Market Based

EBIDTA Multiple

Sales Multiple

Cost Based

Cost to Date

Net Assets / Liquidation Value

SUITABLE METHODS OF VALUATION

CASE STUDIES

As per latest annual filings, the business follows a going concernassumption and the management neither has any intention toshut down its operations nor there is any foreseeable certaintyfor the same.

The client is a auto component player incurring losses for past 2-3years. Apart from inventory, it has a large piece of land on a primelocation in NCR.

Considering current circumstances the value of business as perDCF method is half the current market value of its land holding.

Which valuation approach should be used?What factors are to be considered before reaching to finalconclusion?

The development activity was in full swing and around 30%work has been completed when state government announcedMetro line to be passed through the middle of this project.

The client is a new player in the real estate sector who wants todevelop luxury apartments in Bangalore. It acquired a large pieceof land on super prime location in one of Bangalore.

The 40% of the land was compulsorily acquired by thegovernment at a significantly lower price. The existing projectdesign cannot be executed in these circumstances.


Due to its business model the client is able to generate a steadystream of cash with significant certainty.

The client is solar power project owner and has entered in PPA for25 years

It has no further plans to reinvest in new projects


At one hand client seeks to identify the intrinsic value of suchbusiness as well as have to comply with the regulatory valuationguidelines issued by RBI.

The client is auto component player who proposes to buy aGermany based manufacturing plant from a non-residentCompany.

We are exposed to foreign exchange risk and a highly maturedfinancial market. We have gathered comparable transactiondata and hope to consider other relevant factors into ourvaluation.


Now the client is planning to divest this non-core strategicinvestment and therefore seeks to obtain fair market value ofits share.

The client has invested in non-core business where it holdsaround 17% of the business making it minority shareholder.

We have gathered comparable transaction data and calculatedcost of equity on the basis of industry average. However one ofthe valuation experts has advised to do some adjustments.


Currently they are planning to sell 4-Star hotel based out ofcentral business district Gurugram, Haryana.

The client is in the business of owning luxury hotels throughoutIndia.

What factors are to be considered before reaching to finalconclusion?

Which valuation approach should be used?

Currently under stress due to high outstanding debt and isreferred to Insolvency and Bankruptcy Board for Insolvency

The client is a large steel company incurring huge operationallosses for many years.

The Company is currently operating at 80% of its capacity andhas got several long term customer contracts to operate as agoing concern.


The myth is

X Valuation is objective.

X Valuation gives precisenumber

X A single valuation serversmore than one purpose.

X A complex financial modelgives better valuation

X Valuation is worthless as itinvolves lot of assumptions

The truth is

✓ It is subjective

✓ Valuation only gives an estimate

✓ That the value will change if the purpose is changed

✓ That it doesn’t give better valuation

✓ That it is useful in decision making

Valuation MythMyths around valuation profession

RELATIVE VALUATION

The Value of an asset is compared to the values assessed by the market for similar or comparable assets.

Research

Compare

Identify➢ Comparable Assets➢ Obtain Market Values

ConvertMarket values into Standardized Values

Analyze

Relative Valuation Is Pervasive

Value of assets is compared to value assessed by market forcomparable assets

Most equity research report / Investment banking userelative method of valuation c75%+.

Many DCF valuation use relative valuation to determineterminal value (See Example on Next Slide)

Relative Method of Valuation

(INR Million)

Particulars Terminal Value

Revenue 77,801

FY-21 Revenue x EV / Sales multiple (4.6 X)

Free cash flow to firm 357,885

Discounting factor 0.37

Present value of free cash flow to firm 132,417

Terminal Value Calculation

Easy to sell and easy to value• Requires less information

Easy to defend valuation

Why Relative method of valuation?

Group of companies comparable with respect to:• Size• Products• Recent trends and future prospects

Key ratios are calculated for each company and are averagedfor group.

Average ratios applied to absolute data for company of interest and indicated market values obtained from each ratio based on which valuation judgments are made.

Comparable Companies multiple Method

Valuation based on companies involved in the same kind ofmerger transactions

Market value refers to transactions in a completed dealwhich is more directly applicable than companycomparisons

May be difficult to find truly similar transactions within arelevant time frame

Comparable Transactions Method

The valuation ratio typically expresses the valuation as a function of a measure of Key Financial Metrics

• Price/Book Value• Revenue/Room

• EV/ Sales• Price Earning

• EV/ EBITDA

Earning Multiples

Revenue Multiples

Book Value

Multiples

Industry Specific

Multiples

Method of determination of equity value

Price Earnings ratio is the ratio of company's current shareprice to its earnings per share.

Have to use very carefully

Price Earnings Ratio (PE Multiple)

EV is enterprise value

EV = Market Capitalization + Outstanding Debt – Cash & Bank balances

EBITDA is earnings before interest, tax, depreciation and amortization. It is a proxy for CASH

Most widely accepted multiple for valuation

EV / EBITDA Multiple

EV = Market Capitalization + Outstanding Debt – Cash & Bank balances= 24,062 + 2,145 – 912 = INR 25,295 crore

EBITDA = Earning before interest, tax, depreciation and amortization.= INR 2,003 crore

EV / EBITDA = 12.63 times

Example: Ashok Leyland

Dividing both sides by the expected free cash flow to the firmyields the Value/FCFF multiple for a stable growth firm:

The value/EBITDA multiple, for instance, can be expressed asfollows:

The value of a firm in stable growth could be derived as under:

Value of Firm = n

10

gk

FCFFV

c

V0

FCFF1

1

kc gn

Value

EBITDA =

(1 - t)

kc - g +

Depr (t)/EBITDA

kc - g -

CEx/EBITDA

kc - g -

Working Capital/EBITDA

kc - g

Key driver-EV / EBIDTA

Reinvestment rate

Lower / Higher

Growth rate Lower / Higher

Cost of capital

Lower / Higher

Tax Lower / Higher

It takes into account the enterprise value and thencompared with the sales of the company.

Generally used in high growth young companies with loss / low profitability

Generally, the lower the ratio, the lower value of the company is. However should be concuded with operating method

EV / SALES Multiple

EV = Market Capitalization + Outstanding Debt – Cash & Bank balances= 24,062 + 2,145 – 912 = INR 25,295 crore

Net Sales = 20,478

EV / Net Sales = 1.24 times

Example: Ashok Leyland

Key driver –EV / Sales method

Operating Margin

Examples –Luxury goods &

Retail

Current - EV / EBIDTA multiples and EV / Sales multipleEV EBITA EV Sales

Average Median Average MedianChemicals 10.49 7.33 1.65 1.13 Auto Ancillary 13.79 9.02 1.73 0.99 Auto LCV / HCV 11.66 12.35 1.12 1.13 Auto Passenger car 11.66 12.35 1.12 1.13 Hotel 13.06 9.41 3.66 2.82 Engineering 13.64 8.74 2.01 1.17 Airconditioner 18.13 18.18 1.39 1.17 Cigarettes 18.00 18.03 5.24 4.67

Price to book

The price-to-book ratio (P/B Ratio) is

a ratio used to compare a stock's market value to

its book value.

Can be used to value bank financial service companies

Comparison of public and private sector banks

Particulars Average MedianPSU Banks 0.66 0.54 Private Sector Banks 2.38 1.76

Industry Valuation Parameters

Hospital EV/ROOM

Engineering Market Cap / Order Book

Mutual Fund Asset under management

Oil EV / Barrel of Equivalent

Print Media EV / Subscriber

Entertainment & Media

EV / Per Screen

Metals EBIDTA / Ton, EV / Metric Ton

Airlines EV / Plane or EV / Per Passenger

Textiles EBIDTA depend upon capacity utilization %

Rule of Thumb

A rule of thumb or benchmark indicator is used

as a reasonableness check against the values

determined by the use of other valuation approaches.

USE WITH CAUTION

• Identification of comparable company

• Comparable similar growth and margin

• Multiple consistently defined – Equity / Enterprise value

• Uniformly estimates for all companies – Gap differences,trailing, forward, extra ordinary items

• Sample size – small / large

Rules for using Relative valuation

Investments and Cross Holdings

Types of Holding Meaning

Minority, Passive Investments If the securities or assets owned in another entity represents less than 20% of the overall ownership of that entity without any active role in management of that entity.

Minority, Active Investments If the securities or assets owned in another entity represents 20% - 50% of the overall ownership of that entity with an active role in management of that entity.

Majority, Active Investments If the securities or assets owned in another entity represents more than 50% of the overall ownership of that entity.

Ways to value Investment in Cross Holdings:-

➢ Investment Value

➢ Dividend Yield Capitalization or DCF based on expected dividends

➢ Separate Valuation (Preferred)

Key Issues : Estimation of excess cash ?

One of the solutions is to estimate average cash/sales or total balance sheet size of the company’s relevant industry and then estimate if the company being valued has cash in excess of the industry’s average.

Non operating Assets are the surplus assets which are not used in operationsof the business and does not reflect its value in the operating earnings of thecompany. Therefore the fair market value of such assets should be separatelyadded to the value derived through valuation methodologies to arrive at thevalue of the company.

However, when valuing a non controlling ownership interest under the incomeapproach, the value of any non operating asset, non operating liabilities, orexcess or deficient operating assets may or may not be used to adjust the valueof the operating entity depending on the valuer’s assessment of the influenceexercisable by the non controlling interest (ICAI Business valuation standard).

Excess cash is defined as :

“Total Cash” (As appearing in Balance Sheet)Less : “Operating Cash” (Minimum cash required to sustain operations and

manage contingencies)

Selection of comparable

Most of the information used in valuation comes from financialstatements.

So select like companies with similar accounting and financialdata :

➢ Ind AS vs IGAAP

➢ Accrual vs Cash Accounting

➢ Presumptive vs Actual Tax

➢ Companies paying MAT

➢ Treatment of Intangible assets

➢ Treatment of Tax Benefits and Losses

Thank You !CA. Romesh Vijay

+ 91 - 971-777-3321

[email protected]

mailto:[email protected]

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