Wolfgang Ballwieser
Value vs. price; add-ons to, deductions from business valueIACVA‘s
5th Annual
Valuation
Conference
Neuss –
11 November 2011
111 November 2011Wolfgang Ballwieser 1
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
211 November 2011Wolfgang Ballwieser 2
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
311 November 2011Wolfgang Ballwieser
1. Value vs. price
a. Basic economic insights 1
Prices result
from
market
transactions
of goods
or
services
Markets
are
large or
small
(liquid or
illiquid): cf. shares
of a Euro
STOXX company
vs. the
painting
of Mona Lisa
Prices depend
on
The
nature of the
good or
service: take
bottles
of Coke
vs. shares
of
BMW
The
transaction
unit: usually
there
is
no price
additivity
The
point of time: usually
there
is
no price
stability
The
location: usually
there
is
no unique
price
for
material goods
at all
places
411 November 2011Wolfgang Ballwieser
1. Value vs. price
a. Basic economic insights 2
Transactions
normally
only
arise
if
values
and price
differ
A good is
bought
if
value
is
not
lower
than
price
A good is
sold
if
price
is
not
lower
than
value
Price might
equal
value
if
A transaction
partner
did
not
negotiate
or
act
well
An authority
(e.g. a judge) set
price
equal
to value
Unrealistic
models
(like
CAPM) are
taken
for
granted
511 November 2011Wolfgang Ballwieser
1. Value vs. price
a. Basic economic insights 3
Why
is
the
CAPM far away
from
being
realistic?
Important
assumptions:
A finite number
of market
participants
Decisions
are
taken
on basis
of probability
distributions
of one-
period
rate of returns
of shares
and a risk-free
bond
Identical probability distributions for all market participants
What drives transactions?
611 November 2011Wolfgang Ballwieser 6
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
711 November 2011Wolfgang Ballwieser
1. Value vs. price
b. Value definitions 1
Subjective
business
value
= subjektiver Unternehmenswert
Objectified
business
value
= objektivierter Unternehmenswert
(IDW S 1)
Fair market
value
= gemeiner Wert or
Verkehrswert
Fair value
= beizulegender Zeitwert
811 November 2011Wolfgang Ballwieser
1. Value vs. price
b. Value definitions 2
Subjective
business
value
is
the
basis
of individual
decisions
Value
results
from
a subject-object
relationship
Valuation
needs
an individual
preference
function
The
price
of a particular
BMW 5 does
not
tell
us
anything
about
individual
value
Objectified
business
value
(IDW S 1) is
a misname
A better
name
would
be
standardised
(or
normalised) business
value
What
are
the
rules
of standardising?
911 November 2011Wolfgang Ballwieser
1. Value vs. priceb. Value definitions 3
Standardisation
rules
for
objectified
business
value
(IDW S 1)
In general, DCF model
with
forecasts
of two
or
more
phases
Stand-alone
value
Measures
considered
must
be
sufficiently
concrete
Direct
or
indirect
standardisation
of personal taxes
Share portfolio
is
alternative to company
No positive NPV of non-distributed
earnings
in second phase
Equity
costs
based
on CAPM or
Tax-CAPM
Risk-free
rate of return
based
on term
structure
of spot
rates
1011 November 2011Wolfgang Ballwieser
1. Value vs. priceb. Value definitions 4
IDW S 1 (Business Valuation) paras 142-4:“7.5.
Considerations
for
plausibility
assessments
7.5.1. Market priceIf
market
prices
are
available
for
shares
in the
entity, they
are
to be
used
to assess
the
plausibility
of the
value
of the
entity
or
of a share
in the
entity
calculated
in accordance
with
the
above
principles
(…).
7.5.2. Simplified
pricingSimplified
pricing
(e.g. earnings
multiples, sales
multiples or
multiples based
on
product
quantities) can
serve
in specific
cases
as a basis
for
assessing
the plausibility
of the
results
of the
valuation
determined
using
the
dividend
discount
method
or
the
DCF methods.In practice, use
is
often
made
of simplified
pricing
methods
for
small
and medium-
sized
entities
(…). Such methods
cannot
substitute
a business
valuation.“ (Emphasis
added.)
1111 November 2011Wolfgang Ballwieser
1. Value vs. priceb. Value definitions 5
IDW S 8 (Fairness Opinions) para 26“The
assessment
especially
follows
present
value-techniques
(DCF or
dividend
discount
methods) as well as market
price oriented
approaches
(analyses
of share
prices
of the
trans-
action
object
and multiples).“
„Die Beurteilung erfolgt insb. über kapitalwertorientierte Bewertungsverfahren (Discounted-Cash-Flow-
oder Ertrags-
wertverfahren) sowie über marktpreisorientierte Verfahren (Analysen von Börsenkursen des Transaktionsobjektes und Multiplikatoren).“
1211 November 2011Wolfgang Ballwieser
1. Value vs. priceb. Value definitions 6
Fair market value (gemeiner Wert)“The
fair market
value
is
determined
by
the
price
which
would
be
gained
according
to the
nature of the
object
in a normal business transaction
when
selling
the
asset. All circumstances
that
influence
the
price
have
to be
considered. Exceptional
or
personal circum- stances
must
not
be
considered.“
(§
9 para
2 Bewertungsgesetz; also
compare
§
738 BGB; §
194 BauGB)
„Der gemeine Wert wird durch den Preis bestimmt, der im gewöhn-
lichen
Geschäftsverkehr nach der Beschaffenheit des Wirtschafts- gutes bei einer Veräußerung zu erzielen wäre. Dabei sind alle Um- stände, die den Preis beeinflussen, zu berücksichtigen. Ungewöhn- liche
oder persönliche Verhältnisse sind nicht zu berücksichtigen.“
1311 November 2011Wolfgang Ballwieser
1. Value vs. priceb. Value definitions 7
Fair value (beizulegender Zeitwert)
IFRS 13: Fair value
is
the
price
that
would
be
received
to sell
an
asset
or
paid
to transfer
a liability
in an orderly
transaction between
market
participants
at the
measurement
date (an exit
price).
That
was the
definition
of fair value
in US GAAP.
1411 November 2011Wolfgang Ballwieser 14
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
1511 November 2011Wolfgang Ballwieser
1. Value vs. pricec. Controversy
Assertion: “objectified business value equals fair market value“
Pros: objectified business value Cons: objectified business value
… is used by courts which decide on
indemnity
payments
according
to
German and Austrian
law
… differs
from
valuation
by
transact- ion
or
trading
multiples though
those
valuations
are
also used
by
market participants
… has a selling
perspective, neglect- ing, e.g. synergies, just like
fair value
… is
conservative
when
forecasting future
cash flows
… uses
capital
market
information
in determining
the
discount
rate
… depends
on many
assumptions which
cannot
be
easily
made
plausible
1611 November 2011Wolfgang Ballwieser 16
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
1711 November 2011Wolfgang Ballwieser
1. Value vs. priced. Assessment 1
I do not
see
advantages
of trading
or
transaction
multiples. WHY?
First, we
need
trading
of shares
of the
same
company
or
of
comparable
companies, since
we
need
homogeneous
goods.
A look
on companies
of the
same
sector
with
comparable
size
and
leverage
does
not
really
lead
to comparable
companies.
Let‘s
take
three
companies
from
the
automotive
sector: BMW,
Daimler, and Volkswagen.
1811 November 2011Wolfgang Ballwieser
1. Value vs. price
d. Assessment 2
Percentage
of sales 2010
BMW Daimler Volkswagen
Motor cars 73 % 61 % 83 %Trucks 22 % 7 %Buses 5 %
Motorcycles 2 %Financial services 25 % 12 % 10 %Sales (bn. €) 60.5 97.8 126.9
1911 November 2011Wolfgang Ballwieser
1. Value vs. price
d. Assessment 3
Second, many
companies
are
(almost) unique. Which
company is
like
Skype, Google, General Electric, Deutsche Bahn?
Companies
may
change
the
business
model
in a radical
way
Nokia: from
paper
products, gumboots, tyres
for
bicycles
and
wheelchairs
to mobile communications
and car
supplier
Mannesmann: from
steel
pipes
to mining
and
telecommunications
Deutsche Bank: from
retail
bank
to investment
bank
2011 November 2011Wolfgang Ballwieser
1. Value vs. price
d. Assessment 4
Third, valuation
based
on share
prices
is
too
short-sighted
Share prices
reflect
average
expectations
of market
participants
without
inside
information
Share prices
reflect
prices
for
shares, not
for
investments
Transaction
prices
usually
differ
from
market
capitalisation
2111 November 2011Wolfgang Ballwieser
1. Value vs. price
d. Assessment 5 (Source: Gaughan 2007, p. 556)
2211 November 2011Wolfgang Ballwieser
1. Value vs. price
d. Assessment 6
Fourth, combination of multiples with DCF valuation does not help!
1
0 1 EBITDA 0 0(FCF )EV (EBITDA ) m = E + D
wacc risk premium g
wacc + risk premium > g
How is EBITDA1 determined?
E0 is usually measured by market capitalisation which is
not equal to equity value
2311 November 2011Wolfgang Ballwieser
1. Value vs. price
d. Assessment 7
I do not say
that
the
objectified
business
value
is
a good value for
preparing
decisions; many
of its
standardisation
rules
are
criticised
by
good reasons
I only
detect
no advantages
in transaction
or
trading
multiples
2411 November 2011Wolfgang Ballwieser 24
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
2511 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
a. Starting point
Modifications
of business
value
need
a reference
point
My reference
valuation
is
one
by
DCF having
integrated
Expected
synergies
Operating
(= investment
or
cash flow) risk
Leverage
risk, but
no liquidation
risk
In a technical
sense
it
does
not
matter whether
there
is
A deduction
from
reference
value
or
an increase
of discount
rate
An add-on
to reference
value
or
a decrease
of discount
rate
2611 November 2011Wolfgang Ballwieser 26
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
2711 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valueb. Add-ons
Add-ons
became
popular
in the
80s and 90s of last century
They
should
reflect
“strategic
value“
or
“options
value“
To my
conviction, they
were
nothing
more
than
an excuse
for
an overpayment
Strategic
value
must
be
able
to be
calculated
in cash flows; that was Rappaport‘s
message
Real options
(like
companies) cannot
be
valued
like
financial options. The
binomial
model
and the
Black-Scholes
model
require
market
prices
of the
underlying
in order to estimate
the model‘s
parameters. We
have
market
prices
for
shares, but
not
for
whole
companies.
2811 November 2011Wolfgang Ballwieser 28
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
2911 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions 1
Deductions
seem
to be
the
most
popular
game
today
They
shall
reflect
all kinds
of risks
A deduction
from
reference
value
can
be
substituted
by
an increase
of discount
rate
What are the relevant risks?
3011 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions 2
Risk
components
(models
or
authors)
Operating
risk
= investment
risk
= cash flow
risk
(CAPM, Tax-CAPM)
Financial risk
= leverage
risk
(Modigliani-Miller; Miles-Ezzell)
Size risk (Fama-French; Ibbotson; Duff & Phelps)
Non-diversification risk = “cluster
risk“
(Total Beta; Damodaran)
Immobility risk = Illiquidity risk
Country risk (Damodaran)
Insolvency risk (Damodaran; Gleißner)
Political
risk
…
3111 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for small size 1
Size risk
Prominent discussion
by
Fama-French, Grabowski-King, Ibbotson,
Duff & Phelps
Controversial
debate
inside
and outside
the
U.S.A.
3211 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for small size 2
Source: Duff & Phelps Risk Premium Report 2011, p. 30
3311 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for small size 3 (Source: Duff & Phelps Risk Premium Report 2011, p. 16)
3411 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for small size 4
CAPM cannot
be
connected
with
SSRP on a theoretical
level
Fama-French
model
is
no theoretical
model
Size
effect
is
empirically
controversial
with
respect
to direction, stability
over
time and country
dependency
Schulz 2009 mostly
gets
no statistically
significant
effect
for Germany
Is
size
effect
the
result
of data
mining
or
even
data
snooping?
3511 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for small size 5
Schulz uses
the
Grabowski-King 1995 method
(more
recently
Pratt-
Grabowski 2008) for
monthly
returns
between
April 1995 and March 2008; no banks, insurance
companies
and companies
with
less
than
1
mio
Euro sales
or
less
than
5 employees; listed
for
at least 5 years
Schulz finds
a positive (!) relationship
of size
and return, being
robust
against
model
or
parameter
variation
Size
premiums
of small
companies
are
almost
completely
insignificant,
size
premiums
for
large companies
–
if
at all –
have
mostly
a 10 per cent
level
significance
and depend
on the
market
portfolio
surrogate
3611 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for non-diversification 1
Unsystematic risk
Prominent discussion
by
Damodaran, Gleißner-Wolfrum, etc.
Controversial
debate
inside
Germany
3711 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for non-diversification 2
Pros
CAPM requires
market
participants
using
the
portfolio
model
of
Markowitz
Owners
of SMEs
are
not
diversified
Total beta: addition
of a second risk
premium
according
to
j
jM
( ß ) MRP , e. g. (2.5 1.5) 5% 5%
3811 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business valuec. Deductions for non-diversification 3
Cons
Damodaran
2002, p. 668 (earlier
Camp-Eubank
1981, p. 54) has no
theory: “To measure
exposure
to total risk
(σj
), we
could
divide
the market
beta
by
ρjM
. “
(Emphasis
added.) One also could
have
taken ρjM
= 1.
If
one
does
not
believe
in CAPM, one
cannot
take
the
structure
of
CAPM (ß) for
help: contradiction
It
is
not
necessary
to be
diversified
for
valuing
a SME: The
question
is,
what
amount
is
necessary
to reconstruct
the
cash flows
of the
firm that has to be
valuated? The
reconstruction
price
can
be
gained
by
using
CAPM.
3911 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for illiquidity 1
Pros
Selling
businesses
is
highly
uncertain
with
respect
to time and
price; selling
shares
only
need
a phone
call
and has low
time- price
uncertainty
Analytical
models
(Liquidity-CAPM), empirical
studies
(restricted
stocks, IPOs), court
decisions
and practical
experience
support deductions
for
illiquidity
4011 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for illiquidity 2
Cons 1
Risk
premium
for
illiquidity
makes
sense, when
selling
is
expected;
the
regular
assumption
is
not
to sell; if
selling
is
expected, a
scenario
approach
could
count
for
this
expectation
The
selling
problem
is
one
of forecasting
cash flows, not
one
of
adding
a risk
premium
to discount
rate or
deducting
an amount
from reference
value
4111 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for illiquidity 3
Cons 2
The
mere
possibility
of selling
necessity
is
not
sufficient: a nuclear
war or
a war of the
U.S. with
Saudi Arabia or
Mexico
might
also be possible
I do not
know
how
the
Liquidity
CAPM can
be
used
practically
The
empirical
studies
have
many
drawbacks
which
are
well-known
in the
valuation
community
(misspecification, omitted-variable
bias,
etc.)
4211 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for country risk 1
Pros
Investment in Ukraine, Belarus or
Greece
is
more
risky
than
one
in UK
CAPM does
not
reflect
this
kind
of risk
Damodaran‘s
proposal
Default spread
for
country
x volatility
factor
(1.5 for
emerging
countries)
Volatility
factor: stand. dev. of rates
of return
of shares
divided
by
stand. dev. of rate of return
of government
bonds
of the
country
Example: Belarus Jan. 2011 (Damodaran‘s
website)
CRP = 4.0 % x 1.5 = 6.0 %
Risk
Premium = Beta x (5.0 % + 6.0%) = Beta x 11 %
4311 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for country risk 2
Cons
Country
risk
again
is
a problem
of forecasting
cash flows
Damodaran‘s
proposal
combines
CRP with
CAPM, even
though
CAPM was blamed
for
neglecting
country
risk: contradiction
There
is
no theoretical
basis
for
multiplying
beta
and the
sum
of
MRP and CRP
There
is
no theoretical
basis
for
adding
CAPM risk
premium
and
CRP (cf. Kruschwitz-Löffler-Mandl
2010 and 2011)
4411 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for insolvency risk 1
Pros
Investment with
expected
insolvency
is
less
worth
than
investment
without
this
expectation; CAPM does
not
reflect
this
kind
of risk
If
one
takes
the
insolvency
as identical
and stochastically
independent distributed, then
the
result
looks
like
a negative growth
rate model
(Gleißner
2011, p. 247)
01
0E E
D (1 p)(D )Er p r p
4511 November 2011Wolfgang Ballwieser
2. Add-ons to, deductions from business value
c. Deductions for insolvency risk 2
Cons
It
is
not
clear, why
the
probability
of insolvency
is
not
integrated
in
the
calculation
of µ(D1
)
Constant
and stochastically
independent probabilities
of insolvency
seem
to be
unrealistic
rE
cannot
be
determined
without
reflection
of getting
insolvent
A global sample
of more
than
50,000 listed
companies
in 1986-
2008 shows
an average
rate of insolvency
per year
as of 0.18%
(Lobe/Hölzl
2011, p. 255)
4611 November 2011Wolfgang Ballwieser 46
Agenda1.
Value
vs. price
a.
Basic economic
insights
b.
Value
definitions
c.
Controversy
d.
Assessment2.
Add-ons
to, deductions
from
business
value
a.
Starting
point
b.
Add-ons
c.
Deductions3.
Implications
4.
Literature
4711 November 2011Wolfgang Ballwieser
3. Implications
Example: Assume a dividend discount model with
MRP = 5.0 %
Risk-free
rate of return
= 3.0 %
Beta (levered) = 1.5
µ(D1
) = 100
g = 2.0 %
Then equity value is
0
100 100E 1,1760.03 1.5 0.05 0.02 0.085
4811 November 2011Wolfgang Ballwieser
3. Implications
Example: Assume
Size
premium
over
CAPM = 6.0 % (p. 32)
Non-diversification
premium
over
CAPM = 5.0 % (p. 37)
Illiquidity
premium
over
CAPM = 3.0 %
Country risk premium (Belarus) = 6.0 % (p. 42)
Insolvency
risk
premium
= p x (1 + g) = 0.04 x 1.02 = 4.08 %
Then the equity value is
0
100 100E 3070.03 1.5 0.05 0.02 0.06 0.05 0.03 0.06 0.0408 0.3258
4911 November 2011Wolfgang Ballwieser
3. Implications
Reference
value
has been
diminished
by
(roughly
speaking) 74%
The
result
is
neither
based
on theory
nor
on empirical
evidence
But
I will not
exclude
that
such valuations
can
be
seen
in practice
5011 November 2011Wolfgang Ballwieser
4. LiteratureBallwieser, Wolfgang (2011), Unternehmensbewertung –
Prozeß, Methoden und Probleme, 3. Aufl., Stuttgart.Damodaran, Aswath
(2002), Investment Valuation
–
Tools and Techniques
for
Determining
the
Value
of Any
Asset, 2. Aufl., New York.
Dörschell, Andreas/Franken, Lars/Schulte, Jörn (2009), Der Kapitalisierungszinssatz in der Unternehmensbewertung –
Praxisgerechte Ableitung unter Verwendung von Kapitalmarktdaten, Düsseldorf. Duff & Phelps
(2011), Risk
Premium Report 2011, Selected
Pages
and Examples, http://www.duffandphelps.com/sitecollectiondocuments/2011_Duff_Phelps_Risk_Premium_Report_EXCERPT.
pdf.
Camo, Robert C./Eubank, Arthur A., Jr. (1981), The
Beta Quotient: A new
measure
of portfolio
risk, in: Journal of Portfolio Management 7, Nr. 4, S. 53-57.
Gaughan, Patrick A. (2007), Mergers, Acquisitions, and Corporate Restructurings, 4. Aufl., New York u.a.Gleißner, Werner (2011), Der Einfluss der Insolvenzwahrscheinlichkeit (Rating) auf den Unternehmenswert und die
Eigenkapitalkosten, in: CFB 2, S. 243-251.Knoll, Leonhard/Tartler, Thomas (2011), Alles hat ein Ende …
–
Anmerkungen zu einer mehrstufigen Diskussion in FB und CF biz, in: CFB 2, S. 409-413.
Kruschwitz, Lutz/Löffler, Andreas/Mandl, Gerwald (2011), Damodarans
Country
Risk
Premium –
und was davon zu halten ist, in: WPg
64, S. 167-176.Kruschwitz, Lutz/Löffler, Andreas/Mandl, Gerwald (2010): Damodaran’s
Country
Risk
Premium: A Serious
Critique. SSRN Working
Paper (as of 31 July
2010): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1651466.Lobe, Sebastian/Hölzl, Alexander (2011), Ewigkeit, Insolvenz und Unternehmensbewertung: Globale Evidenz, in:
CFB 2, S. 252-257.Schulz, Roland (2009): Größenabhängige Risikoanpassungen in der Unternehmensbewertung, Düsseldorf.