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Importance of Valuation in M&A

National Conference on "Value Creation through M&A"
- CA Sujal Shah
30
th
April 2013
Valuation Concept
Value Price
Valuation not an exact Science, More of Art and
Subjective assessment
Value varies with situations
Date specific
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Merger/
Demerger
Private
Equity
IPO/ FPO
Family
Separation
PPA
Portfolio Value
of Investments
Regulatory
Approval
Litigation
Test of
Impairment/
IFRS
Buyback of
Shares
Purchase /
Sale of
Business
Why
Valuation?
Fair Value of Assets
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Earning based approach
Discounted Cash Flow
Earnings Multiple Method
Market Approach
Market Price
Market Comparables
Asset Based Approach
Net Assets Method
Replacement Value/Realisable Value
Principal Methods of Valuation
Analysis of Company
SWOT Analysis
Profitability Analysis- Past and
vis--vis industry
Ratio Analysis
P&L Ratios
o Expense & Profitability ratios
Balance Sheet Ratios
o Turnover Ratios
o Liquidity Ratios
o Debt Equity - of Company &
Industry
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Discounted Cash Flow
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
Considers Cash Flow and Not Profits
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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DCF When to use?
Most appropriate for valuing firms:
Limited life projects
Large initial investments and predictable cash
flows
Regulated business
Start-up companies
Earnings Multiple Method
Commonly used Multiples
Parameters
Future Maintainable Profits
Capitalization Rate/Multiple
Price to Earnings Multiple
Enterprise Value / EBITDA Multiple
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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--vis Peers
Size & Market Share
Historical Multiples enjoyed on the Stock
Exchange by the Company and its peers
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 Price Approach
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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.
Market Comparables
NAV Formula
Total Assets
(excluding Miscellaneous Expenditure and debit balance
in Profit & Loss Account)
Less: Total Liabilities
NET ASSET VALUE
Share Capital
Add: Reserves
Less: Miscellaneous Expenditure
Less: Debit Balance in Profit & Loss Account
NET ASSET VALUE
OR
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Investments
Surplus Assets
Auditors Qualification
Preference Shares
ESOPs / Warrants
Contingent Liabilities/Assets
Tax concessions
Findings of Due Diligence Reviews
Important Issues
Selection of Methods
Situation Approach
Knowledge based companies Earnings/Market
Manufacturing Companies Earnings/ Market/ Asset
Brand Driven companies Earnings/Market
A Matured company Earnings/Market
Investment/Property companies Asset
Company going for liquidation Asset
Generally, Market Approach is used in combination
with other methods or as a cross check
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Other Value Drivers
Final Value
Final Price is a result of negotiations
IPR / Brand Valuation
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INCOME
APPROACH
MARKET
APPROACH
COST
APPROACH
Relief from
Royalty Method
Market Price on
Active Markets
Comparable
Method
Incremental Cash
Flow Method
Reproduction
Cost Method
Replacement
Cost Method
Valuation Approach
Market Approach
Market Price on active markets:
Valuation is based on market prices.
Requires the relevant asset to have an ascertainable
price in an active market.
Comparable Method:
Price of a comparable market transaction can be
used, subject to strict comparability criteria regarding
the similarity between two intangible assets.
Analysis of similar intangible assets that have
recently been sold can be used.
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Income Approach
Relief from Royalty Method:
Typically employed for valuation of brands and patents
Based on the assumption that an external third party
would be prepared to pay a license fee for the use of brand
or patent that it does not own.
Value of the intangible asset is calculated as the present
value of the saved license payments.
Incremental Cash Flow Method:
To determine the difference between the cash flows of the
acquired company with the relevant intangible assets and
a fictitious company without these assets.
Difference represents the additional cash flow related to
the intangible asset and discounting this at the asset
specific capitalization rate leads to its fair value.
Cost Approach
Reproduction Cost Method:
Cost to construct an exact duplicate using same
materials, production standards and design, etc.
Replacement Cost Method:
Cost to construct equivalent utility using modern
materials, production standards and design, etc.
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Indian Regulatory
Requirement
Income Tax Act
Sec. 56(2)(vii)
Where a firm or a private company receives any property, being
shares of a private company without consideration or with
inadequate consideration (i.e. less than FMV), FMV of such shares
to be computed in accordance with Rule 11UA (given below)
Quoted shares - lowest price of such shares quoted on any
recognized stock exchange on the valuation date
Unquoted equity shares value as computed under option (a)
or (b) below at the option of the assesses
a) Net worth of the company after making adjustments as
specified in Rule 11UA; or
b) FMV as determined by a merchant banker or a chartered
accountant as per the DCF Method.
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Fresh Issue
Transfer of Shares
Listed on SE
(Quoted)
Unquoted
As per Listing
Guidelines Of
SEBI
Value as per DCF
Method as certified
by a Merchant
Banker or a CA
Unquoted
Listed on SE
(Quoted)
DCF Method
Certified by a
Merchant
Banker or a CA
As per Listing
Guidelines Of
SEBI
Investment in
Indian Co
FEMA
Direct Investment
Outside India
Investment >
USD 5 Million
Investment <
USD 5 Million
Fair Valuation by Category I
Merchant Banker registered
with SEBI or Investment
Banker / Merchant Banker
registered in target country
Fair Valuation by a CA or a
Certified Public
Accountant (CPA)
FEMA
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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
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)
Judicial Pronouncements
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