APT TECHNICAL CPD - MAF (Valuations) 1
Valuations Nicholas Riemer
Agenda • Workflow to understanding Valuations • What are Valuations? Generic Problem • How are valuations performed in specific industries? • What is the specific problem? • How to incorporate into your file
Valuation Workflow Approach
What are valuations? Generic problem • Why we do valuations? Need to know the purpose of your valuation at hand, not just the theory. • Myths: Precise?, Objective?(Valuations are all about the inputs, assumptions being made) who is valuating this business. • Quantitatively correct? Is a valuation perfect in its final answer?
Thought process from a practical view • Step 1: Purpose of the valuation – For whom? (buyer/seller) – What for? Pe company buying a minority? Individual buying a majority to run? Selling a portion to fund future growth? – Limitations (information available, assumptions, industry) • Step 2: Date of valuation • Step 3: Parties involved – Companies/ individuals/banks/PE – Reason for sale (WHY?) • Step 4: What is being valued? – Preference shares/debentures (COC module – value instrument). Link Pref share funding to purchase of businesses. – Equity = enterprise as a whole – Components of the enterprise – Size of the interest (pay more for controlling interest)
Thought process continued. • Step 5: Choice of valuation method – MOTIVATE THE USE OF THE METHOD Going concern? Yes No (most likely asset value) or use of assessed loss Investment versus income generating Minority versus majority shareholding Fluctuating growth Earnings versus cash
Thought process continued. • Step 6: Calculate maintainable income for ? Given past income statements Make certain adjustments to reflect future maintainable income Growth trends – General principles – Dividend yield – Earnings PE and EBITDA – Net asset value – Free cash flow
Thought process continued • Step 6 cont.: Calculating maintainable income – Past income statements – Make adjustments to reflect future – GIVE REASONS FOR ADJUSTMENTS • General principles: – Emphasis on the word MAINTAINABLE – Impact of buyer/seller – Adjust for: Non-recurring items Extraordinary items Changes in business policy Changes in accounting policy Changes in tax rate Abnormal profit or losses on investments/assets Abnormal levies to directors/management Changes in salary expense Private expenditure Changes in inflation
Thought process continued • Step 6 cont. : Calculating maintainable income • General principles (continued): – Adjust for: Finance costs unreasonable Lease/rent expense – replaced with property purchased Etc – Growth in maintainable earnings Growth trend Buyer/Seller Accounting average Weighted average Abnormal years (excluded)
Thought process continued • Step 6 cont.: Calculating maintainable income • Dividend yield method – calculating the maintainable dividend – Starting point: Identify the future dividend policy: (Link to dividend policy) Fixed payout in Rand terms maintainable income calc not necessary Fixed payout ratio payout dependent on the maintainable income, therefore calculate maintainable income first • Earnings yield method/EBITDA – calculating the maintainable earnings – Starting point Calculate maintainable income or EBITDA • Net asset value – Calculation of maintainable income not necessary – Emphasis on balance sheet – Future benefits come from sale of assets @ MV or liquidation value – NAV = Assets – Liabilities • Free cash flow method Starting point Calculate free cash flow, applying the general principles
Thought process continued • Step 7: Discount the maintainable income – Choosing the appropriate discount rate – Starting point similar listed companies NB for PE and EBITDA – Factors that increase/decrease risk – impact on discount rate – If there is a difference, make adjustments such as: Asset structure – age of assets Industry changes Capital structure Economic cycle Management experience Years of existence Unlisted status Loss of key staff Changes in legislation Political risks Etc
Thought process continued Step 7 cont.: Discount rate • Dividend yield method – Cost of equity • Earnings yield method – Earnings yield %/ PE Multiple which is PPS/EPS • Net asset value – No discount rate – MV and liquidation value are values today • Free cash flow – Cost of capital – Why??? Permanent sources of finance. Blended approach.
Thought process continued. • Step 8: Perform the valuation – Discount the maintainable income – Apply the size of the shareholding – NB Subjective, explain what you are doing. If reasoning is sound C or HC • Step 9: Reasonableness test NB for real world. – Perform alternative valuations, based on info available – Listed price (if available) • Step 10: Recommendations and negotiation factors NB – For APT and APC this can be an important step. You could simply be asked by the CFO or FD to look at the valuation already performed and give your views as a young CA without reperforming? – NB never too critical. Language, soft skills. Maye re look at the growth rate as WACC should be used to give us a clearer answer as the company does have permanent sources of finance which it utilizes to grow the business, thus leverage must be taken into account etc. not jut, the growth rate is wrong because of…
Methods NB • Dividend • Earnings (PE) NB • EBIT/DA NB – Calculate EBITDA multiple of a similar company Market capitalization + MV of debt EBITDA – Adjust EBIT/DA multiple to reflect company risk – Calculate maintainable EBITDA – MV of assets (Enterprise value) = EBITDA multiple x maintainable EBITDA – Deduct market value of debt = Equity value. • Before interest = different gearing is accounted for • Before depreciation and amortisation = closer to cash(Older assets)
DCF (Discounted cash flow) • Free Cash Flow Available for Distribution to all providers of permanent capital included in the WACC” • Bucket Principle…. I like Revenue when given the option • Bucket for all stakeholders vs. Bucket for equity • Starting point Income Statement Balance Sheet Cash flow Statement
How do we do Free Cash Flow ? planning Into calculation Base Year “0” Year 1 Year 2 Year 3 Current Year – Historical Planning Period of Representative data i.e. IS extraordinary growth year Expect > 1 growth rate Expect stable growth • Use of PV techniques in order to value the cash flows in the FUTURE years only • Base Year is our starting point but not included in the valuation • Growth phase – new business or reasonably forecast-able • Representative year – annuity • PV of future cash flows, discounted at required rate of return 17
STEP 1 – Calculating the cash flows: Base Year Make adjustments to manipulate from our starting point in order to get “Free Cash Flow available for distribution to all providers of WACC capital” 1.Non-Cash items – we want the cash flows 2.Non-Operating Item – not related to core business, different risk profiles 3.Finance Costs why? Permanent sources of finance key principle for valuations in the APT and APC 4.Cash tax adjustments 18
Planning Phase • Growth – Real {volume} – Inflation {price} – Nominal – N = [(1 + R)(1 + i) – 1] • Make adjustments for the following 1.Working capital adjustments 2.Costs to maintain the business 3.Costs to expand the business 19
Representative Year • Make adjustments in order to make the year representative (in addition to all the other adjustments mentioned) perpetuity, so must be a clear reflection of the business going forward. • Sustainable – as it will be the PV of an annuity, thus must be representative of the future • Formula for an annuity = Po = D1/(Rqd Return-g) • When is the representative year – growth is stable, normally year 6 or year 11 of a forecast. 20
STEP 2 – Discounting to PV • WACC(Ke=CAPM), market value of debt • Annuity for representative year – Gordons Growth Model • Only future cash flows • Value obtained = Value of business for both equity and debt providers – Remember the bucket principle 21
STEP 3 – Obtaining the equity value • Deducting the MV of debt • Adding the value of non-operating items such as properties and investments etc. 22
Specific Industry? • What is the industry? • How are valuations performed in this industry, Fast food, pharmaceutical, Fuel? • Research, but what kind of research? What type of information are you looking for? • Are you applying the technical detail of the topic to the industry in your research time?
Models in practice? • EBITDA and PE: the multiples here are the big talking point. Can we find comparable multiples in the industry research? Why need this for the day’s tasks. Not going to be there. • DCF: Growth rates in the industry, industry outlook, discount rate(WACC) but? CAPM requires the Rf rate and b. do you have those? • Have you calculated the market value of Debt? Can you? • Need this information as its not ITC now.
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