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 Capitalisation (PECV) Method
Enterprise Value/ EBITDA Multiple (CCM) Method
Discounted Cash Flow (DCF) Method
Market Price Method
Judicial Pronouncements
Conclusion
Valuation Concept

Value-Price

Value varies with Not an Exact Science

situation

Subjective More of an Art

Date Specific
 Merger/
Merger/
Purchase / Demerger
Demerger
Private
Sale of
Equity
Business

Buyback of
IPO/ FPO
Shares

Why
Test of Valuation? Family
Impairment Separation

PPA
Litigation

Portfolio
Regulatory Value of
Approval Investments
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
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
Analysis of Company

SWOT Analysis
Profitability Analysis- Past and vis--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
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
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
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

OR

Share Capital
Add: Reserves
Less: Miscellaneous Expenditure
Less: Debit Balance in P&L account
Net Asset Value
NAV An Example

NET ASSETS METHOD (INR lacs)

Particulars XYZ Ltd.
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
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
Price/Book Value Multiple

The Price/Book Value Multiple of Comparable Company is

arrived as follows:

STEP 1: Weighted Average Market Price

Divide by: Value per share as per Net

STEP 2: Assets Value as calculated in the
previous slide

STEP 3: Price/Book Value Multiple

Price/Book Value An Example
P/B Multiple Method (INR lacs)
Particulars XYZ Ltd.
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
Earnings Multiple Method

Commonly used Multiples:

Price to Earnings Market Cap/

Multiple PAT

Enterprise Value to Enterprise Value/

EBITDA Multiple EBITDA
Price Earnings Capitalization Method
(PECV) - Parameters

Maintainable Appropriate
PE Multiple
Profits Tax Rate
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)
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
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
PECV Example (CONTD...)
Price Earnings Capitalisation Value Method (INR Lacs)
Particulars ABC Ltd.
Adj. PBT Weight Product
2013-14 144 0 -
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
Enterprise Value / EBITDA Multiple Method

Determination of Maintainable EBIDTA.

EV/EBITDA Multiple
Not affected by the pattern of Funding adopted by Company/
Comparable Companies
EV/EBITDA Example
EV/EBITDA Multiple Method (INR Lacs)
Particulars ABC Ltd
Adj. EBITDA Weight Product
2013-14 388 0 -
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
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
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
Discounted Cash Flow (DCF)

Considers Cash Flow and Not Profits

Cash is King
Free Cash Flow (FCF)
FCF to Firm
FCF to Equity
DCF Parameters

Cash Flows
Projections
Horizon period
Growth rate

Discounting
Cost of Equity
Cost of Debt
Weighted Average Cost of Capital (WACC)
Cash Flows

Business
Plan

Business Working
Cycle Capital

Capital Depreciation
Expenditure Tax
Amortization
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
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
Cost of Debt

Kd = (Int x (1-t))

Where , Kd = Cost of Debt

Int = Average Interest Rate
t = Marginal rate of tax
DCF Discounting Rate

Weighted Average Cost of Capital (WACC)

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

D = Debt
E = Equity
Kd = Post tax cost of debt
Ke = Cost of equity
DCF Terminal Value

Terminal Value is the residual value of business at the end

of projection period used in discounted cash flow method

TERMINAL VALUE

LIQUATION MULTIPLE STABLE GROWTH

APPROACH APPROACH APPROACH
The Final Value

Under the FCF to the firm approach - The Value is the summation
of:
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)
DCF When to use?

Most appropriate for valuing firms:

Limited life projects
Large initial investments and predictable cash flows
Regulated business
Start-up companies
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
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
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
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
Issues in Market Price Method

Market price mat not capture intrinsic value

Thinly traded / Dormant Scrip - Low Floating Stock

Unusual fluctuations in Market Price

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
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
Fair Value An Example

Value per
Method Weight Product (INR)
Share (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
Other Value Drivers

Final Value

Final Price is a result of negotiations

Some Issues (Common)

Relying on Technical Valuers Report

Joint Reports
Fairness Opinion by Merchant Bankers
Engagement Letter
Management Representations
Reporting
Judicial Pronouncements

Exchange Ratio not disturbed by Courts unless

objected 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
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)
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