Appreciating Value New Zealand Edition six March 2015 Contents Introduction Introduction 1 Does the increase in value of NZX listed companies have an impact on private company values? 2 Building quality financial models 6 In this edition of Appreciating Value Our second feature article shares our we reflect on a strong 2014 in terms of 15 Best Practice Financial Modelling deal activity, IPOs and listed share price tips. Given the importance of financial Risk Free Rate revisited 10 performance. Against this backdrop, models in business decision making, it and certainly a surprise compared to is critical that those models are robust Deals update 12 expectations this time last year, we and understandable. Our specialist observe a significant decline in the business modelling team has developed risk-free rate due to a steady decline in these tips through their experience Government bond yields over the last creating and reviewing financial models Cost of Capital and Market Multiples 16 Justin Liddell quarter of 2014 and continuing into throughout New Zealand. Our team’s Partner 2015. credentials are underpinned with team (09) 355 8330 members Alex Gordon and Michael In our first feature article we discuss [email protected] Clarke having achieved first, second the higher trading multiples observed and third placings between them at the from New Zealand listed companies last three ModelOff Financial Modelling and consider what impact this is likely World Championships in New York. to have on private company and SME values. Finally we include our regular Deals update and cost of capital and multiples of listed companies. We welcome your feedback. 2 PwC Appreciating Value March 2015 1 The average historical EBITDA multiples The theory behind using a market DoesEBITDA Mul tipthele Ranges as aincreaset 31 December 2014 in value of NZX for the trailing 12 months (i.e. the multiple valuation methodology is EBITDA Multiples ratio of enterprise value to the prior that similar firms will typically trade - 5 10 15 20 25 30 35 12 months reported EBITDA) shows a at similar multiples. However, the strong upward trend through 2012 and subjectivity to this approach is driven listedAgric ulcompaniesture & Fishing have an impact relative stability since then at around by; how do you determine how similar 9.5x to 10.0x. a company is? Even within an industry Building Materials & Construction on private company values? Given that most private, small and sector, multiples can vary significantly. medium sized businesses (SME) are For example, as at 31 December 2014, Industrial Products valued on an earnings multiple basis, it companies within the NZX listed is reasonable to assume that generally, Agriculture and Fishing sector were Retail • With the NZX All Gross Index increasing 39% in the past two years, seven values would have increased since 2011. trading in an EBITDA multiple range of 7x to 33x, with a median of 10x. initial public offerings (IPOs) in 2013, and 12 in 2014, the New Zealand It does not, however, follow that using Utilities an EBITDA multiple of 9.5x or 10.0x to In forming a view on the appropriate share market is performing exceptionally well. value a SME is appropriate. multiple, judgement is required around snapshot expectations of future earnings, growth • Whilst some of this strong performance is due to increased earnings, The earnings multiple is a valuation prospects of each respective company there has also been a step change in the observed earnings multiples. methodology that uses the derived and the perceived risks of the company. earnings multiple of a comparable • It is reasonable to assume there would be a similar positive impact on company and applies to it to the subject private company values and our first-hand experience supports this. company’s earnings. These comparable companies are typically sourced from similar entities that are listed on a public stock exchange, or from a publically announced transaction. Average EBITDA multiple for selected New Zealand companies EBITDA Multiple Ranges as at 31 December 2014 EBITDA Multiples 10.5x - 5 10 15 20 25 30 35 Agriculture & Fishing 10.0x 9.75x Building Materials & Construction 9.5x Industrial Products 9.0x Retail 8.5x 8.5x Utilities 8.0x 8.0x 7.5x Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Dec 14 Average EBITDA multiple NZ Government bond yields Average EBITDA multiple for selected New Zealand companies 7.50 10.5x 7.00 10.0x 6.50 2 PwC 9.75x Appreciating Value March 2015 3 6.00 9.5x 5.50 t n e 5.00 c 9.0x r e P 4.50 8.5x 4.00 8.5x 3.50 8.0x 8.0x 3.00 2.50 7.5x Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Dec 14 Dec 2004 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013 Dec 2014 Average EBITDA multiple 5 year Government bond yield 10 year Government bond yield NZ Government bond yields Implied 1 year yields interpolated from NZ Government bonds 7.50 5.5% 7.00 5.0% 6.50 6.00 4.5% 5.50 4.0% t n e 5.00 c r e P d l 3.5% 4.50 e i Y 4.00 3.0% 3.50 2.5% 3.00 2.0% 2.50 0 1 2 3 4 5 6 7 8 9 10 Year Dec 2011 31 Dec 14 30 Jun 14 Dec 2004 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2012 Dec 2013 Dec 2014 5 year Government bond yield 10 year Government bond yield Rolling Last Twelve Months Deal Activity 200 1,800 Implied 1 year yields interpolated from NZ Government bonds 175 1,575 5.5% ) d ) n a a i l l 1,350 150 a a r 5.0% e t Z s u w A 1,125 125 ( e s N l ( 4.5% a s e l a 900 100 D e f D o 4.0% f r o e r b 675 75 e m b u d l m 3.5% N e u i 450 50 N Y NZ Australia 3.0% 25 225 - - 2.5% Dec 09 June 10 Dec 10 June 11 Dec 11 June 12 Dec 12 June 13 Dec 13 June 14 Dec 14 2.0% 0 1 2 3 4 5 6 7 8 9 10 Year 31 Dec 14 30 Jun 14 Australian Last Twelve Month Deal Data Rolling Last Twelve Months Deal Activity 200 1,800 1,600 80% s l a 1,575 175 1,400 70% e ) D d l ) n a a t a i l l 1,350 150 o a 1,200 60% a T r e t f Z s o u e w A s 1,125 125 ( l e g 1,000 50% a a s N l t e ( a n D s e l e f a c 900 100 D o r e 800 40% f e r D o e P f r b a o e m r b 675 75 s u e 600 30% a m b N u s l m N a u e 450 50 N 400 20% D g NZ Australia n i n 25 225 200 10% i M - - - 0% Other Deals Mining Deals Mining Deals % Dec 09 June 10 Dec 10 June 11 Dec 11 June 12 Dec 12 June 13 Dec 13 June 14 Dec 14 Inbound Investment Activity by Country / Region 18 2013 2014 Australian Last Twelve Month Deal Data 16 14 1,600 80% s l a 1,400 70% e 12 D l a t 1,200 60% o T 10 f o e s l 1,000 50% g a a t e 8 n D e f c o r 800 40% e r e P 6 b a m s u 600 30% a N s l 4 a e 400 20% D g n i 2 n 200 10% i M - Australia United Asia (excl. United Europe China Canada Other - 0% Kingdom China) States Other Deals Mining Deals Mining Deals % Note: Excludes transactions where the aquiror was not disclosed Inbound Investment Activity by Country / Region 18 2013 2014 16 14 12 10 8 6 4 2 - Australia United Asia (excl. United Europe China Canada Other Kingdom China) States Note: Excludes transactions where the aquiror was not disclosed Although a listed company’s trading Although a listed company’s trading 3. Key person risk. This is often seen in Given the most common methodology multiple can give guidance as to an multiple can give guidance as to an smaller private business and reflects in valuing SMEs is an earnings multiples appropriate multiple and therefore the risk to the business if a key approach and a valuer is likely to take appropriate multiple and therefore value of a privately held business in employee (often the founder) were guidance from the implied trading value of a privately held business in a a similar sector, various factors need to leave the business or something multiple as a starting point for the value similar sector, various additional factors to be considered and a number of happen to him or her. Publically of the SME; we consider that movement adjustments may need to be made. listed companies are generally much in listed company values should need to be considered and a number of These can include: less exposed to this risk. generally impact the value of SMEs in adjustments may need to be made.