Business Valuation & Emerging Opportunities for Professionals Chander Sawhney FCA, ACS, Certified Valuer (ICAI) Partner & Head – Valuation & Deals Gurgaon Branch NIRC of ICAI 11th November 2017 -Overview of Valuation Agenda -Valuation Approaches and Methodologies -Valuation Methodologies and Value Impact -History of Valuation in India -Major Business Valuation Methodologies . Discounted Free Cash Flow . Relative Valuation -Regulatory Valuation in India . Transactions . Applicable Laws -Emerging Opportunities in Valuation in India . Registered Valuer . Ind AS -Tricky Issues Company Share Valuation Share Company “ “ Price is what you Pay, Value is what you get “ Warren Buffett Valuation is the process of determining the “Economic Worth” of an Asset or Company under certain “Assumptions” and “Limiting Conditions” and subject to the “Data” available on the “Valuation Date” *Source -International Valuation Standard Council • Mergers ‘WHY VALUATION’ ? • Acquisitions / Investment Transactions • Fund Raising • Sale of Businesses • Voluntary Assessment • RBI • Income Tax Regulatory • SEBI • Stock Exchange • Companies Act • CLB/Courts • ESOP • Purchase Price Allocation Accounting • Impairment / Diminution • Fair Value (Ind AS) CHOOSING THE RIGHT ‘STANDARD’ & ‘PREMISE’ OF VALUE Standard of Value is the hypothetical conditions under which a business is valued. While selecting the Standard of Value following points is to be taken care of Subject matter of Valuation; Standard Purpose of Valuation; Statute; of Value Case Laws; Circumstances. Types of Standard of Value: FAIR MARKET VALUE INVESTMENT VALUE INTRINSIC VALUE FAIR VALUE Premise of Value relates to the assumptions upon which the valuation is based. Premise of Value Premise . Going Concern – Value as an ongoing operating business enterprise. of Value . Liquidation – Value when business is terminated . It could be ‘forced’ or ‘orderly’. Value-in-use Value-in-exchange ‘VALUATION APPROACHES’ Fundamental Relative Other Methods ‘VALUATION APPROACHES’ Fundamental Income • Capitalization of earning Approach Method (Historical) • Discounted Cash Flow Method (Projected Time Value) Asset • Book Value Method Approach • Liquidation Value Method • Replacement Value Method ‘VALUATION APPROACHES’ Relative • Comparable Companies Market Multiples Market Based Method (Listed Peers) Approach • Comparable Transaction Multiples Method (Unlisted Peers) • Market Value Method (For Quoted Securities) ‘VALUATION APPROACHES’ Other Methods • Contingent Claim Valuation (Option Pricing models : Black Scholes / Binomial etc.) • Price of Recent Investment / Backsolve Method • First Chicago Method (Start Up) – Scenario based • Venture Capitalist Method (Start Up) • Rule of Thumb (Industry wise) In General, Income Approach is preferred; The dominance of profits for valuation of share was emphasised in Choice of “McCathies case” (Taxation, 69 CLR 1) where it was said that “the real value of shares in a company will depend more on the profits which the company has been making and should be capable of making, having Valuation regard to the nature of its business, than upon the amount which the shares would realise on liquidation”. approaches This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.) (122 ITR 38). However, Asset Approach is preferred in case of Asset heavy companies and on liquidation; The liquidated value of the Net Assets Purpose of Valuation (Regulatory or Transaction), Size of is also considered the minimum value of the whole company and Transaction (Minority or Control), Stage of Business, and will prevail even if Earning capacity is low or negative subject to any discounting in appropriate circumstances (like Reluctance to wind Business Model determine Valuation Approaches up, Ability to control, Tax adjustments etc.) Market Approach is preferred in case of listed entity and also to evaluate the value of unlisted company by comparing it with its peers; Major Valuation Ideal for Result Methodologies Valuation Net Asset Value Net Asset Value (Book Value) Minority Value Equity Value methodologi Net Asset Value (Fair Value) Control Value Comparable Companies Multiples (CCM) Method es & Value Price to Earning , Book Equity Value Value Multiple Minority Value Impact EBIT , EBITDA Multiple Enterprise Value Comparable Transaction Multiples (CTM) Method Price to Earning , Book Equity Value Value Multiple Control Value EBIT , EBITDA Multiple Enterprise Value Discounted Cash Flow (DCF) Equity Control Value Equity Value Firm Enterprise Value ‘Enterprise / Business Valuation’ Intangibles# Equity# Net Current Assets# Fixed of Business Value Enterprise Valuation Net Debt# Assets# Stakeholders Assets # Based on Market Values Valuation across business cycle follow the LAW of ECONOMICS Investor assign value based on the cash flow they Key drivers expect to receive in the future of - Dividends / distributions - Sale of liquidation proceeds Valuation Value of a cash flow stream is a function of - Timing of cash Receipt Cash Flow - Risk associated with the cashflow ThaT’s why DCF is most prominent valuation method Operating Assets • Assets used in the operation of the business Key drivers including working capital, Property, Plant & Equipment & Intangible assets of • Valuing of operating assets is generally reflected in the cash flow generated by the business Valuation Non - Operating Assets • Assets not used in the operations including excess cash balances, and assets held for investment purposes, such as vacant land & Securities Assets • Investors generally do not give much value to such assets and Structure modification may be necessary Need for restructuring Skills required for performing Valuations Knowledge of Strong prescribed understanding of Valuation Valuation principles requirements under different Laws Awareness of Market multiples (Listed Companies) and Deal/ Funding Transactions Understanding (Unlisted Companies) Knowledge of of Sectoral across Industries and relevant dynamics, Stages Accounting Trends and (Seed, Angel, VC, PE, Standards Rule of Thumb Buyout etc.) (IND AS) for Industries Knowledge of Taxation aspects (Tax on Asset Sale, Profits, Tax shield on Accumulated Losses etc.) History of Valuation in India DFCF Method was Since SEBI Act was prescribed by RBI made, companies for all FDI There was fixed Pricing are free to price Valuations (which ICAI issued Income Tax Law ICAI issued Guidelines for valuation of their issues in later changed to Valuation standard prescribed Valuation Valuation shares done as per erstwhile consultation with any Internationally CAS-1 for Transfer of Shares Comptroller of Capital Issue Guidance accepted method) the Merchant (recommendatory) Income Tax Law (CCI) guidelines which Bankers ESOP tax was also prescribed Valuation prescribed Net Assets Value introduced as for Issue of Shares (NAV), Profit Earning Perquisite April April Capacity Value (PECV) and March Draft Registered Market Value (in case of Valuer provisions Listed Company). As the 2010 governing both value was based on Historical 2014 Technical & Financials and formulae Oct 2009; – Financial Valuer drives, resultant value was June 2010 were brought in fixed (Start Up) Companies Act, 2013) April 2013 From 1.4.2016, Had provision for Ind AS came into Valuation of unquoted force for large shares and Company companies; Now Emphasis was given on applicable to Book Value Method Sep 2013 Listed companies (Adjusted) as per and those with Balance Sheet duly 250 cr. Net Worth adjusted for discount Registered Valuer for Marketability, Lack provisions of Dividends etc. Wealth Tax Rules,1957 2016 and 2017 implemented (repealed w.e.f. w.e.f. 18th Oct, 1.4.1989) 2017 Discounted Free Cash Flow Valuation Major Forward Looking and focuses on cash generation Recognizes Time value of Money Characteristi Allows operating strategy to be built into a model cs of Incorporates value of Tangible and Intangible assets Only as accurate as assumptions and projections used Discounted Works best in producing a range of likely values Free Cash It Represents the Control Value Flow (DFCF) Valuation DFCF expresses the present value of the business as a Discounted function of its future cash earnings capacity. In this method, the Free Cash appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working Flow Method capital and capital expenditure is being met. Valuing equity using the (DFCF) free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off. Understand Business Model Identify Business Cycle DFCF Analyze Historical Financial Performance Review Industry and Regulatory Trends Valuation Understand Future Growth Plans (including Capex needs) Segregate Business and Other Cash Generating Assets Process Identify Surplus Assets (assets not utilized for Business say Land/Investments) Create Business Projections (Profitability statement and Balance Sheets) Discount Business Projections to Present (Explicit Period and Perpetuity) Add Value of Surplus Assets and Subtract Value of Contingent Liabilities Discounted Cash Flow Valuation The following box provides generalized steps for using discounted free cash flows to estimate the value of the firm and then to derive the value of equity shareholders of the Company STEPS FOR FINDING FCF TO VALUE EQUITY SHARES