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-à-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-à-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 Valuer’s 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