VALUATION TECHNIQUES

Presented by:
Kaushal Shah
Anup Agarwal

September 29, 2007

 Index

„ Approach to Valuation Section I

„ Valuation Methods Section II
„ Practical Difficulties in Valuation Section III
„ Resources Section IV

Valuation Techniques
Page 2
Section I: Approach to Valuation

Valuation Techniques
Page 3
 Approach to Valuation

Develop an overall range of values,

based on certain underlying
assumption
Select an
appropriate
method for
valuation
Progress

Collect financial
projections,
market feedback
Understand the
business and
background of the
company and the
country and industry
in which it operates
Time

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Background Information

„ Primary Source of Information: Undertake management

interviews and collect background documents/ information
on following:
z Country of operations
z Regulations impacting the operations of the industry in
general and the company in particular
z Key products and services
z Audited financial statements
- Ratio analysis (ROE, growth rate of earnings, margins,
Debt/Equity ratio, capital employed)
- Scan the financials to the maximum extent possible so as to
compute a trend which can be mapped or correlated with the
financials of competitors financials

z The technology used, utilized capacity, human resources,

etc
„ Secondary source: Industry reports, research report,
newspapers and etc

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Future Projections

„„ Why
Whydodowewerequire
requiretotocompute
computethe thefuture
futureprojections?
projections?
z Understand the free cash flow generated from the investment made
z Understand the free cash flow generated from the investment made
z Depending upon the growth rate and the ROE
z Depending upon the growth rate and the ROE
„„ The
The“Explicit
“ExplicitForecast
ForecastPeriod”
Period”
z Basic assumption being that a firm would grow at a rate higher than the industry
z Basic assumption being that a firm would grow at a rate higher than the industry
rate
rate&&earn
earnaaROE
ROEhigher
higherthan
thanthe
theindustry
industryrate
rate
z However, the “law of economics” would come in play over time
z However, the “law of economics” would come in play over time
z Returns to be in line with the industry rate and the growth to be lower than or
z Returns to be in line with the industry rate and the growth to be lower than or
equal
equalthan
thanthethegrowth
growthrate
rateofofthe
theeconomy
economy
„„ To
Tounderstand
understandwhenwhenthethefirm
firmwould
wouldhit hitthe
thestable
stablegrowth
growthlook
lookfor:
for:
z Size of the firm, relative to the market it serves (a new IT company can probably
z Size of the firm, relative to the market it serves (a new IT company can probably
grow
growatataarate
rateofof80-100%
80-100%perperannum
annumfor forthe
thenext
next11year,
year,however,
however,the
thesame
same
cannot
cannotbebeexpected
expectedfrom
fromInfosys)
Infosys)
z Competitive advantages & barriers to entry that give the firm its capacity for high
z Competitive advantages & barriers to entry that give the firm its capacity for high
growth
growth&&highhighreturns
returns

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Page 6
Future Projections

„ While working out the future projections, „ Following macro level issues should also
understand key assumptions underlying be considered while forecasting
each variable. projections:
„ Some of the variables to that you should z Country
pay attention to are: - Developed or a developing
z Capacity Utilization economy – Impacts the growth
z Volumes and the risk assumptions
- Political and Economic scenario
z Price trends - Inflation
z Cost of goods sold z Industry
z Administration overheads - Rules and regulations applicable
z Selling & Marketing costs - Growth cycle of the Industry
z EBITDA Margins
z Tax workings and calculations
z Capital expenditure
z Working capital requirements

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Section II: Valuation Methods

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Page 8
Methods for Valuation
„ Determine suitability of alternative methods to arrive at a
valuation
„ Valuation can be based on Earnings or Assets of the Company
„ Certain valuation methods can be applied universally; some are
specific to respective industry

Discounted Cash Flow (DCF)

Analysis
„ “Fundamental” or
“theoretical” valuation
„ Estimates firm’s value by
discounting expected free
cash flows at a rate which
reflects the risk of the cash
flows
„ Terminal value based on
two methodologies
z EBDITA multiple
z Perpetuity
z Discount the resulting
free cash flows at a cost
of capital that reflects
company specific risk
Trading Multiples
„ “Market” valuation
„ Investors view on prospects
of an entire industry and
specific companies
„ Considerations for peer
group include similar size,
life of assets and similar
management quality
„ Difficult to establish peer
group on account of diverse
business activities.
Transaction Multiples
„ “Acquisition” related
valuation
„ Applies multiples of related
industry transactions to the
valuation of a business
„ Measures premium paid for
acquiring control and places
value on intangible strategic
factors
Net Asset Value (NAV)
„ Acquisition related
valuation
„ Useful when the historical
costs of assets purchased is
not comparable to its
current market value
„ NAV is based on expected
future cash flows the
market expects from the
asset
„ Two methods
z Replacement Cost
z Future cash flows

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 Discounted Cash Flow (Cont’d.)

„„ The
TheDiscounted
DiscountedCash
CashFlow
Flow(DCF)
(DCF)method
methodisisuniversally
universallyaccepted
acceptedas
asthe
themost
most
fundamental
fundamentalvaluation
valuationtechnique
technique
„„ DCF
DCFhas
hasits
itsfoundation
foundationininthe
thePresent
PresentValue
Value(PV)
(PV)rule,
rule,where
wherethe
thevalue
valueofofany
anyasset
assetisis
the
thePV
PVofofthe
theexpected
expectedfuture
futurecash
cashflows
flows
z
z
Investment
InvestmentofofRs.
Rs.11lacs
lacsininaaproject
projecttoday
todaygives
givesaareturn
returnofof12%
12%p.a
p.atill
tillinfinity
infinity
z
z
How
Howtotocompute
computethe thetotal
totalcash
cashflow
flowreceived
receivedfrom
fromthis
thisproject
project??Find
Findoutoutwhat
whatwould
would
Rs.
Rs. 12,000 earned say after 1 year, 3 years or 5 years would be worth today, i.e., findout
12,000 earned say after 1 year, 3 years or 5 years would be worth today, i.e., find outthe
the
NPV of the cash flows
NPV of the cash flows
„„ DCF
DCFisisbased
basedon
onthe
theprinciples
principlesofofFree
FreeCash
CashFlow
Flow––totothe
thefirm
firmand
andtotothe
theShareholders
Shareholders
z
z
Free
FreeCash
CashFlow
FlowtotoFirm
Firmmethod
methodofofDCF
DCFvaluation
valuation(FCFF)
(FCFF)
z Free Cash Flow to Equity method of DCF valuation (FCFE)
z Free Cash Flow to Equity method of DCF valuation (FCFE)
„„ In
InDCF,
DCF,the
thevaluation
valuationofofthe
thefirm
firmisisaacombination
combinationofoftwo
twofactors:
factors:
z
z
Valuation
Valuationbased
basedfree
freecash
cashflows
flowsininthe
theexplicit
explicitforecasted
forecastedperiod,
period,lets
letssay
say55or
or10
10years
years
z
z
Terminal
Terminalvalue
valueofofthe
thefirm
firmbeyond
beyondthetheexplicit
explicitforecasted
forecastedperiod
period
- - Company
Companyisisassumed
assumedtotobe
beoperating
operatingafter
afterthe
theexplicit
explicitforecasted
forecastedperiod
periodtill
tillperpetuity
perpetuity- -
Concept
ConceptofofOngoing
Ongoingconcern
concern

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Page 10
 Discounted Cash Flow (Cont’d.)

„ Steps followed in applying this approach include:

„ Steps followed in applying this approach include:
„„ Step
Step11: :Projecting
Projectingthe
thefree
freecash
cashflows
flowsofofthe
the“business”
“business”over
overthe
theselected
selectedperiod
periodofofestimation
estimation––
forecasted
forecastedperiod
period
z FCFF is arrived at as follows:
z FCFF is arrived at as follows:
Earnings
Earningsbefore
beforeinterest,
interest,tax,
tax,depreciation
depreciationand
andamortisation
amortisation(EBITDA)
(EBITDA)
(-)
(-)//++ Adjustment
Adjustmentfor fornon-cash
non-cashexpenditure
expenditureor
orincome
income
(-)
(-) Adjusted
Adjustedtaxes
taxeson onEBITDA
EBITDA
(-)
(-) Planned
Plannedcapital
capitalexpenditure
expenditure
(-)/
(-)/++ (Increase)/
(Increase)/Decrease
Decreaseininnet
networking
workingcapital
capital
z FCFF can also be derived from PAT
z FCFF can also be derived from PAT
z FCFE is derived as follows:
z FCFE is derived as follows:
Profit
ProfitAfter
AfterTax
Tax
(-) / +
(-) / + Adjustment
Adjustmentfor fornon-cash
non-cashexpenditure
expenditureor
orincome
income
(+)
(+) Depreciation
Depreciation
(-)
(-) Planned
Plannedcapital
capitalexpenditure
expenditure
(-)/ +
(-)/ + (Increase)/
(Increase)/ Decreaseininnet
Decrease networking
workingcapital
capital
(-)/ +
(-)/ + Scheduled repayment of loans
Scheduled repayment of loans

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 Discounted Cash Flow (Cont’d.)

„„ The
Theforecasted
forecastedperiod
periodisisthe
theperiod
periodpost
postwhich
whichthethegrowth
growthofofthe
thebusiness
businessisisstable
stable
„„ AAfirm
firmisisininstable
stablegrowth
growthwhen
when
z It is growing at a rate less than or equal to the growth rate of the economy in which
z It is growing at a rate less than or equal to the growth rate of the economy in which
ititoperates
operates
z Its risk characteristics and leverage resemble those of a stable growth firm in that
z Its risk characteristics and leverage resemble those of a stable growth firm in that
market.
market.
z Its returns on capital converge towards the industry average (or the cost of capital)
z Its returns on capital converge towards the industry average (or the cost of capital)
„„ All
Allfirms
firmswill
willbecome
becomestable
stablegrowth
growthfirms
firmsatatsome
somepoint
point
z Because no firm can grow at a rate higher than that of the economy forever
z Because no firm can grow at a rate higher than that of the economy forever
z Size becomes an enemy
z Size becomes an enemy

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 Discounted Cash Flow (Cont’d.)

„„ The
Theimpact
impactofofinflation
inflation- -Nominal
Nominalcash
cashflows
flowsand
andreal
realcash
cashflows
flows
„„ Lets
Letstake
takeananexample:
example:In
Incase
casethe
theprice
priceofofaaparticular
particularcommodity
commodityincrease
increasebyby8%
8%ininaa
year
yearininan
aneconomy
economywhich
whichhas
has5%
5%inflation.
inflation.In
Inthat
thatcase
casethe
thereal
realgrowth
growthrate
ratehas
has
actually
actually been only 3% and not 8%. In the sense the price has grown in real termsby
been only 3% and not 8%. In the sense the price has grown in real terms by
3%
3%only
only
„„ Normally
Normallyvaluations
valuationsare
aredone
donetaking
takingnominal
nominalcash
cashflows
flowsas
asthe
thebasis
basiswhich
whichincludes
includes
inflation.
inflation.
„„ However,
However,aafirm firmcan
canalso
alsobebevalued
valuedon onaareal
realcash
cashflow
flowbasis
basisby
byadjusting
adjustingthe theimpact
impact
ofofinflation
inflationnot
notonly
onlyon
onthe
thecash
cashflows
flowsbut
butalso
alsoininthe
theDiscounting
DiscountingFactor
Factor. .This
Thisisisso
so
because the Discounting Factor is calculated taking into account the risk free
because the Discounting Factor is calculated taking into account the risk free returns returns
which
whichisisnothing
nothingbut
butthe
thereturn
returnonongovernment
governmentsecurities
securitieswhich
whichincludes
includesinflation.
inflation.
z
z
The
Thenumerator
numeratorand
andthe
thedenominator
denominatorshould
shouldbe
beon
onsame
sameterms
terms
„„ However,
However,the
thevaluation
valuationarrived
arrivedatateither
eitherfrom
fromthe
thenominal
nominalcash
cashflows
flowsor
orthe
thereal
realcash
cash
flows
flowswould
wouldalways
alwaysbe
besame
same

Valuation Techniques
Page 13
 Discounted Cash Flow (Cont’d.)

„„ Step
Step2:2:Converting
Convertingthese
thesefree
freecash
cashflows
flowsinto
intopresent
presentvalue
valuethrough
throughdiscounting
discounting
„„ The
Thediscounting
discountingfactor
factorisisthe
theexpected
expectedreturn
returnfrom
fromthetheinvestment
investmentatataaparticular
particularlevel
level
ofofrisk; Alternatively it is the cost of funds or the opportunity cost
risk; Alternatively it is the cost of funds or the opportunity cost of capitalof capital
„„ Assuming
Assumingan aninvestment
investmentofofRs. Rs.100
100gives
givesaareturn
returnofof10%
10%p.a.
p.a.However,
However,ififthere
thereisisan
an
option
optiontotolend
lendthe
themoney
moneytotoaafriend
friendatatan
aninterest
interestrate
rateofof12%
12%p.a.
p.a.Would
Wouldyou youinvest
invest
or lend?
or lend?
„„ Discounting
Discountingfactor
factorisisbased
basedon onaasimple
simpleprinciple
principlethat
thathigher
higherthetherisk
riskofofaaproject
project(risk
(risk
ofofachieving a projected cash flow of the project) higher would
achieving a projected cash flow of the project) higher would be the returnbe the return
expectation
expectationofofan aninvestor
investorand andvice
viceversa
versa
„„ Discounting
Discountingfactor
factorcould
couldeither
eitherbebeaacost
costofofequity
equity(Equity
(EquityValuation)
Valuation)or oraacost
costofof
capital
capital(Firm
(FirmValuation)
Valuation)
„„ Various
Variousfactors
factorstotobe
beconsidered
consideredwhilewhilecomputing
computingthe thediscounted
discountedrate,
rate,assuming
assuming
WACC
WACC are:are:
z Cost of Equity (Ke)
z Cost of Equity (Ke)
z Cost of Debt (Kd)
z Cost of Debt (Kd)
z Target Debt Equity Ratio
z Target Debt Equity Ratio

Valuation Techniques
Page 14
 Discounted Cash Flow (Cont’d.)
„ Cost of Equity (Ke)
„ Cost of Equity (Ke)
z
z
Several
Severalmethods
methodsavailable
availabletotocompute
computeKe. Ke.However,
However,Capital
CapitalAssets
AssetsPricing
PricingModel
Modelisisthe
themost
most
universally accepted method.
universally accepted method.
z As per CAPM, Ke = Rf + (Rm – Rf)*b = Rf + (equity risk premium) * firm specific risk
z As per CAPM, Ke = Rf + (Rm – Rf)*b = Rf + (equity risk premium) * firm specific risk
- - Rf Rf––Risk
Riskfree
freerate
rateofofreturn
return––government
governmentsecurities
securitiesfor
forthe
themaximum
maximumpossible
possibleperiod
periodor or
the project period
the project period
- - Rm Rm––Expected
Expectedreturn
returnon onmarket
marketindex
index (Market
(Marketprovides
providesthe thebest
bestreturn
returnatataaparticular
particular
level of risk)
level of risk)
- - bb––Beta
Beta
„ In simple words, Rm denotes the returns from an asset class in addition the risk free return or an
„ In simple words, Rm denotes the returns from an asset class in addition the risk free return or an
incentive
incentivethat
thatananinvestor
investorwouldwouldlook
lookatatfor
forinvesting
investingininaaparticular
particularclass
classofofasset
asset(say
(sayequity)
equity)
which is riskier than investing in a risk free asset (say government
which is riskier than investing in a risk free asset (say government securities) securities)
„ Currently, a 6-7% market risk premium is assumed while calculating the cost of equity for
„ Currently, a 6-7% market risk premium is assumed while calculating the cost of equity for
investments
investmentsininIndian
Indianequity
equitymarkets
markets
„ Beta calculates the risk which is specific to the company in direct correlation to the market index.
„ Beta calculates the risk which is specific to the company in direct correlation to the market index.
When
Whenbetabetaisisless
lessthan
than1,1,ititmeans
meansthe
therisk
riskofofthe
thesecurity
securityisisless
lessthan
thanthe
themarket
marketriskrisk
z Can be calculated by regression of the stock price returns with the Index returns
z Can be calculated by regression of the stock price returns with the Index returns
z Can be sourced from Bloomberg, Yahoo or from research agencies like Dun & Bradstreet
z Can be sourced from Bloomberg, Yahoo or from research agencies like Dun & Bradstreet

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 Discounted Cash Flow (Cont’d.)

„ Beta calculates the risk factor of a particular asset (say risk of investing in Reliance) with
„ Beta calculates the risk factor of a particular asset (say risk of investing in Reliance) with
reference
referencetotoaabasket
basketofof assets
assets(say
(sayinvesting
investingininSensex)
Sensex)
z Risks can be classified as Systematic risks and Unsystematic risks.
z Risks can be classified as Systematic risks and Unsystematic risks.
- - Unsystematic
Unsystematicrisks:
risks:
These
Theseare
arerisks
risksthat
thatare
areunique
uniquetotoaafirm
firmororindustry
industryand
andunknown.
unknown.
- - Systematic
Systematicrisks:
risks:
These
These are risksassociated
are risks associatedwith
withthe
theeconomic,
economic,political,
political,sociological
sociologicaland
andother
othermacro-level
macro-level
changes. They affect the entire market as a whole and cannot be controlled or eliminated
changes. They affect the entire market as a whole and cannot be controlled or eliminated
merely
merelyby
bydiversifying
diversifyingone's
one'sportfolio.
portfolio.
„ The degree to which different portfolios are affected by these systematic risks as compared to the
„ The degree to which different portfolios are affected by these systematic risks as compared to the
effect
effecton
onthe
themarket
marketasasaawhole,
whole,isisdifferent
differentand
andisismeasured
measuredby byBeta.
Beta.
„ Beta can be based on leveraged or de-leveraged Beta
„ Beta can be based on leveraged or de-leveraged Beta
Last 2 years adjusted Beta from Bloomberg
Real Estate FMCG IT
Mah Gesco 1.45 HLL 0.98 TCS 0.92
Unitech 1.1 Marico 0.92 Wipro 1.07
Ansal 1.49 Dabur 0.94 Infosys 0.97

Valuation Techniques
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 Discounted Cash Flow (Cont’d.)

„„ Cost
CostofofDebt
Debtisisconsidered
consideredon
onaapost
posttax
taxbasis
basis
z Cost of recent loans taken by the company
z Cost of recent loans taken by the company
z
z
Cost
Costbased
basedon
onthe
theratings
ratingsofofthe
thecompany
company
- - ICRA,
ICRA,CARE,
CARE,CRISIL
CRISIL
z
z
Cost
CostofofDebt
Debtwould
wouldbebedefault
defaultspread
spreadover
overand
andabove
abovethe
therisk
riskfree
freerate
rateofofreturn
return
from
fromgovernment
governmentsecurities
securities
z
z
Government
GovernmentSecurities
Securitiestotobe
beconsidered
consideredfor
forthe
thelongest
longestmaturity
maturityavailable
availableand
andthe
the
security
securityshould
shouldbe
beliquid
liquidtotodetermine
determinethe
theactual
actualvalue
value
- - Generally
Generallyaasecurity
securityofof10
10year
yearmaturity
maturityconsidered
considered
„„ Target
TargetDebt
DebtEquity
EquityRatio
Ratio
z Based on the ratio of debt as would be expected in future
z Based on the ratio of debt as would be expected in future
z
z
Proportion
ProportionofofDebt
Debtand
andEquity
Equitybecomes
becomesthe
theweight
weightfor
forderiving
derivingthe
theWACC
WACC

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 Discounted Cash Flow (Cont’d.)

(FCFn(1+g)
„ Step 3: Terminal Value – Terminal value is Terminal Value =
the value of the business at the end of/ (WACC - g)
beyond the explicit forecasted period, i.e., the FCFn = free cash flow of the last year of the
period where it is assumed that the ROE or forecasted period
the growth rate is assumed to be higher than g = growth rate beyond the explicit forecasted
period
the industry rates
WACC = weighted average cost of capital
„ The formula for calculate terminal value is:
Growth trend
„ The growth rate used for calculating the
terminal value is the rate at which the cash
flows are expected to increase beyond the
explicit forecast period till infinity
„ You may also use a various exit multiples to the free cash flow of the terminal year for
computing the terminal value; P/E, P/B or multiple on EBITDA

„ Terminal growth is the rate the firm would grow after it reaches the steady state growth phase

„ A firm which is presently growing at 22%, in a industry which is growing at 10%, is unlikely to
grow at that rate once it has reached a stable growth, because it has exhausted some or all of the
differential advantage that gave it the high margin
Valuation Techniques
Page 18
 Discounted Cashflow Valuation
Cashflow to Firm
EBIT (1-t) Expected Growth
- Cap Ex – Depr) Reinvestment Rate *
- Change in WC Return on Capital Firm is in stable growth:
= FCFF Grows at constant rate
forever

Terminal Value = FCFFn + 1/(r-gn)

Value of Operating Assets FCFF1 FCFF2 FCFF3 FCFF4 FCFF5 FCFFn
………..
+ Cash & Non-op Assets
= Value of Firm Forever
– Value of Debt Discount at WACC = Cost of Equity (Equity/(Debt + Equity)) + Cost of Debt (Debt/Debt + Equity))
= Value of Equity

Cost of Equity Cost of Debt

(Riskfree Rate +
Default Spread) (1-t)

Riskfree Rate:
- No default risk Risk Premium
Beta
- No reinvestment risk + - Measures market risk x - Premium for average
- In same currency and in risk investment
same terms (real or nominal
as cash flow)
Types of Operating Financial Base Equity Country Risk
Business Leverage Leverage Premium Premium

Valuation Techniques
Page 19
 Discounted Cash Flow (Cont’d.)

Free Cash Flows & Enterprise Value Rs. lakhs

Particulars Year 1 Year 2 Year3 Year 4 Year 5 Year 6 Year 7 Year 8

EBITDA 4,485 5,119 5,038 4,927 4,810 4,687 4,558 4,423

Less: Adjusted Taxes as per workings (227) (353) (1,124) (1,198) (1,241) (1,260) (1,262) (1,251)
Cash Flows from operating activities 4,258 4,766 3,914 3,729 3,569 3,427 3,296 3,172
Less (Increase)/ Add Decrease in W/C (1,006) (561) (22) (14) (15) (15) (16) (17)
Less: Capex (2,552) (1,311) (1,100) (950) (750) (500) (500) (500)
Free Cash Flows for the year 701 2,893 2,792 2,765 2,805 2,911 2,780 2,655

Terminal Value Calculation Calculation of Value Per Share Rs. Lakhs

Terminal Growth Rate 3.0%
Terminal Value (in Rs Lakhs) 39,468 Gross Enterprise Value 31,607
Discount Rate 9.9% Less: Debt as on 31-Dec-06 (18,181)
PV of Terminal Value (in Rs Lakhs) 18,506 Equity Value of the Company 13,426
NPV of Free Cash Flows for xxplicit forecast period Number of equity shares in lakhs 115.59
Discount Rate 9.9% Value per share (fully paid-up) 116.16
NPV as on 31-Dec-06 (in Rs. Lakhs) 13,101

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 Discounted Cash Flow (Cont’d.) – Scenario/ Sensitivity Analysis

„„ Sensitivity
SensitivityAnalysis
Analysisisisgenerally
generallydone
doneon
onkey
keyfactors
factorstotogauge
gaugethe
therange
rangeofofvalues
values
„„ WACC
WACCand
andTerminal
Terminalgrowth
growthrate
rateare
arethe
thekey
keydrivers
driversofofthe
thefirm
firmvalue
value

Sensitivity Summary Current 1 2 3 4 5 6

Values
Changing Cells:
Rupee Depreciation* 0% 5.00% 0% 0% 0% 0% 0%
Change in Selling Price 0% 0% -1.00% 0% 0% 0% 0%
Change in Cost of Material 0% 0% 0% 1.00% 0% 0% 0%
R/M as % of sales 49% 49% 49% 49% 50% 49% 49%
WACC (Weighted Average Cost of Capital) 9.44% 9.44% 9.44% 9.44% 9.44% 10.44% 9.44%
WACC (Weighted Average Cost of Capital) 9.44% 9.44% 9.44% 9.44% 9.44% 9.44% 8.44%
Result Cells:
Share price Rs 26.3 Rs 33.3 Rs 24.2 Rs 25.2 Rs 24.0 Rs 21.8 Rs 31.9
Change in share price Rs 7.0 -Rs 2.1 -Rs 1.1 -Rs 2.3 -Rs 4.5 Rs 5.6
% change in share price 27% -8% -4% -9% -17% 21%

Valuation Techniques
Page 21
 Market Multiples

„ Valuation parameter is based on the valuation driver

„ Valuation parameter is based on the valuation driver
„ Valuation multiples of the domestic and international peers are applied to the financial results of
„ Valuation multiples of the domestic and international peers are applied to the financial results of
the
thecompany
companytotoderive
derivethe
thecompany
companyvaluation
valuation
z Adjustment to be made as regards the country, size, growth etc
z Adjustment to be made as regards the country, size, growth etc
„ Valuation based on one year forward multiples
„ Valuation based on one year forward multiples
As a multiple of EPS As a multiple of operating profit As a multiple of Sales
• Globally Accepted valuation • Globally Accepted valuation • Start-ups
parameter parameter • Net profit and operating profit not
• Directly related to the profits, • Financial jugglery and capex below the right parameters due to initial
which is supposed to be the operating profit levels distorts stages of business
distributed to the shareholders the P/E
As a multiple of Book Value Net Asset Value/Replacement Value PEG
• Banks • Real Estate, Shipping companies • Retail, Media and Entertainment, IT
• Assets suggest true value of • Fixed assets are the valuation driver • High growth companies
business
EV/EBITDAR Sum of Parts As a multiple of operating asset
• Airline companies • Diversified companies • Per tonne for Cement, steel etc
• Lease value forms a significant • Synergy value may be an addition • Per square feet for retail
portion

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Page 22
 Case Study of XYZ Limited – Valuation Basket

„ Valuation matrix of Domestic companies

Sales PAT EBITDA Margins PAT Margins PE EV/EBITDA
Market
Rs mn MCap FY05 FY06 FY07 FY05 FY06 FY07 FY05 FY06 FY07 FY05 FY06 FY07 FY05 FY06 FY07 FY05 FY06 FY07
Price
A 545 9,367 7,198 8,795 11,314 396 531 687 9.6 9.0 9.5 5.5 6.0 6.1 18.9 17.6 13.6 15.0 13.0 9.6
B 133 9,628 3,617 8,252 9,417 328 623 641 23.6 21.3 18.6 9.1 7.5 6.8 30.3 16.3 15.2 17.2 8.4 8.4
C 129 27,018 16,887 17,503 19,977 1,385 2,177 2,212 24.1 29.8 25.6 8.2 12.4 11.1 18.2 12.4 12.2 9.6 7.5 7.6
D 405 24,859 14,218 17,315 19,662 910 1,540 1,925 15.9 14.5 15.9 6.4 8.9 9.8 27.3 15.5 12.7 13.7 12.3 9.9
E 6,281 7,250 9,500 164 251 584 6.8 8.2 11.8 2.6 3.5 6.1
Average 23.7 15.5 13.4 13.9 10.3 8.9

„ Valuation matrix of International companies

Share price Market Cap P/E EV/EBITDA (X)
(Local currency) (US$ mn) FY06/CY05 FY07/CY06 FY06/CY05 FY07/CY06
F 10.2 1,144.8 8.8 7.4 4.0 3.4
G 3.8 386.2 16.0 10.4 8.8 6.6
H 5.9 999.5 12.7 10.7 7.7 6.6
I 3.4 435.1 13.7 12.3 4.7 4.2
J 2.7 121.4 5.9 5.9 4.1 3.2
K 2.2 157.1 4.7 3.7 4.1 3.2
Average 10.3 8.4 5.6 4.6

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Page 23
 Net Realizable Value or the Net Asset Value

„„ In
Inthe
theNet
NetAsset
AssetValue
Value(NAV)
(NAV)method,
method,the
thenet
netrealizable
realizablevalue
valueofofthe
theassets
assetsisis
computed
computedbased
basedon
onthe
thevaluation
valuationdate
date
„„ The
Thegenesis
genesisofofthis
thismethod
methodofofvaluation
valuationlies
liesininthe
thetotal
totalassets
assetsthat
thatthe
thecompany
companyowns
owns
z
z
The
Thevalues
valuesofofintangible
intangibleassets
assetsare
areexcluded
excluded
z
z
Any
Anyreserves
reservesthat
thathave
havenot
notbeen
beencreated
createdout
outofofgenuine
genuineprofits
profitsare
arenot
nottaken
takeninto
into
account
account
z
z
Loan
Loanfunds
fundsare
arededucted
deducted
z
z
Contingent
Contingentliabilities,
liabilities,totothe
theextent
extentthat
thatthey
theyimpair
impairthe
thenet
networth
worthofofthe
thecompany,
company,
are
arealso
alsodeducted
deducted
z
z
The
Theresultant
resultantfigure
figurerepresents
representsthe
thenet
networth
worthofofthe
thecompany
companyon
onthe
thegiven
givenday
day
„„ However,
However,this
thismethod
methodisisagainst
againstthe
theconcept
conceptofofgoing
goingconcern
concern
„„ Shipping
Shippingcompanies
companiesgenerally
generallyfollow
followthis
thismethod
method

Valuation Techniques
Page 24
Valuation Methodology – Real Estate

„ Net Asset Value: Value of Ongoing Projects + Value of Land Bank

z DCF for the projects being executed
- Assets sold
- Assets leased
– Capitalization rate of 10%, based on a market yield of 10% on the commercial
property
- Price and cost escalation is considered to derive at a future sale value
– Price escalation is generally considered @ 5%-7%
– Cost escalation is generally considered @ 3%-5%
z Value of the Land Bank
- Replacement Value
- Value derived from the surrounding developed property less the Construction cost,
other expenses and the Developers margin
– Interest cost and taxation is a debatable issue since many consider the
valuation at the EBITDA level

Valuation Techniques
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 Profit Earnings Capacity Value - PECV

„„ In
Inthe
theProfit
ProfitEarnings
EarningsCapacity
CapacityValue
Value(PECV)
(PECV)method,
method,the
thevalue
valueofofthe
thebusiness
businessisis
determined
determinedas asfollows:
follows:
z
z
Determine
Determineaverage
averageearnings
earningsbased
basedon
onthe
thepast
past33toto55years
yearsofofearnings
earnings
z
z
Make
Makeadjustments
adjustmentsfor
forexceptional
exceptionaltransactions
transactionsor
oritems
itemsofofaanon-recurring
non-recurringnature
nature
z
z
Capitalize
Capitalizethe
theadjusted
adjustedaverage
averageearnings
earningsatatananappropriate
appropriatecapitalization
capitalizationrate
ratetoto
compute
computethethevalue
valueofofthe
thebusiness.
business.(what
(whatisisthe
thecorrect
correctcapitalization
capitalizationrate
ratehas
hasbeen
been
discussed
discussedininWACC)
WACC)
„„ The
Theerstwhile
erstwhileCCI
CCIguidelines
guidelinesprovided
providedthe
thefollowing
followingindicative
indicativecapitalization
capitalizationrate:
rate:
z
z
Manufacturing
Manufacturingcompanies
companies––15%
15%
z
z
Trading
Tradingcompanies
companies––20%
20%
z
z
Manufacturing
Manufacturingand
andtrading
tradingcompanies
companies––17.50%
17.50%

Valuation Techniques
Page 26
 Other Valuation Methods

„„ Option
Optionvaluation
valuationbased
basedon
onthe
theBlack
BlackScholes
Scholesformula
formula
z
z
Applicable
Applicablefor
forbiotech,
biotech,pharma
pharmacompanies
companiesand
andcompanies
companiesinvolved
involvedininR&D
R&D
„„ Dividend
Dividendgrowth
growthmodel
model

„„ Internal
InternalRate
RateofofReturn
Return(IRR)
(IRR)
z
z
Applicable
Applicablefor
forprojects
projects

Valuation Techniques
Page 27
Finalise the Working

„ Develop an overall range of values based on the above

considerations and any other strategic factors

Valuation Techniques
Page 28
Section III: Practical Difficulties in Valuation

Valuation Techniques
Page 29
 Practical Considerations

„„ Valuation
Valuationisisaascience
scienceand
andan
anart
art––varies
variesfrom
fromone
oneperson
persontotoanother
another
„„ Assumptions
Assumptionsand andsources
sourcesused
usedininvaluation
valuation
„„ Different
Differentaccounting
accountingpolicies
policies
„„ Premium
Premiumorordiscount
discountfor
for“Other
“OtherFactors”
Factors”that
thatimpacts
impactsthe
thevaluation
valuation
zControl
zControl––30%
30%premium
premium
zStock
zStockLiquidity
Liquidity
zCovenants
zCovenantsininagreements
agreements
zExisting
zExisting capitalmarkets
capital markets––bull
bullor
orbear
bearphase
phase
zPush
zPushororPull
Pullstrategy
strategy––Distresses
Distressesasset
assetsale
saleisisatataaconsiderable
considerablediscount
discount
„ Legal requirements – Floor price requirements
„ Legal requirements – Floor price requirements
„ Limitation on IT systems – complex structures and voluminous data may not be feasible on a
„ Limitation on IT systems – complex structures and voluminous data may not be feasible on a
worksheet
worksheet
z System crashes are common
z System crashes are common

Valuation Techniques
Page 30
Section IV: Resources

Valuation Techniques
Page 31
 Resources

„„ Beta
Beta––www.nse-india.com,
www.nse-india.com,Bloomberg
Bloomberg
„„ Books
Books
z
z
Valuation
ValuationConcepts
Conceptsby
byCopeland
Copeland
z
z
Dark
DarkSide
SideofofValuation
Valuation––Damodaran
Damodaran
z
z
The
TheIntelligent
IntelligentInvestor
Investor- -Benjamin
BenjaminGraham
Graham
z
z
The
TheWarren
WarrenBuffett
BuffettWay
Way- -Robert
RobertHagstrom
Hagstrom
z
z
The
TheLittle
LittleBook
Bookthat
thatBeats
Beatsthe
theMarket
Market- -Joel
JoelGreenblatt
Greenblatt
z
z
The
TheLittle
LittleBook
BookofofValue
ValueInvesting
Investing- -Christopher
ChristopherBrowne
Browne
„„ Financials,
Financials,script
scriptprices,
prices,ratios,
ratios,CAPITALINE
CAPITALINE

Valuation Techniques
Page 32