MAC 4

OTHER CONCEPTS
& VALUATION
TECHNIQUES
CHAPTER 7
 OTHER VALUATION
CONCEPTS & TECHNIQUES
As mentioned in the previous chapters, there are various business valuation methods
appropriate for unique circumstances. You may have encountered some terms and
concepts related to valuation. The following special topics will be discussed in this
chapter.

• Due Diligence
• Mergers and Acquisition
• Divestitures
• Other Valuation techniques discussed in other literatures.
 DUE DILIGENCE
• Due diligence is a process of validating the representations made by a seller,
normally to an investor. This process would require thorough examination of all
records that would be relevant in the realization of returns or the so-called
advertised benefits.

• Due Diligence was started to be a formal exercise since the mid 1900. In the
USA, the Securities Act of 1993 requires full disclosure of information from
the dealers and brokers, this provides protection to the investors in engaging
with any concealed information that would impair the value of investment.
 DUE DILIGENCE
• In the Philippines, Republic Act 8799 or the Securities Regulation Code which
serves as the equivalent regulation that protect investors in the country. The law
enumerates the information that needs to be disclosed by companies and the
frequency to enable the commission to monitor the operations of the
partnerships and corporations in the Philippines.

• Due diligence varies and designed according to the size of the nature of the
investment. The exercise maybe categorized into who conducts the process and
what is the nature of the prospective investment.
 • Corporate Due Diligence – If the due diligence
exercise is to be conducted or commissioned by a
company or corporation that will invest to business.
Due Diligence
• Private Due Diligence – If due diligence exercise
According to the is facilitated or conducted by individual or at least
few individual investors but is not yet incorporated,
Executor
• Government Due Diligence – If due diligence is
commissioned or conducted by the government.
 • Hard Due Diligence – When the due diligence focuses
on the data and hard evidential information.

Due Diligence • Soft Due Diligence – Focuses on the internal affairs or

the internal organization of the company and its
According to customers.

Subject • Combined Due Diligence – When the focus of the due

diligence is to cover both quantitative and qualitative
areas of the company or business. It is also known as
comprehensive due diligence.
 • Market Capitalization – The company’s market
capitalization or total value provides an indication on
how volatile the value of the company in the market.
Factors to be
considered in the • Performance / Profitability Trend Analysis – The
historical performance and trend of the company would
add more integrity on the realization of future earnings.
Due Diligence
•
Process
External Environment Analysis – Assessing the
position of the company in the industry is also a good
input to the due diligence exercise.
 • Management and Share Ownership – Assessment of the
personalities involved in the governance and policy making of the
company is critical. Their leadership style may serve as reference

Factors to be for the analyst or investor to assess the integrity of initial valuation.

considered in the
• Financial Statements – Serves as the best document to support the
financial performance and financial position of the company
including their cashflows.
Due Diligence
• Stock Price History – Investors should research both the

Process short-term and long-term price movement of the stock and whether
the stock has been volatile or steady.
 • Stock Dilution Possibilities – Related to the analysis of the
stock price history, investors should know how many shares
outstanding the company has and how that number relates to
Factors to be the competition.

considered in • Market Expectations – Investors should find out what the

consensus of the market analysis is for earnings growth,

the Due revenue, and profit estimates for the next two to three years.

Diligence • Long & Short-Term Risks – The main objective of due

diligence is essentially risk management. An important part of
the process is taking into consideration the long & short - term
Process risks.
 MERGERS AND ACQUISITIONS
Mergers and acquisitions (M&A) is a corporate strategy that allows a company to
combine its assets to another company or to acquire another company.

• Merger is when two companies combine to form another company.

• Acquisition is taking over or taking a part of company.

M&A became a popular business strategy for some companies to expand and for
other to save from distress. This allows the company to increase its revenue to
cover expenses, especially the fixed costs, or increase its asset base or even a
market share or control the supply chain.
 MERGERS AND ACQUISITIONS
• In M&As, there should be a

(1) Company that must be willing to take the risk and vigilantly make investments
to benefit fully from the merger as the competitors and the industry take heed
quickly.

(2) Multiple bets must be made to maximize the opportunities available

(3) The acquiring firm must be patient in the realization of its investment.
 M&As maybe classified according to how they are
formed. It is either through absorption or consolidation.

M&As According Absorption is done when a company takes over another

company, normally the latter are in a more
to Form disadvantageous position.

Consolidation is when two companies combined its

assets and/or restructure their debt profile.
 M&As maybe also be dependent on its economic
perspective.

Horizontal M&As is when two firms in the same

M&As According industry is combined.

to Economic Vertical Merger is when two companies merged coming

from different stages of production or value chain.
Perspective
Conglomerate from completely unrelated industries.
 M&As can also be classified according to their legal
perspective.

Short-form M&As is when parent purchase more interest

M&As based on from its subsidiary.

Legal Statutory M&As is when company combines where the

company, the acquire, retains its name.
Perspective
Subsidiary M&As is the consolidation of the
subsidiaries of a holding or parent company.
 1. Pre-acquisition Review – conducting internal
evaluation with regard to the business opportunity.
2. Investment Opportunity Scanning – scanning the
opportunity for any potential or interest parties.
Five Stages of 3. Valuation of Target Investment – a more
comprehensive valuation and sensitivity analysis
M&A should be conducted.
4. Negotiation – Finding the common sweet spot.
5. Integration – Executing the agreement and
reincorporation is needed.
 • Determine objective behind the acquisition and the
benefits expected by both acquirer and target
company from the deal.

Considerations
• Understand industry of both acquirer and target.
to Maximize
• Identify key operational advantages of acquirer and
M&A target company.

Opportunity • Check with the acquirer if the takeover is friendly or

hostile.
 • Analyze pre-merger operating and financial
performance of acquirer and target company through
key ratios such as return on equity, gross and profit
Considerations margins, operating expenses % to sales and working
capital metrics.
to Maximize
• Evaluate tax position of both companies and
M&A determine if there are net operating loss carry
forwards and deferred tax assets in their books.
Opportunity
 • Poor Strategic Fit – This is when companies that
entered M&A failed to find a ground to align their
mission, vision, and more importantly their goals.
Reasons for the
• Poorly Executed And Ill Managed Integration
failure of M&A Phase – Integration is the most critical part of the
M&A process. The inception of all the affairs that
will start the realization of the perceive returns of the
business will take place. Setting the wrong foot may
lead to a cliff.
 • Inadequate Due Diligence – Failure to identify and
validate the solidity of the inputs in decision-making
process will end up with the risk encountering issues
Reasons for the and unforeseen liabilities.

failure of M&A • Too Aggressive Projections And Estimates- It will

be unfortunate if the company wil not provide
sufficient cushion or provision to absorb these
unforeseen risks in the calculation of the initial
investment of future net cash flows.
 • Discounted cash flow (CF) method - The target’s
value is calculated based on its projected future cash
flows with appropriate discount rate.
Major Valuation
• Comparable company analysis – Relative
Methods used in valuation metrics for public companies are used to
determine the value of the target.
Merger &
• Comparable transaction analysis – Valuation
Acquisition metrics for past comparable transactions in the
industry are used to determine the value of the target.
 DIVESTITURE
• Divestures or divestments refer to the disposal of the assets of an entity or
business segment often via sale to the third party. Divestiture generally means
the sale of any assets that the company owns but is also used as a term to
described a sale of a non-core business segment.

• Divestiture is also a strategy used in portfolio management but is used less

frequently compared to mergers and acquisitions. This enables companies to
improve cash flows, discontinue operating segments that are not aligned with
the strategic direction of the company and create shareholder value.
 • Sell non-core or redundant business segments –
Companies tend to sell non-common core segments
in order to focus on maximizing profitability of their
core business.
Rationales
behind • Generate additional funds – The company may opt
to divest assets to generate cash.

Divestiture
• Take advantage of resale value of non-performing
segments instead of incurring losses – If an
operating segment is consistently generating losses,
it might be worth more as a divestment instead of
bleeding money in retaining it.
 • Ensure Business Stability or Survival – In periods
where the business face severe financial difficulties,
divesting assets can be a better option that
bankruptcy or disclosure.
Rationales
behind • Adapt to Regulatory environment – Divestment
may also occur if the regulatory authorities mandate
it to improve market competition.
Divestiture
• Lack of Internal Talent - The absence of qualified
internal talent to manage a business segment may
result in consistent losses.
 • Take Advantage if Opportunistic Offer from
Rationales Third Party – Unsolicited offers from third party to
purchase an asset from the company can also be a
behind reason for divestment. Since the asset is not being
offered for sale, the selling company is in a better
Divestiture position to negotiate and demand a higher price.
 • Partial Sell-Offs – The divesting company only sells
a portion of the business in order to raise funds that
can be used to fund growth of more productive
Types of segments

Divestitures • Equity Carve-Out – This occurs when an initial

public offering is performed for up to 20%
ownership of a subsidiary. The parent company
retains control of the subsidiary from the remaining
80% shareholding.
 • Spin-off – A business segment of the parent
company is separated and is made into an
independent new company. Shares os the spin-off
company is distributed to the existing shareholders
Types of of the parent company.

Divestitures • Split-off – A business segment of the parent

company is also separated and made into an
independent entity. However, the shareholders are
offered the option to exchange parent company
shares for the new company shares or just retain the
parent company shares.
 When deciding to divest, three values are compared:
going concern value, liquidation value, and divestiture
value
Deciding
Impact of divestitures to the firm:
whether to • If divestiture value is same as going concern value,
divestiture will not have the impact to selling
continue, company’s value.
• If divestiture value is higher than the going concern
liquidate or value, divestiture will increase value of selling
company.
divest • If divestiture value is lower than the going concern
value, divestiture will reduce value of the selling
company.
OTHER VALUATION
TECHNIQUES
 Measures the earnings generated by the business in
relation to the investment made to the business.
ROI-based valuation method is a quick computation of
company value based on the investment that the
investor is willing to pay for the business.
ROI-based
Valuation
For example, if the business is asking for P250,000 in
exchange of 25% ownership in the business, total
company value can be derived using ROI-based
Method valuation method. To compute for the value of the
company, divide the amount of ask (P250,000) by the
ownership stake (25%). This will result in a quick
computation of business value at P1,000,000
 The Dividend Paying Capacity Method, also called as
Dividend Payout, is conceptually an income-based
method but can also be classified as market approach as
Dividend it also considers market information.

Paying The Dividend Paying Capacity method links the

relationship between the following varaiables:
Capacity
a. Estimated amount of the future dividends that can be
Method paid out (based on historical earnings and dividend
payout of the business)
 b. Weighted Averafge dividend yields of comparable
companies

Dividend c. Estimated value of the business

Paying Company to pay out dividends is also linked with

liquidity and should be considered in the analysis.
Capacity Profitable companies can still be illiquid as working and
fixed cash capital requirements may require significant
Method amount of cash. Without excess cash, the company will
not be able to declare dividends.
 To illustrate, SV Company has a five-year history of weighted
average annual profits of P500,000. The weighted average dividend
payout percentage of SV Company over the last five years is 30
percent while weighted average dividend yield rate of comparable
Dividend companies is at 7.5%

Paying A. Compute for the future annual dividends that can be paid
(capacity to payout by multiplying average annual profits by the
Capacity dividend payout ratio.

Method Wtd. Ave Profits x Wtd. Ave Dividend Payout = Future Dividends

P500,000 x 30% = P150,000

 B. Compute for the value of the company by dividing future
dividends by the weighted average dividend yield rate of
comparable companies at 7.5%

Dividend Future Dividends / Wtd. Ave Dividend Yield = Value of Company

Paying
P150,000 / 7.5% = P2,000,000
Capacity
This method is useful in computing the value of companies that are
Method stable and has history of consistently paying dividends to their
shareholders. This method is preferred in valuation since it links the
market price with how much shareholders really receive (dividends)
as a percentage of company earnings.
 SUMMARY
• Due Diligence is an investigation, audit, or review performed to confirm the
facts of a matter under consideration.

• There are 2 types of Due Diligence. First is based on who initiated / performed
the activity and based about the activity. Former includes, company initiated
and individually initiated while the latter includes hard and soft due diligence.

• Hard due Diligence is concerned with people, within the company and in its
customer base.
 SUMMARY
• Mergers and Acquisitions (M&A) are defined as consolidation of companies.
Differentiating the two terms, Mergers is the combination of two companies to
form one, while Acquisitions is one company taken over by the other.

• A divestiture (or divestment) is the disposal of company’s assets or a business

unit through a sale, exchange, closure, or bankruptcy.

• Valuation is important part of both M&A and divestiture.

• Other valuation techniques include ROI-based valuation method, and dividend

paying capacity method.