Module 3 - Valuation Aspects of M&A Module Outlines Fundamental and methods of valuation Calculations of financial synergy and retumn Different approaches of valuation ‘Comparable company & transaction analysis method DeF Formula approach for valuation and other important methods of valuation Fundamental and methods of valuation No matter the reason for the merger ot acquisition, the main objective is always to increase the size and market value of the parties involved. Following a merger or acquisition, the worth of the patti involved is equal to the sum of their individual values, However, it frequently occurs that mergers and acquisitions have a detrimental effect on the parties involved because the value of the parties was not properly entity's value, doing so in practis imated. Even though there are exact methods and procedures for estimating an is a difficult task, Becaus of this, it is crucial to choose the appropriate methodology and techniques when valuing entities in mergers and acquisitions in order to prevent financial pitfalls Need for valuation During mergers and acquisitions, the intended purpose of the valuation is identified so that the calculated value mate! y instances where the valuation is done based on the purpose are 's with the required purpose. FeCorporate Restructuring; Calculating the consideration for the sale of business or acquisition; Liquidation of the company; Calculating the consideration for sale or purchase of equity stake; During family separation, there is a need to calculate the value of assets and businesses owned by such a family; The portfolio value of investments is calculated by the virtue of Private Equity Funds or Venture Funds; Purchase or sale of intangible assets such as rights, patents, trademarks, copyrights, brands For the purpose of getting listed on the Stock Exchange, calculating the fair value of the shares is required; culating the fair value of shares for providing Employee Stock Ownership Plan following the Employee Stock Ownership Plan guidelines. Indian laws impacting valuation Valuation of entities is subject to the following Indian laws, authorities and actions ~ Companies Act, 2013 Foreign Exchange Management Act, 1999 Securities Exchange Board of India and Stock Exchanges Competition Commission of India Stamp DutyIncome Tax Takeover Regulations Indirect Tax: Accounting Standards Valuation approaches © There are three basic methods—asset-based approach, income approach, and market approach—for estimating a company's worth. While figuring out the value, one strategy can be used alone or in conjunction with the other two. @ Asset-Based ApproachAccording to this strategy, the buyer shouldn't pay more for an item when a comparable asset may be purchased for the same price. The net asset value of an entity is the main emphasis of the asset-based approach. Total liabilities are subtracted from total assets to arrive at the net asset value. The aforementioned method is used for appraisal in both continuing businesses and those that are being liquidated, When a target company has tangible assets, this strategy is also used. @ Income Approach According to the income approach, the acquisition candidate's value must be equivalent to the potential future benefits of its revenue channels, discounted to the current value after accounting for investment risk and the time value of money. Dividends and net cash flow both count as income sources for estimating the acquisition candidate's worth. Economic income is the name given to this estimate. Economic income is valued by applying a discount or capitalization rate. The discount rate reflects the total return an investor expects to receive based on the amount invested, whereas the capitalization rate represents the income channel for a specific period @ Market Approach According to the market approach, a thorough market search for businesses that are comparable to the acquisition candidate must be done by the valuer during the valuation process. The market approach includes a minority interest market value, The market approach enables the valuer to ‘transform a number of results from a control interest value to a minority interest value, The multiplier illustrates the relationship between the book value or a certain revenue stream and the gross purchase price.Methods of Valuation Based on the above-mentioned approaches there are specific methods for estimating the value of an acquisition candidate. © Net Asset Method The asset-based approach is where this strategy fits in. Every asset and liability's fair market value as of the valuation date is determined. The equity value is calculated using this method based on adjusted assets less adjusted liabilities. Usually, the purchasing business uses this strategy to bring in the underperforming assets. @ Excess earnings treasury method The asset- and income-based approach encompasses this technique. It distinguishes between adjusted net tangible assets and intangible assets. By capitalising the company’s earnings that exceed the nings attributable to a reasonable return on the fair market value of its net assets, intangible value is estimated. Combining the tangible net adjusted assets at fair market value with the previously assessed intangible value results in the company's overall value. The surplus earnings treasury approach uses industry averages or average returns on equity from comparable companies to assess a fair return and determine the appropriate capitalization rate. @ Excess earnings reasonable rate method The asset- and income-based approach encompasses this technique. A acceptable rate of return is applied to the adjusted net assets in this strategy. By capitalising the company’s earnings that exceed the earings attributable to a reasonable return on the fai market value of its net assets, intangible value is estimated. The fair market value of the adjusted net assets is added to the intangible value to calculate the company's overall value. @ Capitalization of earnings method The income approach includes this tactic. When an investor wants to facilitate a yearly return on investment over the fair pay of the owner, they utilise this method to calculate thevalue of a profitable business, To arrive at a value, the future expected earings are calculated and divided by a capitalization rate, This approach does not distinguish between tangible and intangible assets. For businesses that require a lot of capital, this strategy is inappropriate. @ Discounted Cash Flow (DCF) method Th (DEM). In this approach, a company's earnings are defined in order to evaluate its worth. The terms income approach includes this tactic. Another name for it is the Discounted Earnings Method -ash flow from operations” both refer to cash flow after taxes. The capitalization rate approach is that the entire value of the sings" and. is applied in this method. The underlying premise of thi business may be calculated by calculating the present value of both the terminal value and the predicted future earnings. In this procedure, the valuer must be certain that the management's assumptions support the predicted earnings and that they represent realistic future earnings. © Price/Earnings ratio method This technique combines the market and income approaches. With this approach, the multiple that will be applied to post-tax earnings is estimated using market comparisons. Capitalizing the projected future net income is made easier by using the weighted average price/earnings ratio of comparable publicly traded companies (post-tax). Finding publicly traded companies that are comparable to the targeted company is the main challenge in performing market comparisons. This approach is typically used to estimate the worth of big, diversified businesses. @Dividend-paying capacity method This technique combines the market and income approaches. It is typically used to estimate the worth. of large dividend-paying corporations. The future predicted dividend that will be paid or that can bepaid is capitalised using a five-year weighted average of dividend yields of five comparable corporations. This approach is utilised for valuing more complex and huge enterprises @ Guideline method Based on the market approach, this strategy is used. It compares the targeted company to public companies (guideline companies) that are comparable to it on both a qualitative and quantitative level. The assessor must be convinced that the target company and the publicly traded companies perform comparable tasks, offer comparable goods and services, and are headquartered in the same region. The valuer must make the necessary modifications to the financial statements of the public companies used for comparison. Direct market data method Based on the market approach, this strategy is used. It compares the acquisition candidate with an entity's sales transactions. Comparing sales transactions is a difficult endeavour, though, as they frequently go through due to advantageous purchase terms, realised synergies, etc. As a result, the valuator must modify the direct market data used to determine a premium or discount. @ Rule of thumb method Based on the market approach, this strategy is used. It was created using the direct market data approach. Based on widespread market experiences, a formula is developed. In order to determine the relationships between the sales price and the operational unit of measurement for a certain industry, this formula is utilised, Risks that could negatively impact value in a materialistic sense are not included in the process. However, this approach offers a useful test to determine whether or not the value estimations derived from other approaches are appropriateComparable company & transaction analysis methodAn good technique for analysing the cost and potential price of a merger or acquisition is comparable transaction analysis. We hall go over the following in this artiele: ‘What is similar transaction analysis? How is it done? Comparable company analysis versus comparable translation analysis? An example of comparable transaction analysis? Finally, what are the benefits and drawbacks of comparable transaction analysis? WHAT IS COMPARABLE TRANSACTION ANALYSIS? A company that is being looked at for a merger or acquisition might be analysed using comparable transaction analysis. This analysis method's primary goal is to examine identical or comparable merger and acquisition transactions. Imagine someone buying a new laptop as an analogy. The consumer must first compare the computer they wish to purchase with others of a similar kind HOW TO DO COMPARABLE TRANSACTION ANALYSIS? Comparable Transaction Analysis is similar to Comparable Company Analysis in that it seeks out prior transactions that are comparable to our company’s current ones in order to do the analysis. It might be challenging for a novice investor to know where to begin. This frequently takes a long time. To compile a solid list of comparable deals, professional investors consult a variety of sources. Investor sources could include: + Public Tender and Merger Proxy Statements: ‘This is a record submitted whenever a business makes an acquisition. They frequently have to submit a public report in which they explain the history of that particular trade. These records typically contain previous transactions that the acquirer has examined. In connection with the tender offer, a Schedule TO and Schedule 14D-9 are filed.+ 8-K: When a significant event occurs, a public corporation is required to file an 8-K. Acquisitions, sales, or other similar occurrences are frequently regarded as material events, and as a result, &-K forms are filled out. Details about transactions are included. + SDC Database: With information on deals from the past 30 years, Security Data Corporation's database is perhaps the largest. The database allows you to conduct searches for businesses, industries, and time periods. + Factset, Bloomberg, or Capital IQ are additional databases that all provide historical transaction data. + Research Notes: If by chance you have access to industry-specific research studies, you'll usually find information about previous agreements in the reports for companies and indus + Google Search: Surprisingly, Google is @ great resource for learning about deals and subsequent multiples, The deal value is typically disclosed when a deal is anounced. In the end, this is a long process that can result in no exact numbers. As always, the best approach is to start at the SEC website as this an official regulator website where companies have to file documentation COMPARABLE COMPANY ANALYSIS: VS COMPARABLE TRANSACTION ANALYSIS Comparable Transaction Analysis and Comparable Company Analysis are very similar. There are variations, though. + Timing: When doing a comparable transaction analysis, it's crucial to take notice of the transaction's, timing, For instance, it may not be necessary to consider transactions from a long time ago while analysing our company in the current market + Size: If the two deal sizes have very different valuations, it might not be possible to compare them.* Capital Structure: If a deal's capital structure differs from that of our target firm, we will give it less weight in our study. + Examining Previous Transactions: Comparable transactions examine past transactions rather than the prices at which listed companies are now trading, Included in these are Enterprise Value/Sales and Enterprise Value/EBITDA. If you examine several acquisition announcements, you will notice that almost usually the acquirer pays more than the share price was trading at prior to the announcement. This premium typically represents a 30% premium over the stock's previous trading price as a benchmark. Occasionally, if the target firm is in a very "hot" industry, it could even be higher. There are various procedures to take when conducting a Deal Comp, just like when conducting a Comparable Company Analysis. COMPARABLE TRANSACTION ANALYSIS EXAMPLE So let's look at a comparable transaction analysis case. Comparable Company Analysis and the comparable transaction analysis example have a similar appearance. ADVANTAGES & DISADVANTAGES The positive aspects of a “Deal Comp" are: + The appraisals are based on what people actually paid for businesses, and all valuations are based on publicly available data. This data is helpful in providing direction as to what a buyer is generally willing to pay for objectives. ‘The analysis gives a clear grasp of the multiples paid for various industries at various market junctures.+ The study provides a sense of the overall market demand for various sorts of assets, as well as a good idea of the types of transactions that are trending, the most frequent buyers, and what they are searching for.The negative aspects of this valuation methodology are: + Previous transactions may have taken place in a different market context, which taints the valuation; + The public information that is accessible can be limited and occasionally misleading, + Additionally, it’s possible that deal dynamics from previous transactions don't apply to the current circumstance, making them a poor comparison. + Lastly, considerations like possible synergies, intangibles (such patents), or other contextual factors may taint the transaction multiples as a comparison, DCF Analysis An analyst projects the company’s unlevered free cash flow into the future and discounts it back to today at the firm's weighted average cost of capital (WACC). This is known as a discounted cash flow (DCF) analysis (WACC). Building a financial model in Excel is used to execute a DCF analysis, which calls for a lot of detail and analysis. It involves the greatest estimations and assumptions of the three approaches because it is the most thorough. However, the time spent creating a DCF model will frequently yield the most precise valuation. An analyst can anticipate value using several scenarios and even carry out a sensitivity analysis using a DCF model. The DCF value for larger organisations is frequently a study of the total of the parts, where various modelled individually and added together. To leam more, see CFI's DCF model info graphic.