insight of valuation

Insight of Valuation

http://www.corporateprofessionals.com/

http://www.corporatevaluations.in/

20/12/2013 Corporate Valuations – Techniques & Application

“In the business world, the rearview mirror is always clearer than the windshield”

Warren Buffett

Valuation (Part – A)What and Why 5

How 12

Valuation in Indian Regulatory Environment (Part – B)When and Who 23

Macro Valuation Issues in M&A (Part – C)Why Merger 58

Valuation for Merger 64

Case Study 70

Some Specific Tricky Issues (Part – D)Tricky Issues 74


Part – A Valuation

WHAT & WHY

Value & Valuation

Value is*

An Economic concept;

An Estimate of likely prices to be concluded by the buyer and seller of a good or service

that is available for purchase;

Not a fact.

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


Key Facts

PRICE IS NOT THE SAME AS VALUE

TRANSACTION CONCLUDES AT NEGOTIATED PRICES

VALUATION IS HYBRID OF ART & SCIENCE

VALUE VARIES WITH PERSON, PURPOSE AND TIME


S Standard of Valuation

T Thesis of Valuation

E Economics of Valuation

M Methodologies of Valuation


FAIR MARKET VALUE

INTRINSIC VALUE FAIR VALUE

INVESTMENT VALUE

Standard of Valuation

Thesis of Valuation Economics of Valuation

Methodologies of Valuation

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;

Purpose of Valuation;

Statute;

Case Laws;

Circumstances.

Types of Standard of Value:





Thesis of Value is Premise of value which relates to the assumptions upon which

the valuation is based.

Premise of Value

Going Concern – Value as an ongoing operating business enterprise.

Liquidation – Value when business is terminated . It could be ‘forced’ or ‘orderly’.

Value-in-use

Value-in-exchange


Growing Cos.

Turnover/Profits: Increasing still Low Proven Track Record: Limited Valuation Methodology: Substantially on Business Model Cost of Capital: Quite High

High Growth Cos.

Turnover/Profits : Good Proven Track Record: Available Valuation Methodology: Business Model with Asset

Base Cost of Capital: Reasonable

Mature Cos.

Turnover/Profits: Saturated Proven Track Record: Widely Available Method of Valuation: More from Existing Assets Cost of Capital: May be High

Declining Cos.

`

Turnover/Profits: Drops Proven Track Record: Substantial

Operating History Method of Valuation: Entirely

from Existing Assets Cost of Capital: N.A.

Turnover/Profits: Negligible Proven Track Record: None Valuation Methodology: Entirely on Business Model Cost of Capital: Very High

Start Up Cos.

Turn

over

/ P

rofit

s

Time

Valuation across business cycle follow the law of economics





Enterprise / Business Value

Net Debt#

Equity#

Fixed Assets#

Net Current Assets#

Intangibles#

Stakeholders Assets

# Based on Market Values





Valuation Approaches

Income Based Method

Asset Based Method

Market Based Method

Fundamental Method Relative Method

Other Method


While concluding Value, all the methodologies must be considered and then weights applied

as per the facts of the case. In other words, Value conclusion should be based on the

Professional Judgement and Simple Average should best be avoided while concluding

Value.

Need of several valuation methods?

Each has strengths and weaknesses

Different methods useful in different situations

Each gives a different “take” on the value of the company’s stock

Provides a range of valuations instead of point estimates

Helps in Sanity Check

Choice of Valuation Approaches

“Value in Valuation is a question,

and

Your choice of Method is the first step

towards answer”

Applicability of a particular approach depends upon:

On whose behalf? – one buyer vs another buyer, buyer vs seller;

For what purpose? – independent strategic acquisition, group company consolidation, cross

border transaction;

When? – distress situation, industry downturn, boom etc;


Choice of Valuation Approaches

• In General, Income Approach is preferred;The dominance of profits for valuation of share was emphasised in “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 regard to

the nature of its business, than upon the amount which the shares would realise on liquidation”.

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;

•Market Approach is preferred in case of listed entity and to evaluate the

value of unlisted company by comparing it with its listed peers;


• Mergers

• IPO

• RBI

• Income Tax

• ESOP

• Companies Act

• SEBI

• Stock Exchange

Purpose Regulatory Accounting

• Purchase Price Allocation

Dispute Resolution

• Company Law Board/ Courts

• Impairment / Diminution

• Arbitration

• Mediation

• Acquisitions / Investment

• Voluntary Assessment

Value Creation

• Equity Research

• Credit Rating

• Corporate Planning

Valuation depends upon


Sources of Information for Valuation

Sources of Information

Historical financial results – Income Statement, Balance

Sheets and Cash Flows

Data available in Public Domain – Stock Exchange /

MCA/SEBI/Independent Report

Data on comparable companies – SALES/EV-

EBITDA/ PAT/BV

Promoters and Management background

Data on projects planned/under implementation including future

projection

Discussion and Representation with/by the management of the

Company

Industry and Regulatory trends


CASH FLOW Investor assign value based on the cash flow they expect to receive in the future - Dividends / distributions - Sale of liquidation proceeds Value of a cash flow stream is a function of - Timing of cash Receipt - Risk associated with the cashflow

ASSETS

Operating Assets - Assets used in the operation of the business including working capital, Property, Plant & Equipment & Intangible assets - Valuing of operating assets is generally reflected in the cash flow generated by the businessNon - Operating Assets - Assets not used in the operations including excess cash balances, and assets held for investment purposes, such as vacant land & Securities - Investors generally do not give much value to such assets and Structure modification may be necessary

Key drivers of valuation

That’s why DCF is most

prominent valuation

method

Need for Restructuring20/12/2013 Corporate Valuations – Techniques &

Application

Rule of Thumb

A rule of thumb or benchmark indicator is used as a

reasonableness check against the values determined by the

use of other valuation approaches.

Industry Valuation Parameters

Hospital EV/Room

Engineering Mcap/Order Book

Mutual Fund Asset under management

OIL EV/ Barrel of equivalent

Print Media EV/Subscriber

Power EV/MW, EBITDA/Per Unit

Entertainment & Media EV/Per screen

Metals EBITDA/Ton, EV/Metric ton

Textiles EBITDA depend upon capacity utilization Percentage & per spindle value

Pharma Bulk Drugs New Drug Approvals , Patents

Airlines EV/Plane or EV/passenger

Shipping EV/Order Book, Mcap/Order Book

Cement EV/Per ton & EBITDA/Per ton

Banks Non performing Assets , Current Account & Saving Account per Branch

However, Exclusive use of Rule of Thumb is not recommended20/12/2013 Corporate Valuations – Techniques &

Application


Part – B Valuation in Indian Regulatory Environment

WHEN & WHO

Inbound Investment Inbound Investment DFCFDFCF

Gift of Unquoted Equity Shares (Min)

Gift of Unquoted Equity Shares (Min) NAVNAV

Outbound Investment Outbound Investment Valuer DiscretionValuer Discretion

Gift of Unquoted Shares other than Equity Shares

Gift of Unquoted Shares other than Equity Shares Price it would fetch if sold in open

marketPrice it would fetch if sold in open

market

Takeover Code/ Delisting - Infrequently Traded

Takeover Code/ Delisting - Infrequently Traded

Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis

Industry Average

Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis

Industry Average

Takeover Code/ Delisting - Frequently Traded

Takeover Code/ Delisting - Frequently Traded Based on Market PriceBased on Market Price

Reserve Bank of India

ESOP Tax ESOP Tax Valuer DiscretionValuer Discretion

ESOP AccountingESOP Accounting Option – Pricing ModelOption – Pricing Model

Income Tax

SEBI

CA / MBCA / MB

>5Mn$ - MB, otherwise CA/MB>5Mn$ - MB, otherwise CA/MB

--

MBMB

MBMB

--

CA/MBCA/MB

--

Stock Exchanges Preferential Allotment to promoters / their relatives for consideration other than cash

Preferential Allotment to promoters / their relatives for consideration other than cash Valuer Discretion Valuer Discretion

Companies Act, 1956 Sweat EquitySweat Equity

Valuer DiscretionValuer Discretion

CA / MBCA / MB

--

Transactions Prescribed Methodologies Mandate to be done by

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

Gift of Unquoted Equity Shares from Resident (Max)

Gift of Unquoted Equity Shares from Resident (Max)

DCF (Valuation Based on Assets, Business & Intangibles is also

acceptable)

DCF (Valuation Based on Assets, Business & Intangibles is also

acceptable)FCA / MBFCA / MB

Preferential Allotment to OthersPreferential Allotment to Others Based on 26 weeks / 2 weeks Market Price

Based on 26 weeks / 2 weeks Market Price --

Companies Act, 2013

any property, stock, shares, debentures, securities or goodwill

or any other assets or the net worth of the Company or its

liabilities

any property, stock, shares, debentures, securities or goodwill

or any other assets or the net worth of the Company or its

liabilities

To be prescribedTo be prescribed REGISTERED VALUERREGISTERED VALUER

Transfer PricingTransfer Pricing Arm Length PriceArm Length Price --

RBI Valuation Guidelines

FDI VALUATION

• Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals

with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside

India) Regulations, 2000.

•In terms of Schedule 1 of the Notification, an Indian company may issue equity

shares/compulsorily convertible preference shares and compulsorily convertible debentures

(equity instruments) to a person resident outside India under the FDI policy, subject to inter alia,

compliance with the pricing guidelines.

•The price/ conversion formula of convertible capital instruments should be determined upfront

at the time of issue of the instruments.

Particulars Valuation before April 21, 2010 Valuation after April 21, 2010

Guidelines in Force CCI Guidelines In case of FDI Transactions:Listed Company: Market Value as per SEBI Preferential Allotment Guidelines

Unlisted Company: DFCF

In case of ODI Transactions:No method has been prescribed

Methods Prescribed Net Assets Value (NAV)Profit Earning Capacity Value(PECV)Market Value (in case of Listed Company)

Discount 15% Discount has been prescribed on account of Lack of Marketability

No such Discount has been prescribed

Historical / Futuristic It is based on Historical Values It is based on Future Projections

Possibility of variation in Value Conclusion

As valuation is more Formulae based, final values came standardized

As valuation is more dependent on Assumptions and choice of factors like Growth Rate, Cost of Capital etc, value conclusion may vary significantly.

FEMA Guidelines to Valuation

Note: Valuation guidelines do not apply to SEBI registered venture capital

Discounted Free Cash Flow Method (DFCF)

Approaches to FDI Valuation

RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for

initial subscription); but has not provided any guidance on its technical aspects.

Though DFCF is one of the most acceptable Valuation methods used by Business

valuers worldwide; however DFCF for all FDI transactions-excluding for initial

subscription (like minority stake/start up valuation etc) may not yield Fair Value in

line with the Commercial understanding. However Law being such, suitable Logical

adjustments may be necessary on a case to case basis.DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off.

DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off.

Forward Looking and focuses on cash generation

Recognizes Time value of Money

Allows operating strategy to be built into a model

Incorporates value of Tangible and Intangible assets

Only as accurate as assumptions and projections used

Works best in producing a range of likely values

It Represents the Control Value

Major Characteristics of DFCF Valuation

DFCF Valuation Process

Understand Business Model

Identify Business Cycle

Analyze Historical Financial Performance

Review Industry and Regulatory Trends

Understand Future Growth Plans (including Capex needs)

Segregate Business and Other Cash Generating Assets

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

Free Cash Flows- Value Trend

Terminal Value is calculated for the Perpetuity period based on the Adjusted last year cash flows of the Projected period.

Free cash flows to firm (FCFF) is calculated as

EBITDAEBITDA

Taxes

Change in Non Cash Working capital

Capital Expenditure

Free Cash Flow to

Firm

Note that an alternate to above is following (FCFE) method in which the value of Equity is directly valued in lieu of the value of Firm. Under this approach, the Interest and Finance charges is also deducted to arrive at the Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows) over the definite period of Cash Flows and also in Perpetuity workings.

Theoretically, the value conclusion should remain same irrespective of the method followed (FCFF or FCFE), (Provided, assumptions are consistent).

FREE CASH FLOWS

Free Cash Flow calculation

DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL

Where:D = Debt part of capital structureE = Equity part of capital structureKd = Cost of Debt (Post tax)Ke = Cost of Equity

(Kd x D) + (Ke x E)

(D + E)

In case of following FCFE, Discount Rate is Ke and Not WACC

WACC

Cost of Capital calculation

DISCOUNT RATE - COST OF EQUITY

Where:Rf = Risk free rate of return (Generally taken as 10-year Government Bond Yield)B = Beta Value (Sensitivity of the stock returns to market returns)Ke = Cost of EquityRm= Market Rate of Return (Generally taken as Long Term average return of Stock Market)SCRP = Small Company Risk PremiumCSRP= Company specific Risk premium

Mod. CAPM Modelke = Rf + B ( Rm-Rf) + SCRP + CSRP

The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing

Model (Mod. CAPM)

Cost of Equity calculation

PERPETUITY FORMULA

– Usually comprises a Large part of Total Value and is sensitive to small changes

– Capitalizes FCF after definite forecast period as a growing perpetuity;

– Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows

– Gordon Formula is often used to derive the Terminal CashFlows by applying the last year cash flows as a multiple of the growth rate and discounting factor

– Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of last year projected cash flows

(1 + g)

(WACC – g)

IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation Multiples to the Terminal Year Financials and also doing Scenario Analysis.

Terminal value calculation

An Insight of Valuation- www.CorporateValuations.in

SEBI / Stock Exchange Valuation Guidelines

Traded Turnover of Shares ≥ 10%

[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]

Takeover Regulations

APPLICABLE LAW:

SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011

FREQUENTLY TRADED SHARES

Method of Valuation1.Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A.

2.The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks;

3.The Highest Price paid or payable by acquirer or PAC in last 26 Weeks;

4.Volume weighted average Market Price of Shares for a period of 60 trading days

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A.

Traded Turnover of Shares < 10%

[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]

INFREQUENTLY TRADED SHARES

Method of Valuation1.Book value, 2.Comparable Trading Multiples;

Such other Parameters as are customary for valuation of shares of such companies

Preferential Issue (1 of 3)

APPLICABLE LAW:

SEBI (ICDR) Regulations, 2009

Method of Valuation1.The average of the weekly high and low of the closing prices of the related equity shares quoted on the

recognised stock exchange during 26 weeks preceding the relevant date, or

2.The average of the weekly high and low of the closing prices of the related equity shares

quoted on the recognised stock exchange during 26 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Equity shares of issuer have been listed on recognized stock exchange for a period of 26 weeks or more as on relevant date

Preferential Issue ( 2 of 3)

APPLICABLE LAW:


Method of Valuation

1. The price at which equity shares were issued by the issuer in its IPO or value per share

arrived at in a scheme of arrangement under section 391 to 394 of the Companies Act, 1956,

pursuant to which the equity shares of the issuer were listed, as the case may be , or


quoted on the recognised stock exchange during the period shares have been listed

preceding the relevant date, or


quoted on the recognised stock exchange during 2 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Equity shares of issuer have been listed on recognized stock exchange for a period of less than 26 weeks as on relevant date

Preferential Issue ( 3 of 3)

APPLICABLE LAW:


Method of Valuation

No Method for Valuation has been prescribed.

Where equity shares have been issued to promoters / their relatives for consideration other

than cash, the valuation of assets in consideration for which the equity shares are issued

shall be done by an independent valuer

Valuer

Chartered Accountant or a Merchant Banker

ESOP Accounting Valuation

APPLICABLE LAW:

SEBI (ESOS and ESPS) Guidelines, 1999

Method of Valuation

Black-Scholes Model

If a Company listed on recognised stock exchange in India and issued shares under an

ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing model

(Black-Scholes or a binomial model) which shall be treated as employee compensation cost

for the Company.

Valuer

Not Prescribed

Income Tax Act-1961

Equity Shares Valuation

APPLICABLE LAW:

Income Tax Act – 1961 and Rule 11UA

Method of Valuation

Minimum Valuation- Net Asset Value

Maximum Valuation- DCF and other methods factoring Tangible and Intangibles

If Individual, HUF, Firm or *closely held Company receives Equity shares of a closely held

Company – Valuation norms shall apply.

Valuer

No specific Valuer prescribed for undertaking Minimum Value

FCA / Merchant Banker for determining Maximum Value

*If a Public Listed Company receives any shares or anyone receives shares of a Public listed Company, valuation norms are not applicable if transaction takes at market price.

Valuation of shares other than Equity Shares

APPLICABLE LAW:

Income Tax Act – 1961 and Rule 11UA

Method of Valuation

Price at which such shares will fetch in the open market.

If Individual, HUF, Firm or *closely held Company receives shares other than Equity shares

of a closely held Company – Valuation norms shall apply.

Valuer

Valuation report to be issued by Merchant Banker

ESOP Tax Valuation

APPLICABLE LAW:

Income Tax Act – 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT

Method of Valuation

No method has been prescribed

To determine the value of perquisite taxable in hands of employees

Valuer

SEBI registered category – I Merchant Banker

Transfer Pricing

APPLICABLE LAW:

Section – 92 to 92F of Income Tax Act – 1961 and Rule 10A to 10E of Income-tax Rules, 1962

Method of Valuation

Arm Length Price

Any International transaction between associated enterprises at ARM LENGTH PRICE

Valuer

Not Prescribed

Role of TPO critical. Recent cases deliberating on Valuation aspects

20/12/2013

Registered ValuerCompanies Act, 2013

Registered Valuers

Registered Valuers

Financial Valuer Technical Valuer

• A Chartered Accountant,

Company Secretary or Cost

Accountant in whole time

practice or retired member

of Indian Corporate law

Service or any other person

as prescribed.

• A Merchant Banker

registered with SEBI and

which has in employment

under it CA/CS/CWA for

carrying out (signing)

Valuation by such qualified

persons.

• Member of the Institute

of Engineers or Member

of the Institute of

Architects in whole time

practice.

• A person or firm or LLP or

Merchant Banker

possessing both

qualifications may act in

dual capacity.

Shall have 5 Years of Continuous Experience, Post Qualification

Shall have 5 Years of Continues Experience, Post Qualification

Stock, Shares, Debentures, Securities, Goodwill

Property

Persons eligible to apply for being Registered as Valuer

Registered Valuer to be appointed by Audit Committee or in its absence by the Board of Directors.20/12/2013

Registered Valuers Registered Valuers

(Financial Valuation)

Value

Responsibilities• Valuer to make impartial, true and fair

valuation• Not undertake valuation if directly or

indirectly interested • Exercise due diligence• Valuation to be done as per rules

Upon contravention• Fine – 25,000 to 100,000

With intention to defraud• Imprisonment upto 1 year and• Fine- 1,00,000 to 5,00,000

Additionally upon contravention, to refund remuneration received and also liable for damages.


Section wise Requirement of Registered ValuersSection 62(1)(c) – For Valuing further Issue of Shares

Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash transactions involving Directors

Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a Scheme of Corporate

Debt Restructuring

Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a Scheme of

Compromise/Arrangement, a copy of Valuation Report by Expert, if any shall be accompanied

Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the transferor company is a listed

company and the transferee company is an unlisted company, for exit opportunity to the shareholders of

transferor company, valuation may be required to be made by the Tribunal

Section 236(2) – For Valuing Equity Shares held by Minority Shareholders

Section 260(2)(c) – For preparing Valuation report in respect of Shares and Assets to arrive at the Reserve Price or

Lease rent or Share Exchange Ratio for Company Administrator

Section 281(1)(a) – For Valuing Assets for submission of report by Company Liquidator

Section 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency under

voluntary winding up

Section 319(3)(b) – For Valuing the interest of any dissenting member of the transferor company who did not

vote in favour of the special resolution, as may be required by the Company Liquidator

Section 325(1)(b) – For valuation of annuities and future and contingent liabilities in winding up of

insolvent company


Registered Valuers (Draft Rules) – Methods of Valuation

I. Before adopting methods, decide Valuation Approach-

• Asset Approach

• Income Approach

• Market Approach

II. Valuer to consider following points while undertaking Valuation-

•Nature of the Business and the History of the Enterprise from its inception

•Economic outlook in general and outlook of the specific industry in particular

•Book Value of the stock and the Financial condition of the business

•Earning Capacity of the company

•Dividend-Paying Capacity of the company.

•Goodwill or other Intangible value

•Sales of the stock and the Size of the block of stock to be valued

•Market prices of stock of corporations engaged in the same or a similar line of business

•Contingent Liabilities or substantial legal issues, within India and Abroad, impacting business

•Nature of Instrument proposed to be issued, and nature of transaction contemplated by parties


Registered Valuers (Draft Rules) – Methods of Valuation

III. Registered Valuer shall make valuation of any asset in accordance with any one or more of the following methods-

a.Net Asset Value Method (NAV)

b.Market Price Method

c.Yield Method / PECV Method

d.Discounted Cash Flow Method (DCF)

e.Comparable Companies Multiples Method (CCM)

f.Comparable Transaction Multiples Method (CTM)

g.Price of Recent Investment Method (PORI)

h.Sum of the parts Valuation Method (SOTP)

i.Liquidation Value

j.Weighted Average Method

k.Any other method accepted or notified by RBI, SEBI or Income Tax Authorities

l.Any other method that valuer may deem fit provided adequate justification for use of suh method (and not

any of the above methods) is provided

IV. Registered Valuer shall make valuation of any asset as on the Valuation date and in accordance with applicable standards, if any stipulated for this purpose.

V. Contents of Valuation report shall contain information as contained in Form 17.3

Registered Valuers (Forms) – Contents of Valuation report

1) Description of valuation engagement

(a) Name of the client:

(b) Other intended users:

(c) Purpose for valuation:

(2) Description of business/ asset / liability being valued

(a) Nature of business or asset / liability

(b) Legal background

(c) Financial aspects

(d) Tax matters

(3) Description of the information underlying the valuation

(a) Analysis of past results

(b) Budgets, with underlying assumptions

(c) Availability and quality of underlying data

(d) Review of budgets for plausibility

(e) Statement of responsibility for information received


Registered Valuers (Forms) – Contents of Valuation report (4) Description of specific valuation of assets used in the business:

(a)Basis or bases of value

(b) Valuation Date

(c) Description of the procedures carried out

(d) Principles used in the valuation

(e) The valuation method used and reasoning

(f) Nature, scope and quality of underlying data and

(g) The extent of estimates and assumptions together with considerations underlying them

(5) Confirmation that the valuation has been undertaken in accordance with these Rules

(6) Further it is certified that valuation has been undertaken after taking into account relevant conditions/regulations/rules/notifications, if any, issued by the Central/State Government(s) from time to time.

(i)The valuation report must clearly state the significant assumptions upon which the value is based. When reporting there may be instances, where there are confidential figures, these must be summarized in a separate exhibit

(ii)In his valuation report, the registered valuer must set out a clear value or range of values along with the reasoning

(ii)In case the valuer has been involved in valuing any part of the subject matter of valuation in the past, the past valuation report(s) should be attached and referred to herein. In case a different basis has been adopted for valuation (than adopted in the past), the valuer should justify the reason for such differences

Part – C

Macro Issues of Valuation in MERGERS & ACQUISITION

Why Merger

Particulars Effect Market Cap

Surplus Assets [including Cash]

Excess Debt in Capital Structure

Excess Trading Business in Manufacturing Sector

Diversified Business Model

Excess Business in Subsidiary Company

Company Performance [Operating Profits; Net Profits; New Products;

Capacity Expansion]

Increasing Cash Flows of Business

Better Corporate Governance

Better Disclosures [Investor, Analysts & Stakeholders Communication]

Regular Dividends / Bonus / Buyback

Corporate Re-organisation / M&A

Joint Ventures / Acquisitions

Market Perception

Capital Market Valuation


M&A

Mergers Acquisitions

Stock Purchase

COURT PROCESS NON - COURT PROCESS

SEBI [TAKEOVER CODE](only if Listed Co. is involved)

Companies Act

Types and Modes of M &A

Asset Purchase

Slump Sale Itemized Sale


Key Drivers for Re-organization

Unlocking of Value and its Sustainability

Positioning the businesses to be more

competitive

Business clarity to Investors and Analysts

Improving Governance Processes

Making Businesswise Fund raising possible

Business Risk Management

Restatement of Balance Sheet

Investor Relations

Stock & Credit Re-rating

20/12/2013

Takeover Regulations

Competition Commission

of India

Companies Act, 2013

Income Tax (DTC)

Stamp Duty

Indirect Tax

(GST)

Regulatory aspects under various statues

SEBI and

Stock Exchanges

FEMA


M&A objectives – What it means?

Diversification of Risks

Access to New Technology and Knowledge

Gain access to new markets, customers, products

Ability to limit competition / gain market share

Synergies & Economies of Scale

M&A is primarily driven with motive of achieving Inorganic growth and Synergy i.e. the potential additional value gain from

combining two firms, either from operational or financial sources.

However, certain studies have shown that most – but not all – M&A fail to deliver value and bridge the price-value gap

One of the reasons is that the aggressive promoters in consultation with eager advisors may result in pushing up the acquisition

price; Resultantly, the value often get transferred from acquirer’s shareholders to target company’s shareholders;


Valuation for Merger

Valuation for Merger

Judicial Pronouncements;

WHETHER VALUATION IS REQUIRED FOR MERGER?

In the matter of Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. the Regional Director (RD) raised an objection that no valuation report has been filed and that the exchange ratio for amalgamation has not been worked out by an independent valuer.

“The Hon’ble High Court of Rajasthan overruled this objection and sanctioned the scheme of amalgamation by holding that there was no legal or factual impediment to grant sanction to the scheme of amalgamation.”

WHETHER ANY VALUATION METHODOLDY IS REQUIRED FOR MERGER?Though there are no specific methodology prescribed for valuation under Merger, however In Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others, Bombay High Court -

“accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the valuation was based.”


“Valuation is generally the Starting Point of the M&A process”

Tool for planning Stamp Duty ?

Valuation for Merger.. Contd..

APPLICABLE LAW FOR VALUATION FOR MERGER INVOLVING LISTED COMPANY:

1.Companies Act, 1956 [Section 391- 394];

2.Fairness Opinion [Clause 24 (h) of the Listing Agreement];

3.SEBI Notification [CIR/CFD/DIL/5/2013], dated 4th February, 2013 and 21st May 2013 Circular

VALUATION REQUIREMENT UNDER SEBI NOTIFICATION

After the SEBI notification, Valuation by Independent CA is required if

shares are issued under the merger and there is change in shareholding

pattern.

Valuation by independent chartered account mandatory other than those specifically exempted.

''Valuation Report from an Independent Chartered Accountant'' is not required in cases where

there is no change in the shareholding pattern of the listed company / resultant company.

1. Differences in Risk Assessment arising from - Company Specific Risk

• Management capability• Future Cash Flows

Industry Risk - Business Cycles, Industry Outlook

2. Intangible Asset Valuations

3. Unproductive, high value fixed assets housed in target company

4. Cash and Stock Payout ratio

5. Ability to raise funding on buyer’s or target company’s b/s

6. Estimation of synergies (cost and revenue)

Why is there a Mismatch between Buyer & Seller expectations?


Need for Restructuring

• In case of a merger valuation, the emphasis is on arriving at the relative values of

the shares of the merging companies to facilitate determination of the swap ratio

– Hence, the purpose is not to arrive at absolute values of the shares of the

companies

• The key issue to be addressed is that of fairness to all shareholders

– This is particularly important where the shareholding pattern and shareholders

vary between the two companies

• There are established legal precedence for merger valuation methodologies

– Valuer’s role is to incorporate case specific factors and use appropriate

methodologies so as to determine a fair ratio

– Usually, best to give weight ages to valuation by all methods

– Market price method and Earnings methods dominate.

Swap Ratio Valuation


• If the exchange ratio is set too high, there will be a transfer of wealth

from the bidding firm’s stockholders to the target firm’s stockholders.

• If the exchange ratio is set too low, there will be transfer of wealth from

the target firm to the bidding firm’s stockholders.

Impact of Swap Ratio Valuation


CASE STUDYCalculation of

Exchange Ratio in M&A and

Independent Buyer-Seller perspective


Features of Steel Company*o Frequently Traded Listed Companyo Low Profit Margin, due to high Power Costo Running in Low Capacity Utilization due to poor supply of Power

Features of Power Company*o Unlisted Companyo Company is implementing the Power Plant of 9.5 MW , The Production is expected to

start with in Year

Acquisition Rationaleo Location Advantage, both companies have their unit in same Locationo Synergistic benefits- (Captive Power Plant will reduce the Operating cost, because Steel

Industry is energy consuming)o Tax benefit from the unabsorbed losses of Power Company o Up the value chaino Capacity utilization will increase in existing steel business, due easy availability of Power

*Common Promoter Group

Merger of a Unlisted Power Company into Listed Steel Manufacturing Company


EXCHANGE RATIO & VALUATION –MERGER• Valuation on Steel Company

• Valuation on Power Company

Valuation Method Rs Crores Weights

Value of Company Weighted Value

Market Cap 2 100 200

Income Method 2 95 190

NAV 1 150 150

Fair Value of Company 108

Valuation Method Rs Crores

WeightsValue of

CompanyWeighted Value

Market Cap 2 NA NA

Income Method^ 2 90 180

NAV 1 50 50

Fair Value of Company 76.67^ considering 3 years forward earnings and 80-90% Capacity utilization basis

Merger of a Unlisted Power Company into Listed Steel Manufacturing Company

20/12/2013

Pre Merger Shareholding of Steel Company

Category No of shares % Holding

Promoter 5,000,000 50%

Public 5,000,000 50%

Total 10,000,000 100%

Pre Merger Shareholding of Power Company


Promoter 5,000,000 100%

Public - -

Total 5,000,000 100%

Post Merger Shareholding of Steel Company


Promoter 12,099,074 71%

Public 5,000,000 29%

Total 17,099,074 100%

Independent Buyer-Seller Perspective

Valuation of Power business on as is basis – Rs.55 crores Assets MethodEarnings Method (Includes premium for the license)

Valuation of Power business taking into account synergies – Rs. 70 crores

An independent Buyer would bid an amount in excess of valuation on standalone basis (Rs. 55 crores) and below Synergy valuation (Rs.70 crores).

Acquisition Price would finally depend on negotiations.

Pre and Post Shareholding


Part – D

Some Specific Tricky Issues

Pre Money or Post Money: If the effect of the money coming in Company is

taken in Projections, the Expanded capital base should be considered or else the

Equity Value should be reduced by the inflow amount to reconcile with the existing

capital base.

Terminal growth rate: Since it is tough to estimate the perpetual growth rate of a

company, it is preferred to take the perpetuity growth rate factoring in long term

estimated GDP of the Country and Historical/Projection Inflation of the Country.

Projection Validation via-a-vis Industry: Need to have Sanity check of the

projections with the trend of the industry.

Beta of Unlisted Company: It is calculated on relative basis by adjusting the

average beta of its comparable companies for differences in Capital Structure of the

unlisted company with the listed peers.

Risk Free Rate: Yield of a Zero Coupon Bond or Long Term government Bond yield

should be taken as the risk free rate since it does not have any reinvestment risk .

Tricky issues in DFCF


Adjustment of Company Specific Risk Premium or Small Company Risk

Premium: Small Companies are generally more risky than big companies. CAPM

model does not take into consideration the size risk and specific company risk as

Beta measures only systematic risk and Market Risk Premium (generally

pertaining to Sensex Companies). These risks should also be taken into account

while computing the cost of equity.

Length of Projections: The Projected Cash Flows should factor in the entire

Business Cycle of a Company.

Notional/Actual Tax: Actual Tax Liability may be worked out and replaced for the

Notional Tax Liability

Investments: Investments should be valued separately based on their

Independent Cash Flows

Surplus Assets: The Value of Surplus Assets (not being utilized for Business

purposes) should be added separately and their cash flows should be ignored

while computing the Free Cash Flows.

Tricky issues in DFCF (Cont.)


Discounts

• Discount for Entity Level

Discounts & Premiums come into picture when there exist difference between the

subject being valued and the Methodologies applied. As this can translate control value

to non-control and vise versa , so these should be judiciously applied.

– Impact on entity as a whole

Key Person DiscountDiscount for Contingent Liability

Discount for diversified companyDiscount for Holding Company

•Discount for Shareholders Level– Impact on specific ownership interestDiscount Lack of Control (DLOC)Discount Lack of Marketability (DLOM)

•Size of distribution or dividends

•Dispute

•Revenue / Earning – Growth / Stability

•Private Company

Tax Payout

•% stake & special rights

•Shareholders Agreement caveats

Global Studies over the years on diversified

companies and holding companies has shown

that companies trade at a discount in the range

of 20%. to 40% each.

DLOM: As per CCI Guidelines, 15%

discount has been prescribed; however

practically DLOM and DLOC depends

upon following factors:

20/12/2013

Premium

“Beauty lies in the eyes of the beholder; valuation in

those of the buyer”

• An investor seeking to acquire control of a company is

typically willing to pay more than the current market price

of the company. Control premium is an amount that a

buyer is usually willing to pay over the fair market value of

a publicly traded company to acquire controlling stake in a

company.

• Control can be direct (shareholding or Authority to appoint

Board) or indirect (veto power, casting vote etc)

• Research has shown that the control premium in India has

ranged from 20% to 37% in the past few years having

median of 30%.

FinancialYear

No. ofTransactions

MedianPremium

2006 25 37%

2007 29 20%

2008 38 26%

2009 44 29%

2010 22 31%

2011 42 32%

Total 228 30%


Excess Cash and Non Operating Assets

Excess cash is defined as ‘total cash (in balance

sheet) – operating cash (i.e. minimum required

cash) to sustain operations (working capital) and

manage contingencies

Key Issue: Estimation of Excess Cash ?

Non operating Assets are the Surplus assets which are not used in operations of the business and does not

reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should

be separately added to the value derived through valuation methodologies to arrive at the value of the company.

One of the solutions is to estimate average

cash/sales or total balance sheet size of the

company’s relevant Industry and then estimate if the

company being valued has cash in excess of the

industry’s average.

What is an asset is not yielding adequate returns ?


Cross Holding and Investments

Holdings in other firms can be categorized into:

Types of Cross Holding Meaning

Minority, Passive Investments If the securities or assets owned in another firm represent less

than 20% of the overall ownership of that firm

Minority, Active Investments If the securities or assets owned in another firm represent

between 20% and 50% of the overall ownership of that firm

Majority, Active Investments If the securities or assets owned in another firm represent more

than 50% of the overall ownership of that firm

Investment Value

Ways to value Cross Holding and Investments:

Dividend Yield Capitalization or DCF based on expected

dividends Separate Valuation (Preferred)

By way of Shareholders

Agreement even less %

holding may command

control value20/12/2013 Corporate Valuations – Techniques &

Application

Accounting Practices and Tax issues

Most of the information that is used in

valuation comes from financial statements.

which in turn are made on certain

Accounting practices considered

appropriate.

•Cash Accounting v/s Accrual Accounting

•Operating Lease v/s Financial Lease

•Capitalization of Expenses

•Notional Tax vs. Actual Tax

•Treatment of Intangible Assets

•Companies Paying MAT

•Treatment of Tax benefits and Losses


Intangible Valuation

Identification of Intangible Assets:

• Market Related : Trade Marks, Service Marks etc.

• Customer Related : Customer Lists, Order backlogs etc.

• Artistic Related : Plays, Books, Pictures, Music, Video etc.

• Contract Related : Licensing, Royalty, Lease agreements etc.

• Technology Related : Patented Technology, Databases,

computer software's etc.


Purchase Price Allocation

What is a Purchase Price Allocation?

-an acquiring entity must allocate the purchase price to the assets acquired and liabilities assumed based on estimated fair values at the date of acquisition;

-The excess of the cost of an acquired entity (including tangible and intangible assets) over the net of the amounts assigned to assets acquired and liabilities assumed is recorded as “Goodwill”;

Consideration paid for

acquisitionAllocated to

Tangible Assets

Intangible Assets

Goodwill

In Proportion

to Fair Value

Balancing Figure

Intangible Valuation Cont.


Private Company Valuation

Some Data Issues:

Valuation of Unlisted

Company..

• Industry Misclassification• Infrequent Collection• Mixing Data from Different Sources• Omission or Inclusion of Information• Poor Data Quality• Tiny Sample Size

Guidance Note:

The valuation of shares should be carried out on the gross profits earned by the Company, as held in

Rakhra Sports Private Limited and Ors. v. Khraithilal Rakhra and Ors. (1993) Vol. 74 CC 545

While carrying out the valuation of shares, the valuer must take into account the salaries and perquisites

paid to the directors and related party transactions.


Company Specific Factors

• Management, Promoter Group

It is the alignment of

Company’s value via-a-

vis to its external

environment

• Operating, Capital and Corporate Finance Strategies

• Competitive advantages and cost position

• Product / Service offering / differentiation / pricing power

•Scale & Diversification

•Customer / Supplier concentration

•Corporate Governance

•Future prospects / Growth potential

•Industry peer group

•Regulatory environment


Valuation Methodologies and Value Impact

Major Valuation Methodologies Ideal for Result

Net Asset Value

Net Asset Value (Book Value) Minority ValueEquity Value

Net Asset Value (Fair Value) Control Value

Comparable Companies Multiples (CCM) Method

Price to Earning , Book Value MultipleMinority Value

Equity Value

EBIT , EBITDA Multiple Enterprise Value

Comparable Transaction Multiples (CTM) Method

Price to Earning , Book Value MultipleControl Value

Equity Value

EBIT , EBITDA Multiple Enterprise Value

Discounted Cash Flow (DCF)

Equity Control Value Equity Value

Firm Enterprise Value


Reliance Group Market prices (In Rs)

Pre demerger Post demerger

Reliance Industries 702 698

Reliance Capital Ventures - 23

Reliance Communication Ventures - 292

Reliance Energy Ventures - 43

Reliance Natural Resource - 18

TOTAL 702 1074

Demerger resulted in increased shareholders value


“That is what learning is, you suddenly understand

something you have understood all your life, but in a new

way”

…………………………….. Doris Lessing

Chander Sawhney, Vice President

Corporate Professionals Capital Pvt. Ltd.

SEBI registered merchant banker

Email : [email protected]

Mobile: 9810557353; Direct: 40622252

www.corporateprofessionals.com;

D-28, South Extension, Part-I, New Delhi-110049

mailto:[email protected]

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