VALUATION
CA Bhavik Shah
16 May 2015
Presentation Overview
 Valuation Concept
 Purpose of Valuation
 Principal Methods of Valuation
 Net Assets Value (NAV) Method
 Price to Book Multiple (P/B) Method
 Price Earnings Capitalisation (PECV) Method
 Enterprise Value/ EBITDA Multiple (CCM) Method
 Discounted Cash Flow (DCF) Method
 Market Price Method
 Judicial Pronouncements
 Conclusion
Valuation Concept
Value-Price
Value varies with
situation
Not an Exact Science
Subjective
More of an Art
Date Specific
Purchase /
Merger/
Merger/
Demerger
Demerger
Private
Sale of
Equity
Business
Buyback of
Shares
Test of
IPO/ FPO
Why
Valuation?
Family
Separation
Impairment
PPA
Litigation
Portfolio
Regulatory
Approval
Value of
Investments
Steps in Valuation

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
Obtaining Information
Data analysis & review
Discussion with the management of the company
Selection of method
Conducting sensitivities on assumptions
Assigning weights
Recommendation
Reporting
Sources of Information







Historical data such as audited results of the company
Management Discussion and Industry Overview
Future projections
Stock market quotations
Representation by the management
Data on comparable companies
Market surveys, news paper reports
Analysis of Company
 SWOT Analysis
 Profitability Analysis- Past and vis-à-vis industry
 Analysis of P&L Ratios
 Operating margins
 EBITDA margins
 PBT margins
 Expense ratios
 Balance Sheet Ratios
 Quick Ratio/ Current Ratio
 Turnover Ratios
 Liquidity Ratios
 Debt Equity Ratio of Company & Industry
Principal Methods of Valuation
Asset Based Approach
• Net Assets Value
• Price to Book Multiple
Earning Based Approach
• Earnings Multiple Method
• Discounted Cashflow Method (DCF)
Market Based Approach
• Market Price
Common Adjustments
Following adjustments may be called for:
 Investments
 Surplus Assets
 Auditors Qualification
 Preference Shares
 ESOPs / Warrants
 Contingent Liabilities
 Tax benefits
 Findings of Due Diligence Reviews
NAV
 The Value as per Net Asset Method is arrived as follows:
Total Assets excluding Miscellaneous expenditure & debit
balance in Profit & Loss Account
Less: Total Liabilities
Net Asset Value
OR
Share Capital
Add: Reserves
Less: Miscellaneous Expenditure
Less: Debit Balance in P&L account
Net Asset Value
NAV – An Example
NET ASSETS METHOD
(INR lacs)
Particulars
XYZ Ltd.
Net Fixed Assets
1,000
Current Assets
2,450
Current Liabilities
(1,565)
Net Current Assets
885
Investments
500
Deferred Tax Liabilities
(100)
Loan Funds
(930)
Net Assets Value
1,355
Adjustments:
Add: Appreciation in the value of Investment
350
Less: Preference Share capital
(150)
Less: Contingent Liabilities
(20)
Adjusted Net Assets
1,535
No. of Equity shares (FV - INR 10 each)
9,00,000
Value per Share (INR)
171
Issues in NAV Method
 Book value may not reflect the true value of assets
 Earnings potential ignored
 Profit generating Intangible assets could be understated
 Brand
 Patent
 Value of Human Resource not captured
Price/Book Value Multiple
 The Price/Book Value Multiple of Comparable Company is
arrived as follows:
STEP 1: Weighted Average Market Price
Divide by: Value per share as per Net
STEP 2: Assets Value as calculated in the
previous slide
STEP 3: Price/Book Value Multiple
Price/Book Value– An Example
P/B Multiple Method
(INR lacs)
Particulars
XYZ Ltd.
Net Fixed Assets
1,000
Current Assets
2,450
Current Liabilities
(1,565)
Net Current Assets
885
Investments
500
Deferred Tax Liabilities
(100)
Loan Funds
(930)
Net Assets Value
1,355
Adjustments:
Add: Appreciation in the value of Investment
350
Less: Preference Share capital
(150)
Less: Contingent Liabilities
(20)
Adjusted Net Assets
1,535
No. of Equity shares (FV - INR 10 each)
9,00,000
Net Asset Value per Share (INR)
171
P/B Multiple
3
Value per Share (INR)
512
Earnings Multiple Method
 Commonly used Multiples:
Price to Earnings
Multiple
Market Cap/
PAT
Enterprise Value to
EBITDA Multiple
Enterprise Value/
EBITDA
Price Earnings Capitalization Method
(PECV) - Parameters
Maintainable
Profits
Appropriate
Tax Rate
PE Multiple
Maintainable Earnings
 Based on past performance and/ or projections
 Elimination of Material non-recurring/ non operational items
 Adjustment if Capacity is under-utilized or recently added
 Profits of various years averaged (simple or weighted)
Multiples
 Multiples to be applied represent the growth prospects/
expectations of the Company
 Factors to be considered while deciding the multiple:
 Past and Expected Growth of the Earnings
 Performance vis-à-vis Peers
 Size & Market Share
 Historical Multiples enjoyed on the Stock Exchange by the
Company and its peers
PECV – Example
CALCULATION OF ADJUSTED PBT
Particulars
Reported Profit before Tax
(INR Lacs)
2013-14 (A) 2014-15 (A) 2015-16 ( E )
540
780
910
Less: Non recurring Income
Dividend Income
Profit on sale of Fixed Assets
Profit on Sale of Investments
Interest on Income tax refund
Interest Income
340
10
50
10
300
100
40
18
300
120
50
30
Total Non recurring Income
410
458
500
Add: Non recurring Expenditure
Loss on Sale of Fixed Asset
VRS paid
Others
Total of Non recurring Expenditure
Adjusted PBT
Add: Interest
Add:Depreciation
Adjusted EBITDA
10
4
10
15
-
20
2
14
25
22
144
165
79
388
347
113
75
535
432
56
70
558
PECV – Example (CONTD...)
Price Earnings Capitalisation Value Method
Particulars
2013-14
2014-15
2015-16
Total
Maintainable PBT
Tax Rate
Maintainable PAT
PE Multiple
Capitalised Value of Business
Adjustments
Add: Value of Investments
Less: Contingent Liabilities
Add: Deferred Tax Liabilities
Less:Preference Share Capital
Adjusted Earning Value
No. of Equity shares (FV - INR 10 each)
Value per Share (INR)
(INR Lacs)
Adj. PBT
144
347
432
34.61%
ABC Ltd.
Weight
Product
0
1
347
1
432
2
779
390
135
255
15
3,821
850
(20)
(100)
(150)
4,401
9,00,000
489
Enterprise Value / EBITDA Multiple Method
 Determination of Maintainable EBIDTA.
 EV/EBITDA Multiple
 Not affected by the pattern of Funding adopted by Company/
Comparable Companies
EV/EBITDA – Example
EV/EBITDA Multiple Method
Particulars
2013-14
2014-15
2015-16
Total
Maintainable EBITDA
EV/EBITDA Muliple
Enterprise Value
Adjustments:
Add: Value of Investments
Less: Contingent Liability
Less: Loan Funds
Less:Preference Share Capital
Adjusted Equity Value
No. of Equity Shares (FV - INR 10 each)
Value per Share (INR)
(INR Lacs)
Adj. EBITDA
388
535
558
ABC Ltd
Weight
0
1
1
2
Product
535
558
1,093
547
9
4,919
850
(20)
(930)
(150)
4,669
9,00,000
519
Issues in PECV / CCM Method
 Valuation of:
 Loss making companies
 Start-up companies
 Finite life project companies
 Ignores time value of money
 Calculation of Maintainable Profits
 Adjustment for non-operating / non-recurring items
 Finding listed comparable companies
 Difficulty in obtaining comparable multiples
 Effective tax Rate in PECV Method
Discounted Cash Flow (DCF)
 Values a business based on the expected cash flows over a given
period of time.
 Involves determination of discount factor and growth rate for
perpetuity
 Value of business is aggregate of discounted value of the cash
flows for the explicit period and perpetuity
Discounted Cash Flow (DCF)
 Considers Cash Flow and Not Profits
 Cash is King
 Free Cash Flow (‘FCF’)
 FCF to Firm
 FCF to Equity
DCF – Parameters
 Cash Flows
 Projections
 Horizon period
 Growth rate
 Discounting
 Cost of Equity
 Cost of Debt
 Weighted Average Cost of Capital (‘WACC’)
Cash Flows
Business
Plan
Business
Cycle
Capital
Expenditure
Working
Capital
Depreciation
Amortization
Tax
DCF – Projections
Factors to be considered for reviewing projections:
 Industry/Company Analysis
 Dependence on single customer/ supplier
 Installed capacity
 Existing policy/ legal framework
 Capital expenditure – increasing capacities
 Working capital requirements
 Alternate scenarios / sensitivities
Cost of Equity
In CAPM Method, all the market risk is captured in the beta,
measured relative to a market portfolio, which at least in theory
should include all traded assets in the market place held in
proportion to their market value
Ke = (Rf + ( x Erp))
Where , Ke = Cost of Equity
Rf = Risk free return
Erp = Equity risk premium
= Beta
Cost of Debt
Kd = (Int x (1-t))
Where , Kd = Cost of Debt
Int = Average Interest Rate
t = Marginal rate of tax
DCF – Discounting Rate
 Weighted Average Cost of Capital (WACC)
WACC =




D
(D + E)
x
Kd
D = Debt
E = Equity
Kd = Post tax cost of debt
Ke = Cost of equity
+
E
(D + E)
x Ke
DCF – Terminal Value
 Terminal Value is the residual value of business at the end
of projection period used in discounted cash flow method
TERMINAL VALUE
LIQUATION
APPROACH
MULTIPLE
APPROACH
STABLE GROWTH
APPROACH
The Final Value
Under the FCF to the firm approach - The Value is the summation
of:
 PV of the FCF to Firm during the horizon period
 PV of the residual value
 PV of the tax benefit on the WDV of the assets, 80IA, 10A/10B
sales tax, etc. beyond the horizon period
 Market value of the investments and other non-operating/
surplus assets (net of tax)/ surplus cash as at the valuation date
 Adjustment for contingent liabilities (net of taxes)
DCF – When to use?
Most appropriate for valuing firms:
 Limited life projects
 Large initial investments and predictable cash flows
 Regulated business
 Start-up companies
DCF – Example
(INR Lacs)
2015-16 2016-17 2017-18 Perpetuity
432
518
596
Particulars
Operating PBT
Add:
Interest
Depreciation
Total Inflows
Less: Outflows
Capital Expenditure
Incremental Working Capital
Tax
Total Outflows
Free Cash Flows (FCF)
Cash Flow for 2019-20
Growth Rate
Capitalised Value for Perpetuity
Discounting Factor
Net Present Value of Cash Flows
Enterprise Value
Less: Loan Funds
Less: Preference Share Capital
Less: Contingent Liability
Add: Value of Investments
Adjusted Value for Equity Shareholders
No of Equity Shares
Value per Share (FV INR 10)
13.00%
56
70
558
44
80
642
46
86
728
45
20
158
223
335
45
30
182
257
385
45
30
208
283
445
0.88
296
0.78
301
0.69
308
445
5%
5,838.15
0.69
4,046
4,952
(930.0)
(150.0)
(20.0)
850
4,702
9,00,000
522
Issues in DCF Method
 Issues in forecasting cash flows
 Estimation of Discounting Factor Parameters




Risk Free Rate
Beta
Market Return
Debt Equity Mix
 Terminal Growth rate
 Pre Money or Post Money Valuation
Market Price Approach
 Evaluates the value on the basis of prices quoted on the stock
exchange
 Thinly traded / Dormant Scrip – Low Floating Stock
 Significant and Unusual fluctuations in the Market Price
 It is prudent to take weighted average of quoted price for past
6 months
 Regulatory bodies often consider market value as important
basis – Preferential allotment, Takeover Code
Market Price Method – Example
Market Price Method
Months
November 2014
December 2014
January 2015
February 2015
March 2015
April 2015
Total
Value per Share (INR)
Volume
16,95,000
14,95,000
15,02,560
13,26,395
11,85,424
10,57,403
82,61,782
Turnover
7261,42,620
5849,22,726
7810,96,596
9112,16,380
8185,98,438
4791,13,336
43010,90,096
520.60
Issues in Market Price Method
 Market price mat not capture intrinsic value
 Thinly traded / Dormant Scrip - Low Floating Stock
 Unusual fluctuations in Market Price
Selection of Methods
SITUATION
Knowledge based companies
Manufacturing Companies
APPROACH
Earning / Market
Earning / Market / Asset
Brand Driven Companies
Earning / Market
A Matured Company
Earning / Market
Investment / Property Companies
Asset
Company going for Liquidation
Asset
NBFC / Banks
P/B Multiple
Generally Market Approach is used in combination
with other methods or as a cross check
Reaching a Recommendation
 Methods throw a range of values
 Consider the relevance of each methodology depending upon
the purpose and premise of valuation
 Mathematical weightage
 Professional judgment
 Subjective Value
Fair Value – An Example
Method
Net Assets Method
P/B Multiple
Price Earning Multiple Method
EV/EBIDTA Multiple Method
DCF Method
Market price Method
Total
Fair Value per share (INR)
Value per
Share (INR)
171
512
489
519
522
521
Weight
1
1
1
1
1
1
6
Product (INR)
171
512
489
519
522
521
2,733
455.49
Other Value Drivers
Final Value
Final Price is a result of negotiations
Some Issues (Common)
 Relying on Technical Valuer’s Report
 Joint Reports
 Fairness Opinion by Merchant Bankers
 Engagement Letter
 Management Representations
 Reporting
Judicial Pronouncements
 Exchange Ratio not disturbed by Courts unless
objected and found grossly unfair.
Miheer H. Mafatlal Vs.Mafatlal Industries (1996) 87 Com Case
792
Dinesh v. Lakhani Vs. Parke-Davis (India) Ltd. (2003) 47 SCL 80
(Bom)
 It is fair to use combination of three well known methods
viz. asset value, yield value & market value
Hindustan Lever Employees’ Union Vs. HLL (1995) 83 Com case
30SC
Judicial Pronouncements
 Valuation will take into account number of factors such as
prospective yield, marketability, the general outlook for the
type of business of the company. Mathematical certainty
is not demanded, nor indeed is it possible
Viscount Simon Bd in Gold Coast Selection Trust Ltd.
Vs. Humphrey reported in 30 TC 209 (House of Lords)
Conclusion
 Valuers must keep in mind fairness to all stakeholders
 Many instances of minority shareholders delaying the
merger process by challenging valuation
 Balance needs to be achieved through transparency,
fairness and best governance practices