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Corporate Valuation

Corporate Valuation

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Corporate Valuation

203 Seiten
2 Stunden
May 15, 2017


This textbook offers readers an interesting overview of the corporate valuation area in a quick and easy way.

It includes:
Discounted Cash Flow Valuation (DCF Valuation)
Comparable Companies Analysis
Precedent Transactions Analysis
Further Valuation Methods
From Enterprise Value to Equity Value
The Tension between Principals, Evaluators, Objectives and Leeway in Corporate Valuations
Value and Price a Tangent on Valuation Theory
Self-Test Questions Proposal for Solutions
May 15, 2017

Über den Autor


Corporate Valuation - Ralf Hafner



Learning Objectives

Get an overview on the different occasions for corporate valuations.

Understand valuation as a complex, interdisciplinary, and comprehensive exercise that requires the application of the entire spectrum of management theory and practice.

Corporate Valuation is one of the most relevant subjects for management practice in business administration education. There are numerous occasions for the valuation of enterprises.

Acquisition and Disposal of Companies (Mergers & Acquisitions; M&A)

In every M&A process, valuation plays a vital role. A potential seller should always investigate

the price range that can realistically be expected from purchase price offers,

how to back the own asking price with a valuation,

and, most importantly, what the minimum proceeds from the sale must be so that the seller does not end up in a worse position compared to omitting the sale and keeping the company.

Conversely, potential buyers will value a target company before submitting a bid. They will analyze

how to back their offer price with a valuation,

how to justify an acquisition with a valuation towards shareholders and supervisory boards,

how much other bidders would be willing to put on the table for the target company,

and, most importantly, what the maximum price is that they could pay so that they do not end up in a worse position compared to not realizing the acquisition and following alternative projects instead.

The same applies to mergers, MBOs (management buyouts), MBIs (management buy-ins), transactions between shareholders, IPOs (initial public offerings) and other partial sales of enterprises.

Value-Based Management

The mantra of modern corporate finance theory and practice is to align management decisions and actions with the value of the company. Decisions that enhance the value are good decisions and should be realized. Strategic decisions, capital budgeting decisions, financing decisions and company value are interrelated and depend on each other.

Investment Management

Private and institutional investors including their advisers, especially financial analysts, perform valuations to support their investment recommendations and portfolio management decisions.

Legal Requirements

Many legislations provide for regulations which require valuations at specified special occasions. One example is the so-called squeeze-out, a compulsory sale of the minority shareholders’ shares to the majority shareholder of a publicly traded company. The conclusion of certain agreements, mergers, spin-offs, split-ups will also lead to corporate valuations being required by law in many jurisdictions.

Contractual and Other Regulations

Corporate valuations may also occur in conjunction with the distribution of estate among heirs, the entry or the exit of partners in a partnership, the distribution of the surplus earned during a marriage in a divorce or in other family law matters.

Financial Reporting and Tax Matters

Valuations are also necessary when performing so-called purchase price allocations for the preparation of annual group accounts (allocation of the purchase price paid for a company to the various assets and liabilities including goodwill). The same applies to the necessary goodwill impairment testing in the subsequent years. Valuation occasions may also arise from tax laws.

Valuations of enterprises are ambitious, extensive and fascinating projects. They require the application of the entire spectrum of management theory and practice. Take any existing company as an example, Boeing or Siemens, Twitter or the mom-and-pop flower store just around the corner. What all is necessary to be able to derive a value for these businesses?

The review of a company’s status is usually based on its financial statements. Hence, a profound knowledge of financial accounting and management accounting is required, so to say the ability to read financial statements.

The projection of the future development of a company necessitates an analysis of the entire value chain: research and development, design, sourcing/production, marketing, distribution, customer service and administration/information technology should be examined regarding competitive advantages, disadvantages and their sustainability.

In addition, forecasts on procurement and sales markets should be performed. Products or services of the company to be valued should be compared with those of its competitors and peers. Strategy and strategic management can be brought to the table here. Ideally coupled with the ability to transform the results of this analysis into hard figures, a budget of sales, margins, necessary investments in fixed assets and working capital and other balance sheet ratios. How will the profit and loss statement, the balance sheet, the cash flow statement look like in the next five years?

Finally, it should be explored how to factor in the uncertainty associated with any forecast. What is risk, what is opportunity in valuations, how can we measure them and how do we account for them in our analysis? This is one of the most ambitious endeavors in theory and in practice. There will be airplanes in five years, but what will Boeing’s market position be compared to their competitors? Are conglomerates like Siemens sustainable? How promising is Twitter’s business model? Will we buy our flowers on the web in five years and if so, what impact will this have on the mom-and-pop flower store just around the corner? Difficult questions? Yes, but the more ambitious the valuation, the more necessary it usually is. We will probably still drink Coke in 20 years from now. But will Twitter still be around then? What about Uber, Facebook, Snapchat?

If you don’t feel comfortable with so many insecurities, you might be better advised to turn to other, more simply structured problems. Risks, uncertainties, subjective judgements on future developments that naturally come along with a high probability to be in error on them, are part of corporate valuation. Valuation is not a precise science. Despite the usage of quantitative models, the values derived are neither objective nor exact and above all not timeless. Valuations determine ranges for the values. And these ranges are subject to change. Every day.

The magnitude of the available literature on valuation also illustrates the depth of the topic. The list of the standard textbooks in English and in German alone is quite extensive, not even mentioning the numerous scientific papers, PhDs and post-doctoral theses on the topic.

Rosenbaum/Pearl’s book Investment Banking can still be considered handy with its 400 plus pages. Damodaran’s book Investment Valuation tops this easily with almost 1,000 pages as does the other standard international textbook on corporate valuation, Koller/Goedhart/Wessel’s Valuation, with over 800 pages. Peemöller’s German practice handbook on valuation even comes with 1,200 pages. Some of the German standard textbooks on valuation are also quite comprehensive: Matschke/Brösel come along with almost 900 pages, Drukarczyk/ Schüler with over 500. Ballwieser/Hachmeister, Hering, Spremann/Ernst and Hommel/Dehmel are laudable exceptions regarding the volume of their works. But each of the books mentioned¹⁰ has an at least slightly, sometimes very different focus and approach to the topic, so that one might as well just add up all the pages to get to a full overview on the status of the German textbook lines on corporate valuation.

The variety of valuation methods is another characteristic of our topic. Also, the long and intensive discussion between academia and valuation practice (at least in Germany) on important aspects of valuation, and the pronouncedly critical and partly cold and distant position some prominent representatives of German valuation academia have towards international (i.e. Anglo-Saxon) valuation theory and practice.

As a strong advocate of applied science, I will start our valuation journey by looking at those methods that are currently (late 2016) most prevalent in international valuation practice. Looking at Germany as an example, these methods have developed more and more towards a valuation industry standard. Chapter 2 introduces the discounted cash flow (DCF) method in its enterprise variant. As the net present value method dominates in capital budgeting, the enterprise DCF approach can be regarded as the mother of all corporate valuation methods by today.¹¹

Chapters 3 and 4 describe two methods which are by now usually also part of most valuations, the comparable companies analysis (trading comps) and the precedent transactions analysis (transaction comps). Chapter 5 elaborates on further valuation methods, Chapter 6 deals with the transition from the enterprise value to the equity value of the firm.

Chapter 7 analyses the leeway resulting from the inevitably subjective judgements¹² which are necessary in performing a valuation. With this I would like to sharpen your view for the interaction between the value resulting from a valuation exercise and the purpose the principal (the initiator, the person that pays for the valuation) pursues with the valuation. In Chapter 8 we look at the topic of value and price or value versus price and try to build a bridge to the perceptions of the functional valuation theory.

¹⁰Apologies for any not mentioned books. This is my personal selection without any intention of an academic assessment.

¹¹I know that this statement is unlikely to be supported by a majority in academia, but valuation practice is as it is.

¹²These judgements can at best be objectivized, but will never be objective.

2Discounted Cash Flow Valuation (DCF Valuation)

Learning Objectives

Understand discounted cash flow (DCF) valuation as an application of net present value (NPV) analysis.

Recognize the differences between the enterprise and the equity DCF valuation approaches.

Recognize the valuation-specific terms enterprise value, equity value, interest-bearing debt, cash and cash equivalents as well as net debt, and understand the relationship between them.

DCF valuation is nothing else but the application of the net present value approach in capital budgeting on corporate valuation. The project we look at is the company, being characterized by its future free cash flows. As in capital budgeting, we work with cash flows instead of accounting earnings. The future free cash flows in the years t=1, 2, 3, …, n of the company under investigation are discounted back to t=0 using the appropriate discount rate, i.e. the rate that reflects both the risk of the investment as well as its funding costs, for equity and debt. This discount rate is the weighted average cost of capital (WACC) of the company being valued. The value of the company can be derived by adding up the present values of the future free cash flows.

Exhibit 1: Discounted Cash Flow Valuation

Other than in standard capital budgeting analysis, there is no initial investment in t=0 in a DCF valuation. Instead, this amount, the sum of the present values of all future free cash flows is the number we are looking for. Once determined and put into a standard net present value analysis with a minus sign in t=0, a net present value of 0 will be the result for this project (the acquisition of the company being valued). The internal rate of return (IRR) of this project will be equal to the weighted average cost of capital (WACC) of the company. What does this imply? If you as an acquirer of the company can negotiate a price below the sum of the present values of the future free cash flows of the target company, you are about to make a good deal. Why? Because the net present value of your project (the acquisition of the target company) will be positive. If you pay more than the sum of the present values of the future free cash flows, your initial investment in t=0 goes up and will lead to a negative net present value for your project. As per the decision rule in capital budgeting analysis, you should not pursue such a project, i.e. not realize the acquisition.

This applies vice versa to a potential seller of a company, who would give up the future free cash flows in case of a divestiture. Consequently, these future free cash flows go into his capital budgeting analysis with a minus sign, whereas the purchase price received is a cash inflow in t=0. If this purchase price equals the sum of the present values of the future free cash flows, the net present value of this project (disposal of the company) will also amount to 0. In case the potential seller receives more than the sum

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