Valuation KPMG Ivca

CORPORATE FINANCE
Valuation
August 2009
ADVISORY
Agenda
Valuation theory a brief reminder Valuation in practice Case studies The vendors perspective The buyers perspective
2009 KPMG India Private Limited, the Indian member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.
Valuation Methodologies
Choose valuation methods
Relative valuation Discounted cash flow valuation Asset based valuation
EV / sales ratio
EV / EBITDA ratio
P / E ratio
Price / book ratio
Relative valuation Discounted cash flow valuation Asset based valuation FCFF
FCFE
Net Asset
Liquidation
Replacement
Relative Valuation
Relative Valuation - introduction

Value of an asset compared to the values assessed by the market for similar similar or comparable comparable assets Commonly used multiples for relative valuation are the Comparable Company (CoCos) and Comparable Transaction (CoTrans) multiples What you need to do:

Identify comparable universe Use standard variables e.g. Sales, EBITDA, PAT, etc Apply multiples to the variables for the asset being analysed Ensure any differences or exceptions are eliminated to ascertain multiples are obtained on a normalised basis
Relative Valuation- EV to Sales

Enterprise value is the sum of market value of equity and market value of debt and securities Can be used for loss making and troubled companies Less impact of accounting policies Eliminates the impact of financial leverage EV to Sales multiples are not as volatile as P/E multiples
Relative Valuation- EV to EBITDA

EBITDA - the closest proxy in the P&L for cash flow from operations Cannot be used in case of negative EBITDA Eliminates the impact of financial leverage like the EV to Sales multiples Impacted by accounting policies, except for depreciation policy
10
Relative Valuation - Price to Earnings

Widely used due to simplicity of computation and easy availability Need to be cautious
Differences in accounting policies
Cannot be used when earnings are negative Considerations

Growth phase Stock liquidity and trading volumes Comparable time period
11
Relative Valuation - Price to Book

Book value of equity is: Difference between book value of assets and book value of liabilities; A relatively intuitive measure of value which can be compared to the market price Firms with negative earnings can be evaluated Cannot be used when book value is negative Book values, like earnings, are affected by accounting policies
12
Relative Valuation - Issues to be Considered

Are the comparable companies / transactions really comparable? What do the businesses do? What are their growth rates/margins? Normalised results Surplus and non-operating assets Transactions data Backwards looking Can be out of date Applying averages Small profit = large multiples
Differences in GAAP / tax regimes between countries

13
Discounted Cash Flow Valuation
14
DCF - Introduction
DCF valuation is the present value of future free cash flows discounted at a specific risk adjusted rate Commonly used valuation methodology Reflects the value derived from future earnings Approach based on Free Cash flows after meeting capex and working capital Assumes the business as a going concern Captures the impact of financial gearing Can be used for asset and non-asset based companies Can be applied to companies with negative earnings or net worth Factors in risk
15
DCF - The Inputs Required

Projected Cash Flows (generally 4-6 years):
Free cash flows to firm (FCFF) Free cash flows to equity holders (FCFE)
Discount rate:
Cost of capital (WACC) in case of FCFF Cost of equity in case of FCFE
Current and targeted capital structure Market view of business risk Terminal Growth Rate
16
DCF - The Steps to be Carried Out

Analyse the historical performance of the business Determine what you are valuing Develop financials projections (generally for 4-6 years) Calculate free cash flows for the projection period FCFF or FCFE Calculate the discount factor - WACC or Cost of Equity Discount free cash flows by the appropriate factor. Sum of the discounted free cash flows during the projection period is termed as the primary value Estimate the terminal growth rate and calculate the terminal value Add the primary and terminal values to arrive at the Enterprise or Equity value (depending upon whether FCFF or FCFE was used) Deduction of net debt from enterprise value results in equity value
17
DCF - WACC Computation
Cost of debt
12.5%
33.99%
8.3% say, 20% Net cost of debt
Cost of debt
x (1-
Tax rate
)=
x [Debt/Total capital]%
14.9% Target capital structure 8.5% 8% Market equity risk premium 16.5% say, 80% Risk-free rate =
Cost of Capital
Cost of equity +
Cost of equity
X [Equity/Total capital]%
18
DCF - Cost of Equity

Cost of equity is calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Rf + (Rm Rf)* + Where: Rf = Risk Free Rate Rm = Market Return (Rm Rf) = Equity Risk Premium = Beta = Alpha
19
DCF - Terminal Value

Measures the value of the business after the projected cash flow period ie, cash flows into perpetuity Estimation of the growth rate is critical - it is a valuation call
20
Asset Based Valuation
21

Net Asset Liquidation
Restate tangible assets to realisable value

Provision for diminution in value
Treatment of intangible assets and special rights Adjustment for contingent liabilities
Replacement
22

Net realisable value of assets on a liquidation assumption

Liquidation costs / taxation / stamp duty Discount for forced sale and time factor Shareholder value to be impaired in case
Replacement
of assets charged to creditors
23

Replacement
Market value of similar assets Useful for valuing implementation

Projects under
24
Valuation in practice
Case studies
The problem with averages Dangerous DCFs Sensitive DCFs The market return paradox Private equity pricing
25
The vendors perspective
Who is selling? Why are they selling? What time pressure is there? What are their price expectations? Do they want to stay with the business? What are their other options? Do they like you!?
26
The buyers perspective
Who is the competition? How are they funding the deal? What are their timing constraints? What are their strengths? Do they know the vendor? What are their hurdle rates? What other options do they have? What other options do you have?
27

Valuation KPMG Ivca

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CORPORATE FINANCE

Relative valuation Discounted cash flow valuation Asset based valuation

Relative valuation Discounted cash flow valuation Asset based valuation

Price / book ratio

Relative valuation Discounted cash flow valuation Asset based valuation

Relative Valuation - introduction

Relative Valuation- EV to Sales

Relative Valuation- EV to EBITDA

Relative Valuation - Price to Earnings

Cannot be used when earnings are negative Considerations

Relative Valuation - Price to Book

Relative Valuation - Issues to be Considered

Differences in GAAP / tax regimes between countries

Discounted Cash Flow Valuation

DCF - The Inputs Required

DCF - The Steps to be Carried Out

DCF - WACC Computation

8.3% say, 20% Net cost of debt

DCF - Cost of Equity

DCF - Terminal Value

Asset Based Valuation

Asset Based Valuation

Restate tangible assets to realisable value

Asset Based Valuation

Net realisable value of assets on a liquidation assumption

of assets charged to creditors

Asset Based Valuation

Market value of similar assets Useful for valuing implementation

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