Valuation in The Context of M&A Activity: Presentation by Ketan Dalal

Valuation
in the context of M&A Activity
Presentation by Ketan Dalal
February 12, 2004

Presentation Outline
 Introduction
 Valuation Methods & Principles
 Valuation Techniques
 Key Issues
 M & A Scene - The Macro Picture
 Key Conclusions
2
Introduction
The Context
 “External” / “Internal” M & A
 Transfer of businesses/shareholdings
 Capital restructuring exercises
 Issue of new shares
 Right issues
 Preferential allotments
 Other instances -
 Issue of ESOP/Sweat Equity (particularly by unlisted
companies)
 Family realignments
Integral to any deal/transaction
4
Valuation - Myths
 Myth 1 - A valuation is an objective search for “true” value

 Truth - All valuations are biased
 Myth 2 - A good valuation provides a precise estimate of
value
 Truth - The payoff to valuation is greatest when valuation is
least precise
 Myth 3 - More quantitative a model, the better the valuation
 Truth - Simple valuation models do much better than complex
ones
Valuation is an art within a science
5
Valuation methods and principles
The Techniques
 More than one right way to value

 Approaches are not exclusive; but complement each other
Limited valuation Extended valuation techniques

techniques  DCF
 NAV  Trading Multiples
 PECV  Comparable Transactions
Contingent upon purpose of the valuation
7
NAV
 Attempts to measure the value of net assets

 Appropriate in the context of -
 Paucity of information about future earnings
 Past profits do not serve as a guide to future earrings
 Loss-making companies
 Companies in liquidation / intended to be liquidated
 Certain industries (e.g. shipping)
 Bases of NAV
 Book Value / Replacement Value / Realisable Value
Continued relevance in certain circumstances/industries
8
PECV
 Attempts to capitalise the value of future maintainable

earnings from past earnings
 Appropriate in the context of valuation of going concerns
 Key elements in valuation
 Earnings
 Past profits adjusted for extra-ordinary items
 Tax incidence
 Capitalisation rate
PECV usually preferred over NAV
9
Trading Multiples
 Estimates value by relating the same to underlying elements of similar

companies or for past years
 Constituents of Trading Multiples - Profits, Sales, Assets
 Generally used trading multiples
 EBIT/EBITDA, Market value/Book Value, Industry specific, etc.
 Application of Trading Multiples
 Understand the company you are valuing & the industry in which it operates
 Develop peer group
 Review several multiples
10
DCF Valuation
 Attempts to compute present value of expected cash flows

 Forces an in-depth understanding of the business
 Can derive values qua product lines, businesses, transactions
 Permits sensitivity analysis
 Typically used for acquisitions and evaluation of new projects
 Key elements in DCF valuation
 Forecasted free cash flows
 Terminal value
 Cost of capital
The Preferred Method
11
Comparables & their application
 Important part of “deal-speak”

 Often necessary for Board of Directors, fairness opinions, etc.
 Provides insights into various factors
 List of likely buyers & their valuation techniques
 Bidding strategies
 Application of Comparable Transactions
 Identify most comparable & recent transactions
 Judgement of the Valuer is important - “Feel the Deal”
Availability of transaction data - Key limitation
12
Controlling Interest
 Derives value from additional powers conferred due to

acquisition of control, such as -
 Control over Board of Directors
 Control over day-to-day operations
 Power to amend Memorandum/Articles
 Power to approve Special Resolutions (for mergers, etc.)
 Facilitates consolidation of financials
Even small percentage of large dispersed capital

could be “controlling interest”
13
“Feel the Deal”
Theoretical analysis will potentially give you an indication of

value, but you need to “Feel the Deal”; for a buyer, for
instance:
 What is the competitive tension in the process?
 How strategically important is the acquisition to you?
 How committed is the vendor?
 How good is the disposal story, how good are the vendor’s
advisers?
 What is your relationship with the target management and key
clients?
14
“Where is the Value”
What underpins the cash flows of this business - fixed assets, people (or
one person), know-how ?
People business
Once you have worked out

what drives the value make
sure that it is still there after
you have acquired
the business!
Asset business
Intangibles - usually a part of business valuation

15
M&A Scene - The Macro Picture
Mergers - Swap ratio
 Mergers require determination of swap ratio
 Absolute values need not be indicated; swap ratio is an
indicator of relative values
 Subject to approvals from regulatory authorities such as
High Court & RBI
 High Court’s role
 Limited scope for review of valuations / valuation reports
 Hindustan Lever Employees’ Union vs HLL (83 Comp Cases 30)
 Hindustan Ciba Giegy (14 SCL 115)
 Not to disturb ratio unless proved to be grossly wrong / unfair
Valuation techniques are identical

17
Listed and Unlisted - Issues
 “External” Merger
 Lack of authentic data, if unlisted
 Recognition of hidden reserves/provisions
 Due diligence required
 “Internal” Mergers
 Valuation - sensitive issue
 Access to insider information
 Intra-group dealings
 Two independent valuations advisable
18
Demerger - Valuation
 Pure “demergers”
 Valuation more in the nature of a capital structuring exercise
 Capital of the “demerged“ undertaking contingent upon -
 Nature of income streams
 Quantum of revenues generated
 Serviceability of capital
 Others cases
 Valuation akin to a merger
19
Acquisition/Divestment ... Valuation
overview
 Principles consistent with other situations (i.e. earnings,

standalone etc)
 However .... bargaining position is the key!
The theory to beat all

other theories on
valuation ….A
business is worth
what someone is
prepared to pay for it
20
Expert Committee Report
 Ministry of Finance constituted an Expert Group in October 2002

 Expert Group submitted Report on Valuation of Shares and
Corporate Assets in January 2003
 Key Recommendations
 Registration of Valuers
 Mandatory and Recommended valuation transactions
 Independence of Valuers
 Valuation Reports - Summary Report and Detailed Report
 Maintenance of Detailed Report under confidential filing procedure
 Review by Screening Committee and Peer Review Committee
Report not yet implemented

21
Regulatory references to Valuation
 Purchase of shares by non resident to resident

 Floor price as per RBI guidelines (old CCI formula)
 Purchase of shares by resident from non resident
 Cap of market price for listed shares
 Maximum as per formula price based on price is to book value
(unless higher price supported by valuation)
 In case of delisting, reverse book building method to be
followed
22
And therefore ....
Key conclusions ….
 Businesses are valued for the future, not the past

 Dynamic and fast changing scenarios is making valuations
increasingly difficult
 Shareholder activism and regulatory constraints make
valuation even trickier
24
.... Key conclusions
 Valuation for mergers has special aspects: to be applied

on the same foundation
 Industry specific issues need cognisance
 Brands are usually part of business valuation: can be
valued separately if “separable”
25
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Valuation

in the context of M&A Activity

Presentation by Ketan Dalal

February 12, 2004

Integral to any deal/transaction

 Myth 1 - A valuation is an objective search for “true” value

Valuation is an art within a science

 More than one right way to value

Limited valuation Extended valuation techniques

Contingent upon purpose of the valuation

 Attempts to measure the value of net assets

Continued relevance in certain circumstances/industries

 Attempts to capitalise the value of future maintainable

PECV usually preferred over NAV

 Estimates value by relating the same to underlying elements of similar

 Attempts to compute present value of expected cash flows

The Preferred Method

 Important part of “deal-speak”

Availability of transaction data - Key limitation

 Derives value from additional powers conferred due to

Even small percentage of large dispersed capital

Theoretical analysis will potentially give you an indication of

Once you have worked out

Intangibles - usually a part of business valuation

Valuation techniques are identical

 Principles consistent with other situations (i.e. earnings,

The theory to beat all

 Ministry of Finance constituted an Expert Group in October 2002

Report not yet implemented

 Purchase of shares by non resident to resident

 Businesses are valued for the future, not the past

 Valuation for mergers has special aspects: to be applied

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