INTRODUCTION
- It may be necessary to carry out a valuation for:
- Quoted Companies – where a bid is made and the offer price is an estimated “fair value” in excess of the current market price of the shares.
- Unquoted Companies – where the company is going public; a scheme of merger is being considered; shares are being sold; taxation purposes (C.G.T., C.A.T.); to establish collateral for a loan etc.
- The valuation of companies is not an exact science.
- It is, generally, necessary to use a number of bases to arrive at a range of values.
- In the end it is a matter of negotiation:
- How badly do you need the company?
- How badly do the existing owners wish to dispose?
- Depending on the circumstances different valuations may be applied to the company. For example, where the bidder wishes to establish a presence in a new market it may be prepared to pay a premium, which will be reflected in the valuation. Likewise, where a company in the same industry makes a bid any synergistic benefits could reflect in the valuation it places on the target.
- VALUATION BASES
Broadly, the various methods of valuation may be based on:
- Earnings
- Assets
- Dividends
- Cash Flow
- Combination of Other Methods
- Earnings
*P/E Ratio – the P/E Ratio is the relationship of a company’s share price to its EPS.
P/E = PriceEPS
Therefore: P/E x EPS = Price
If the prospective EPS can be estimated and a suitable P/E Ratio selected it should be possible to arrive at a price (value) for the company. Where an unquoted company is being valued a “best fit” P/E can be obtained from similar quoted companies (same industry, similar size, gearing etc.). When an appropriate P/E has been selected this should then be reduced by 20% – 30% to recognise that shares in unquoted companies are more risky and less marketable than those of quoted companies.
*Accounting Rate of Return (ARR) – the estimated maintainable earnings of the target can be capitalised using the ARR.
Estimated Maintainable EarningsARR = Value
RWF15m is the absolute maximum which could be paid in order to achieve the 10% rate of return. When estimating the maintainable earnings it may be necessary to adjust them to bring them into line with the bidder’s policies.
*Super Profits – if super profits are expected these are reflected in the valuation. A normal rate of return for the industry is applied to the net tangible assets in order to establish normal profits. These are then compared with the expected annual profits and if the expected profits are higher the difference is regarded as a super profit. The valuation is the net assets plus a number of years (say, 3) of super profits. This method has become less fashionable than previously.
- Assets
The valuation is based on the Net Tangible Assets which are attributable to the equity. Any intangible assets and the interests of other capital providers are deducted.
Net Assets per Balance Sheet X
Less Intangibles (e.g. Goodwill) (X) X Less Other Parties: Preference Shares X
Loan Capital X
(X) Net Tangible Assets – Equity (Valuation) X
The figure attached to an individual asset may vary considerably depending on whether it is valued on a going-concern or a break-up (asset stripping?) basis.
While an earnings basis might be more relevant the Net Assets basis is useful as a measure of the “security” in a share value.
- Dividends
The Dividend Valuation Model may be used to value the company’s stream of expected future dividends. It is suitable for the valuation of small shareholdings in unquoted companies.
- Constant Dividends
Value = dr
Where: d = dividend per share
- = company’s cost of equity
- Growth In Dividends
d o (1 + g)
Value =
r – g
Where: d o = most recent dividend g = expected growth rate in dividends
- = company’s cost of equity
- Cash Flow
The valuation is based upon the expected net present value of future cash flows, discounted at the required rate of return. However, accurate estimates of the cash flows will rarely be available in an acquisition situation.
- Combination
*Berliner Method – this takes the average of the prices calculated using the earnings method and the Net Assets method.
