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; 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.
Price P/E =
EPS
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 Earnings
= Value
ARR
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
d
Value =
r
Where: d = dividend per share
r = company‟s cost of equity
(ii) Growth In Dividends
d o (1 + g)
Value =
r – g
Where: d o = most recent dividend
g = expected growth rate in dividends
r = 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 of Other Methods
*Berliner Method – this takes the average of the prices calculated using the earnings method and the Net Assets method.
DEFENCE TACTICS
Where an unwelcome or hostile bid is received from another company there are a number of steps that can be taken to thwart it:
- Reject the bid on the basis that the terms are not good enough.
- Issue a forecast of attractive future profits and dividends to persuade shareholders to hold onto their shares.
- Revalue any undervalued assets.
- Mount an effective advertising and P.R. campaign.
- Find a “White Knight” that is more acceptable – in 1986 Distillers Co. (U.K.) received an unwelcome bid from Argyll and found a white knight in Guinness. In Ireland in 1988 Irish Distillers Group found Pernod in their battle with G.C. & C. Brands (Grand Metropolitan).
- Make a counter bid – generally only possible if the companies are of a similar size.
- Arrange a Management Buyout.
- Attack the credibility of the offer or the offeror itself, particularly if shares are offered – e.g. commercial logic of the takeover, dispute any claimed synergies, criticize the track record, ethics, future prospects etc. of the offeror.
- Appeal to the loyalty of the shareholders.
- Encourage employees to express opposition to the merger Persuade institutions to buy shares.
D. DUE DILLIGENCE
The main objective of Due Diligence is to confirm the reliability of the information which has been provided and has been used in making an investment decision. Changes in these primary assumptions may have a significant impact on the price to be paid and possibly even raise questions on the wisdom of proceeding with the transaction. This is a very useful process and at minimum will provide additional information on the potential target.
The following should be considered:
- Earnings – audited financial statements are prepared to comply with statutory/tax requirements. To assess the true quality of earnings an in-depth review of the business and detailed management accounts must be performed. Adjustments may need to be made for one-off events, lost customers, discontinued products, changes in cost structure etc. Also, evaluate non-financial information e.g. quality of risk management, quality of management, corporate governance etc.
- Forecasts – may be prepared on a high-level basis with oversimplified assumptions. The assumptions may be difficult to reconcile with historical performance.
- Assets – write-offs for aged debtors, obsolete stock, idle assets, capitalised costs etc.
may need to be made. Also, clarify which assets are to be included in the transfer and agree valuations.
- Undisclosed Liabilities – substantial hidden tax liabilities, penalties and exposures may subsequently arise. Evaluate and possibly, seek protection by obtaining warranties or indemnities against future potential tax issues.
- Trading Performance – related party transactions are often conducted under special pricing terms (e.g. business support services not charged by parent company). The impact on the business of a change in ownership should be assessed to reflect normal commercial arrangements.
- Controls – additional investment in new reporting systems may be required to obtain the quality of information needed to properly monitor performance. Also, ensure the necessary staff are locked-in for an appropriate period.
- Balanced View – issues should be weighed against the upside potential in a balanced way. Examples of the upside might include synergies, optimal financing structure, access to new markets, new management team etc.
- Tax Structure – effective tax planning is a key component in delivering value as quickly as possible.
