Business Valuation

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EV = market value of common stock + market value of preferred stock + minority interest + market value of debt – cash & cash equivalents

Why do valuations occur?

A share market valuation is typically performed from the perspective of investors to assess the intrinsic value of portfolio holdings of publicly listed companies.

A corporate valuation is typically carried out by the company’s management and advisers. Such valuation is required for situations pertaining to the buying and selling of companies, takeovers, restructurings.

In general, M&As often involves acquiring or taking over a company, selling a business, merging of business units, etc.; and valuations form an integral part of such activities. Acquirers or vendors will need to assess or determine the value of the business with a view to making or evaluating an offer. An independent valuation is often carried out to provide an objective range of values to assist the stakeholders in their deliberation of pricing matters. The standard of value adopted for such activities is usually either ‘fair market value’ or ‘value to the acquirer’. In situations involving corporate restructurings, the company’s management, board and its shareholders seek to understand the value implications to the business as well as ascertain the tax consequences of such restructurings. Examples of such transactions include spin-offs of subsidiaries, formation of joint ventures, unwinding of arrangements, dissolution of businesses, etc. Valuation is also required to establish the cost bases for tax (e.g. capital gains, stamp duty and estate duty) purposes in various jurisdictions and tax authorities is one of the key users of valuation. From a fund raising perspective, a company that requires fresh equity injections from prospective investors or seeks debt financing from a bank, also requires some form of valuation to be carried out. Valuations performed for restructuring, tax and fund raising purposes often adopt ‘fair market value’ as the standard of value. As for privately owned companies, valuation is required in situations pertaining to the transfer of shares. In such instances, the valuer often needs to consider the pre-emption rights that may exist between shareholders, be it as part of a purely commercial transaction or arising out of a shareholder dispute. In addition, valuation work is also performed with a view to assess losses or damages for litigation purposes. Today, in addition to its role of driving the investment process across financial markets, increasingly, valuation has also become an important aspect of financial reporting. In this regard, the standard of value adopted should be ‘fair value’.

How do we value?

In general, there are three approaches for business valuation: market-, income- and asset-based approaches.

The market approach is based on the concept that the value of a business is measured via a comparison of the features of the business with those of other comparable businesses. When this approach is adopted, observable data are collected for reasonably comparable companies and adjustments are then made to assess differences.

Two commonly applied methodologies under the market approach are the CCM (comparable companies method) or CTM (comparable transaction methods). This approach focuses on deriving a value indication of a subject company by applying the relevant multiples of comparable companies to the subject company’s financial metrics. A commonly adopted financial metric under this method is the earnings base of the company. In this regard, it is also commonly termed as a capitalisation of earnings methodology. This method applies a multiple to the earnings of a business to capitalise those earnings into a value for the business. The earnings multiples applied are either based on multiples of comparable companies that are publicly listed (CCM) or multiples derived from comparable transactions, for example, involving in a takeover situation (CTM). Amongst other things, the test for comparability is often viewed in terms of sufficient similarity of qualitative and quantitative characteristics. This would encompass considerations of the business activities, markets of operation, size, capital structure, asset backing, profit trends, growth prospects, etc. of the comparables entities to the business being valued. There are various earnings base that could be considered under this approach. This could take the form of net profit after tax (NPAT), earnings before interest and tax (EBIT) and earnings before interest, tax, depreciation and amortisation (EBITDA). Apart from earnings base, there are circumstances whereby an alternative financial metric can be adopted under this approach, such as the revenue base of the business.

Income approach: this method focuses on the income-producing capability of a company. The underlying premise of this approach is that the value of a company can be measured by the present value of the net economic benefit to be received over the life time of the company.

DCF: we estimate the expected future free cash flows of the company and we discount them in order to obtain the present value. We use a discount rate that accounts for both the time value of company and the risks associated with these cash flows. The appropriate discount rate will be determined through the WACC.

Asset-based approach: this approach values the individual assets and liabilities of a company. What is commonly seen in practice is = market value of assets – market value of liabilities at a specific date.

Industry-rules of thumbs: in such situations, a typical profit drive, for example square metre, is identified and it is then multiplied by a factor reflecting risk and growth considerations

Seminar 3

The elements that constitute a profession are:

- a professional body governing the profession in the public interest such as firms, tax authorities and individuals (e.g. CPA in the US, the Chartered Institute of Accountants in Singapore, etc.)

- technical professional standards (e.g. IFRS, US GAAP, etc.)

- rigorous processes that qualify people who meet those standards

- professional development

- a regulatory framework and a disciplinary process to regulate conduct and ethical behaviour to be used in case of violation

- strong and enforced culture of ethical behaviour in accordance