CORPORATE RESTRUCTURING – VALUATION OF SHARES, BUSINESS AND BRANDS

Valuation is an exercise to assess the worth of an enterprise or a property. In a merger or amalgamation or demerger or acquisition, valuation is certainly needed. It is essential to fix the value of the shares to be exchanged in a merger or the consideration payable for an acquisition.

Valuation Methods

1.     Valuation based on assets - This valuation method is based on the simple assumption that adding the value of all the assets of the company and subtracting the liabilities, leaving a net asset valuation, can best determine the value of a business.

If this method is employed, the fixed assets of all the amalgamating companies should preferably be valued on a going concern basis.

An asset based valuation can be further separated into four approaches:

(a)  Book Value – The tangible book value of a company is obtained from the balance sheet by taking the adjusted historical cost of the company’s assets and subtracting the liabilities, intangible assets (goodwill) are excluded in the calculation.

Using book value does not provide a true indication of a company’s value, nor does it take into account the cash flow that can be generated by the company’s assets.

(b) Replacement Cost -   Replacement Cost reflects the expenditures required to replicate the operations of the company. Estimating replacement cost is essentially a make or buy decision.

(c)  Appraised Value – The difference between the appraised value of assets, and the appraised value of liabilities is the net appraised value of the firm. This approach is commonly used in a liquidation analysis because it reflects the divestiture of the underlying assets rather than the ongoing operations of the firm.

(d) Excess Earnings – In order to obtain the value of business using this method, a premium is added to the appraised value of net assets. This premium is calculated by comparing the earnings of a business before a sale and the earnings after the sale, with the difference referred to as excess earrings.

 

2.    Open market Valuation – Open market value refers to a price of the assets of the company which could be fetched or realized by a negotiating sale provided there is a willing seller, property is freely exposed to market, sale could materialize within a reasonable period, orders will remain static throughout this period and without interruption from any purchaser giving an extraordinary higher bid. Each asset of the company is normally valued on the basis of liquidation as resale item rather than on a going concern basis.

 

3.     Valuation based on earnings – Valuation based on earnings based on the rate of return on capital employed is a more modern method. From the last earnings declared by a company, items such as tax, preference dividend, if any, are deducted and net earnings are taken.

An alternate to this method is the use of Price earning (P/E) ratio instead of the rate of return. The P/E ratio of a listed company can be calculated as:

P/E

=

P ______ EPS

 

Where P is the current price of the shares

The Share price can thus be determined as:

                                      P       =           EPS x P/E ratio

 

 4.     Merger negotiations: Significance of P/E ratio and EPS analysis – In practice, investors attach a lot of importance to the earnings per share (EPS) and the price – earnings (P/E) ratio. The product of EPS and P/E ratio is the market price per share. 

Exchange Ratio – The current market value of the acquiring and the acquired firms may be taken as the basis for exchange of shares. 

SER

=

Pb ______ Pa

 

SER = Share Exchange Ratio

Pb = Share price of the acquired firm (seller)

Pa = Share price of the acquiring firm (purchaser)

 

5.    Discounted Cash Flow – It consists of projecting future cash flows, deriving a discount rate and applying this discount rate to the future cash flows and terminal value. Discounted Cash Flow analysis is to project future operating cash flows over projected holding periods. These projections are generally done before debt (but after taxes) to obtain an accurate indication of future free cash flow, without making any assumptions about the company leverage.

 

6.    Valuation based on Super Profit - This approach is based on concept of the company as a going concern. The super profits are calculated as the difference between maintainable future profits and the return on net assets.

Value can be calculated using the following formula:

 

                       V          =             T + P – rT

Where:

T= Value of net tangible assets

P= Maintainable future profits

r = Normal return expected on assets

 

7.    Discounted cash flow valuation method – This method is based upon expected future cash flows and discount rates.

The DCF model is applied in the following steps

1.     Estimate the future cash flows of the target based on the assumption for its post-acquisition management by the bidder over the forecast horizon.

2.     Estimate the terminal value of target at forecast horizon.

3.     Estimate the cost of capital appropriated for the target.

4.     Discount the estimated cash flows to give a value of the target.

5.    Add other cash inflows from sources such as asset disposals or business divestment

6.    Subtract debt and other expenses, such as tax on gains from disposals and divestment, and acquisition costs, to give a value for the equity of the target.

7.     Compare the estimated equity value for the target with its pre – acquisition stand – alone value to determine the added value from the acquisition. Decide how much of this added value should be given away to target shareholders as control premium.

Target cash flows are generally forecast for the next five to ten years. Whatever the forecast horizon, the terminal value of the target at the end of that period based on free cash flows thereafter also needs to be forecast. The level perpetual cash flows are then capitalized at the cost of capital to yield the terminal value.

The Cost of Capital is the weighted average cost of capital (WACC), estimated from the target’s pre – acquisition costs of equity and debt.

WACC

=

Ke   E/V + (1-TC) Kd D/V + Kp P/V

 

    Where:

K^e = Cost of Equity

K^d = Cost of Debt

K^{p =} Cost of Preference Shares

E = Market value of Equity

D= Market value of dept.

P = Market value of Preference Shares

T^C = Corporate Tax rate

V = E+D+P, the value of firm.

 

8.     Valuation by team of experts – Valuation is an important aspect in merger and acquisition and it should be done by a team of experts keeping into consideration the basic objective of acquisition. Team should comprise of financial experts, accounting specialists technical and legal experts who should look into aspects, of valuation from different angles.

Nevertheless, the experts must take following into consideration for determining exchange ratio:

 A.    Market Price Of Shares – If the offeree and offeror are both listed companies, the stock exchange prices of the shares of both the companies should be taken into consideration which existed before commencement of negotiations or announcement of the takeover bid to avoid distortions in the market price which are likely to be created by interested parties in pushing up the price of the shares of the offeror to get better deal and vice versa.

 

 B.    Dividend Payout Ratio (DPR) – The dividend paid in immediately past by the two companies is important as the shareholders want continuity of dividend income.

DPR

=

Dividend ________ Earnings

 

 C.     Price Earnings Ratio (PER) – Price earing ratios of both the offeror and offeree companies be compared to judge relative growth prospects.

PER

=

Price ________ Earnings

 

D.    Debt Equity Ratio (DER) – Company with low gearing offers positive factor to investors for security and stability rather growth potential with a geared company having capacity to expand equity base.

DER

=

Debt _______ Equity

 

E.     Net Assets Value (NAV) – It is compared of the two companies as the company with lower NAV has greater chances of being pushed into liquidation.

NAV

=

Net assets ( Total assets – Liability & Preferred claims _________________ No. of Shares

 

 

9.     Fair Value of Shares – The fair value of shares is arrived at after consideration of different modes of valuation and diverse factors. There is no mathematically accurate formula of valuation. An element of guesswork is involved in valuation. The factors kept in mind in the valuation of shares.

(a)  Capital Cover

(b) Yield

(c)  Earning capacity

(d) Marketability

For arriving at the fair value of shares, three well – known methods are applied:

(1) The manageable profit basis method( the earning per share method)

(2) The net worth method or breakup value method

(3) The market value method.

 

Fair Value of Shares

=

Value of net assets method + Value of yield method ________________________                       2

 

10.    Free Cash Flow (FCF) – It is a financial tool. It will be close to the profits after tax without taking into account depreciation. FCF of a company is determined by the after tax operating cash flows minus interest paid/ payable duly taking into account the savings arising out of tax paid/ payable on interest and after providing for certain fixed commitments such as preference shares dividends, redemption commitments and investments in plant and machinery required to maintain cash flows.

 

 

Valuation of Brands –

Brands is defined as a word, mark, symbol, design, term or a combination of these, both visual and oral, used for the purpose of identification of same product or services.

It is a hallmark of a shrewd businessman to commence his business with a roadmap of his plans.

The Importance of Brand Valuation

Brands/ marks are a class of assets like human resource, knowledge, etc. They create a value premium for the goods and services. Therefore, without the brand/mark, the goods/ services may be address less. There is no prescribed manner to value a brand. But all knows that brands connect markets with products and products and thereby they create value.

Brands do not command any value unless they are able to bring cash flows to the Company that has adopted the same. With the incremental cash flows increasing, the value of brand increases proportionally.

In order to sustain the valuation of the brand, there must be a constant attempt from the company to protect the value of the Brand. Brand has to be associated with good quality goods and services, they require proper show casing and servicing and they should remain active in appropriate markets.