macro issues in valuation for m&a: business valuation article

Macro Issues in Valuation for M&A

By: Chander Sawhney(FCA, CS, Certified Valuer (ICAI)

Asst. Vice President

SEBI REGISTERED (CAT -I) MERCHANT BANKER

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ASSOCHAM National Conference on "Value Creation through Mergers & Acquisitions ” – 30 th April,2013

AGENDA


- Valuation;

- Mergers & Acquisition;

- Macro Issues in Valuation for Mergers & Acquisition;

- M&A Case Study

VALUATION


Valuation

Valuation is the process of determining the “Economic Worth” of an Asset or Company

under certain assumptions and limiting conditions and subject to the data available on the

valuation date.

Source -International Valuation Standard Council

Depends upon :

• Mergers

• IPO

• RBI

• Income Tax

• ESOP

• Companies Act

• SEBI

• Stock Exchange

Purpose Regulatory Accounting

• Purchase Price Allocation

Dispute Resolution

• Company Law Board/ Courts

• Impairment / Diminution

• Arbitration

• Mediation• Acquisitions / Investment

• Voluntary Assessment


Key Facts of Valuation

The Value of a business, by whatever valuation method it is obtained, is not the selling price of the business. Value is an economic concept based on certain data & assumptions, however Price is what a Buyer is willing to pay keeping in consideration the Economic and Non Economic factors like Emotions, Perception, Greed Etc which cannot be valued as such.

The Value is a subjective term and can have different connotations meaning different things to different people and the result may not be the same, as the context or time changes.

Valuation is more of an art and not an exact science. The Art is Professional Judgment and Science is Statistics. Mathematical certainty is neither determined nor indeed is it possible as use of professional judgment is an essential component of estimating value

Though the value of a business can be objectively determined employing valuation approaches, this value is still subjective, dependent on buyer and seller expectations and subsequent negotiations and the Transaction happens at negotiated price only.

PRICE IS NOT THE SAME AS VALUE

TRANSACTION CONCLUDES AT NEGOTIATED PRICES

VALUATION IS HYBRID OF ART & SCIENCE

VALUE VARIES WITH PERSON, PURPOSE AND TIME


CASH FLOWINVESTOR ASSIGN VALUE BASED ON THE CASH FLOW THEY EXPECT TO RECEIVE IN THE FUTURE - Dividends / distributions; - Sale of liquidation proceeds;

VALUE OF A CASH FLOW STREAM IS A FUNCTION OF -Timing of cash Receipt; - Risk associated with the cash flow;

ASSETSOPERATING ASSETS - Assets used in the operation of the business including working capital, Property, Plant & Equipment & Intangible assets; - Valuing of operating assets is generally reflected in the cash flow generated by the business;

NON - OPERATING ASSETS - Assets not used in the operations including excess cash balances, and assets held for investment purposes, such as vacant land & Securities; - Investors generally do not give much value to such assets and Structure modification may be necessary

Key drivers of valuation


Broad Approaches to Valuation


Applicability of a particular

approach depends upon

On whose behalf? – one

buyer vs another buyer, buyer

vs seller;

For what purpose? –

independent strategic

acquisition, group company

consolidation, cross border

transaction

When? – distress situation,

industry downturn, boom etc

MERGERS &

ACQUISITION


M&A is primarily driven with motive of achieving Inorganic growth and Synergy i.e. the

potential additional value gain from combining two firms, either from operational or

financial sources.

However, certain studies have shown that most – but not all – M&A fail to deliver value

and bridge the price-value gap

One of the reasons is that the aggressive promoters in consultation with eager advisors

may result in pushing up the acquisition price; Resultantly, the value often get

transferred from acquirer’s shareholders to target company’s shareholders;

M & A


M&A

Mergers Acquisitions

Stock Purchase

COURT PROCESS NON - COURT PROCESS

Types of M & A

SEBI[TAKEOVER CODE]

Note: Asset Purchase under Acquisition is Ignored


391-394 of Companies Act

Valuation for Merger

APPLICABLE LAW FOR VALUATION FOR MERGER:

1.Companies Act, 1956 [Section 391- 394];

2.Fairness Opinion [Clause 24 (h) of the Listing Agreement];

3.SEBI Notification [CIR/CFD/DIL/5/2013], dated 4th February, 2013

KEY HIGHLIGHTS OF SEBI NOTIFICATION

1. Approval of the Scheme by SEBI on recommendation of Stock Exchange;

2. Recommendation of Audit Committee of the Listed Co. on the valuation done by

Independent Chartered Accountant;

3. Uploading of the Valuation Report on the Website of Co. and Stock Exchange;

4. Filing of Complaint Reports;

5. Meeting of Shareholders through Postal Ballot and e-Voting;

None of the aforesaid laws provide for specific valuation approaches under Mergers;

“Valuation is generally the Starting Point of the M&A process”

Valuation for Merger.. Contd..

4. Judicial Pronouncements;

WHETHER VALUATION IS REQUIRED FOR MERGER?

In the matter of Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. the Regional Director (RD) raised an objection that no valuation report has been filed and that the exchange ratio for amalgamation has not been worked out by an independent valuer.

“The Hon’ble High Court of Rajasthan overruled this objection and sanctioned the scheme of amalgamation by holding that there was no legal or factual impediment to grant sanction to the scheme of amalgamation.”

WHETHER ANY VALUATION METHODOLDY IS REQUIRED FOR MERGER?Though there are no specific methodology prescribed for valuation under Merger, however In Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others, Bombay High Court -

“accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the valuation was based.”


Valuation for Acquisition

APPLICABLE LAW:

SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011

FREQUENTLY TRADED SHARES

INFREQUENTLY TRADED SHARES

Traded Turnover of Shares ≥ 10%

[In the Last Twelve Calendar Months preceding

the Month of Public Announcement (P.A.)]

Traded Turnover of Shares < 10%

[In the Last Twelve Calendar Months preceding

the Month of Public Announcement]

Method of Valuation1.Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A.2.The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks;3.The Highest Price paid or payable by acquirer or PAC in last 26 Weeks;4.Volume weighted average Market Price of Shares for a period of 60 trading days HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A.

Method of Valuation1.Book value, 2.Comparable Trading Multiples;

Such other Parameters as are customary for valuation of shares of such companies


Macro Issues of Valuation in MERGERS & ACQUISITION


Fair Value in M&A ?

Fair Value is “The price at which an entity would change hands between a willing buyer and

willing seller, neither being under compulsion to buy or sell and both having reasonable

knowledge of all relevant facts.”

M&A VALUATIONS MAY HOWEVER DEPART FROM THEIR FAIR VALUES ON ACCOUNT OF:

oValuing Acquisition Targets on Standalone basis and Valuing them with Synergy

oDistress Sale Vs. Desperate Buy

oEmpirical Evidence

o Control Premiums and Minority & Marketability Discounts

oComparable Transaction Multiples (CTM) and Price of Recent Investments (PORI)

oCompetitive Positioning and Risk in Corporate Acquisitions

oValuation of Intangible Assets and Purchase Price Allocation (PPA)


Swap Ratio Valuation

• In case of a merger valuation, the emphasis is on arriving at the relative values of the

shares of the merging companies to facilitate determination of the swap ratio

– Hence, the purpose is not to arrive at absolute values of the shares of the companies

• The key issue to be addressed is that of fairness to all shareholders

– This is particularly important where the shareholding pattern and shareholders vary

between the two companies

• There are established legal precedence for merger valuation methodologies

– Valuer’s role is to incorporate case specific factors and use appropriate methodologies so

as to determine a fair ratio

– Usually, best to give weight ages to valuation by all methods

– Market price method and Earnings methods dominate.


• If the exchange ratio is set too high, there will be a transfer of wealth from the

bidding firm’s stockholders to the target firm’s stockholders.

• If the exchange ratio is set too low, there will be transfer of wealth from the

target firm to the bidding firm’s stockholders.

17

Impact of Swap Ratio Valuation


“Beauty lies in the eyes of the beholder; valuation in those of the

buyer”

• An investor seeking to acquire control of a company is typically

willing to pay more than the current market price of the company.

Control premium is an amount that a buyer is usually willing to

pay over the fair market value of a publicly traded company to

acquire controlling stake in a company.

• Control can be direct (shareholding or Authority to appoint Board)

or indirect (veto power, casting vote etc)

• Research has shown that the control premium in India has ranged

from 20% to 37% in the past few years having median of 30%.

Control Premium and Takeover Bid

FinancialYear

No. ofTransactions

MedianPremium

2006 25 37%

2007 29 20%

2008 38 26%

2009 44 29%

2010 22 31%

2011 42 32%

Total 228 30%


CASE STUDYCalculation of

Exchange Ratio in M&A and

Independent Buyer-Seller perspective


Features of Steel Company*o Frequently Traded Listed Companyo Low Profit Margin, due to high Power Costo Running in Low Capacity Utilization due to poor supply of Power

Features of Power Company*o Unlisted Companyo Company is implementing the Power Plant of 9.5 MW , The Production is expected to start with in

Year

Acquisition Rationaleo Location Advantage, both companies have their unit in same Locationo Synergistic benefits- (Captive Power Plant will reduce the Operating cost, because Steel Industry

is energy consuming)o Tax benefit from the unabsorbed losses of Power Company o Up the value chaino Capacity utilization will increase in existing steel business, due easy availability of Power

*Common Promoter Group

Merger of a Unlisted Power Company into Listed Steel Manufacturing Company


EXCHANGE RATIO & VALUATION –MERGER• Valuation on Steel Company

• Valuation on Power Company

Valuation Method Rs Crores Weights Value of Company Weighted Value

Market Cap 2 100 200

Income Method 2 95 190

NAV 1 150 150

Fair Value of Company 108

Valuation Method Rs Crores Weights Value of Company Weighted Value

Market Cap 2 NA NA

Income Method^ 2 90 180

NAV 1 50 50

Fair Value of Company 76.67

^ considering 3 years forward earnings and 80-90% Capacity utilization basis

Merger of a Unlisted Power Company into Listed Steel Manufacturing Company


Pre Merger Shareholding of Steel Company

Category No of shares % Holding

Promoter 5,000,000 50%

Public 5,000,000 50%

Total 10,000,000 100%

Pre Merger Shareholding of Power Company


Promoter 5,000,000 100%

Public - -

Total 5,000,000 100%

Post Merger Shareholding of Steel Company


Promoter 12,099,074 71%

Public 5,000,000 29%

Total 17,099,074 100%

Independent Buyer-Seller Perspective

Valuation of Power business on as is basis – Rs.55 crores

Assets MethodEarnings Method (Includes premium for the license)

Valuation of Power business taking into account synergies – Rs. 70 crores

An independent Buyer would bid an amount in excess of valuation on standalone basis (Rs. 55 crores) and below Synergy valuation (Rs.70 crores).

Acquisition Price would finally depend on negotiations.

Pre and Post Shareholding


Any Specific Valuation Query may be mailed @ [email protected] / [email protected]

M: +91 9810557353; Ph: 011-40622252W: www.corporatevaluations.in; corporateprofessionals.com

Mr. Chander Sawhney(FCA, CS, Certified Valuer (ICAI)

Disclaimer:This presentation contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither corporatevaluations.in nor any other member of the Corporate Professionals organization accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this presentation. On any specific matter, reference should be made to the appropriate advisor.

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