Value Measurement VALUATION M & A

Value MeasurementVALUATION

M & ARishit Ankola

Need for valuing shares (or business)As far as unlisted companies are concerned the price of shares of such company is not readily available, so we need to determine the value of shares of such companies, but this is not the case with the listed companies. The price of share of a listed company is already available on the stock market. Then why do we need to calculate the value of shares or business separately?

The reasons are:The market price may not represent fair value.There is no guarantee that the market price is not rigged or manipulated.

Steps in Valuation Obtaining information Management Discussion and Industry Overview Data analysis and review Selection of Method Applying Method Conducting sensitivities on assumptions Assigning Weights Recommendation Reporting

Sources of InformationHistorical data such as audited results of the companyFuture projectionsStock market quotationsDiscussions with the management of the companyRepresentation by the managementData on comparable companiesMarket surveys, news paper reports

Methods of ValuationAsset based valuationEarnings or dividend based valuationCAPM based valuationValuation based on Present Value of free cash flowsValuation of Intangible Asset

Did You Ever Notice how come the Apple Brand is Valued at $ 93.8 Billion

Assets Based ValuationThe book value of a firm is based on the balance sheet value of owner's equity or in other words Assets minus liabilities. For assets value to be useful, the target company should have followed a regular depreciation, replacement and revaluation policy.

The reasons for using this method are

It can be used as a starting point to be compared and complemented by other analysisWhere large investment in fixed assets is required to generate earnings, the book value could be a critical factor especially where plant and equipment are relatively new.The study of firm's working capital is also necessary.

Earnings based Valuation (Dividend Discount Model)The dividend discount model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.

In other words, it is used to value stocks based on the net present value of the future dividends.

CAPM based valuationThe Capital Asset pricing model can be used to value the shares. This method is useful when we need to estimate the price for initial listing in the stock exchange. The crux of this model is to arrive at the cost of the equity and then use it as the capitalization of dividend or earning to arrive at the value of share.

CAPM = Rf + beta of the firm (Rm-Rf)

whereRf : Risk Free Rate of ReturnRm : Market Rate of Return

Free Cash flow modelFree cash flow model facilitates estimating the maximum worthwhile price that one may pay for a business. Free cash flow analysis utilizes the financial statements of the target-business, to determine the distributable cash surpluses, and takes into account not merely the additional investments required to maintain growth, but also the tie-up of funds needed to meet incremental working capital requirements. Under this model value of the firm is estimated by a three step procedure:

Determine the free future cash flows: Net operating income + Depreciation - incremental investment in capital or current asset for each year separately.Determine terminal cash flows, on the assumption that there would be constant growth, or no growth.Present values these cash flows can then be compared with the price that we would pay for the acquisition.

However while estimating future cash flows, the sensitivity of cash flows to various factors should also be considered.

Valuation of Intangible Asset(BRAND)

Damodaran on Brand Valuation

Example: Valuing A Brand Name KelloggsKellogg'sGeneric SubstitutePre-Tax Operating Margin22.00%10.50%After-Tax Operating Margin14.08%6.72%Return on Asset32.60%15.00%Retention Ratio56.00%56.00%Expected Growth 18.26%8.40%Length of High Growth Period55Cost Of Equity13.00%13.00%E/(D+E)92.16%92.16%D/(D+E)8.50%8.50%Value/Sales Ratio3.391.1

This is How Brand Apple is Valued at $ 93.8 Billion

Selection of Methods

RBI Pricing GuidelinesTransfer of shares by Resident to Non-resident (i.e. to foreign national, NRI, FII and incorporated non-resident entity)In case of listed companies- the price shall not be less than the price at which a preferential allotment of shares can be made under the SEBI GuidelinesIn case of unlisted companies - the price shall not be less than the fair value to be determined by a SEBI registered Category I Merchant Banker or a Chartered Accountant as per the Discounted free cash flow method.

CONCLUSION