in the business world, the rearview mirror always clearer
TRANSCRIPT
Due Diligence, Legal andRegulatory Valuation aspects
“In the business world, the rearview mirror is always clearer than the windshield”
Warren Buffett
FEMA – Valuation aspect (FDI & ODI)and
Registered Valuer under Companies Act – 2013
Particulars Pg. No.
What and Why 3
How 10
When and Who 22
FEMA Valuation Guidelines 25
Registered Valuer 40
Tricky Issues 46
EOK Study Circle - ICAI22/11/2013
WHAT & WHY
EOK Study Circle - ICAI22/11/2013
Value & Valuation
Value is* An Economic concept;
An Estimate of likely prices to be concluded by the buyer and seller of a good or
service that is available for purchase;
Not a fact.
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
EOK Study Circle - ICAI22/11/2013
Key Facts
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
EOK Study Circle - ICAI22/11/2013
S Standard of Valuation
T Thesis of Valuation
E Economics of Valuation
M Methodologies of Valuation
EOK Study Circle - ICAI22/11/2013
FAIR MARKET VALUE
INTRINSIC VALUE FAIR VALUE
INVESTMENT VALUE
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
Standard of Value is the hypothetical conditions under which a business is valued.
While selecting the Standard of Value following points is to be taken care of
Subject matter of Valuation;
Purpose of Valuation;
Statute;
Case Laws;
Circumstances.
Types of Standard of Value:
EOK Study Circle - ICAI22/11/2013
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
Thesis of Value is Premise of value which relates to the assumptions upon which
the valuation is based.
Premise of Value
Going Concern – Value as an ongoing operating business enterprise.
Liquidation – Value when business is terminated . It could be ‘forced’ or ‘orderly’.
Value-in-use
Value-in-exchange
EOK Study Circle - ICAI22/11/2013
Growing Cos.
Turnover/Profits: Increasing still Low
Proven Track Record: Limited
Valuation Methodology: Substantially on Business Model
Cost of Capital: Quite High
High Growth Cos.
Turnover/Profits : Good
Proven Track Record: Available
Valuation Methodology: Business Model with Asset Base
Cost of Capital: Reasonable
Mature Cos.
Turnover/Profits: Saturated
Proven Track Record: Widely Available
Method of Valuation: More from Existing Assets
Cost of Capital: May be High
Declining Cos.
`
Turnover/Profits: Drops
Proven Track Record: Substantial Operating History
Method of Valuation: Entirely from Existing Assets
Cost of Capital: N.A.
Turnover/Profits: Negligible
Proven Track Record: None
Valuation Methodology: Entirely on Business Model
Cost of Capital: Very High
Start Up Cos.
Turn
ove
r /
Pro
fits
Time
Valuation across business cycle follow the law of economics
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
EOK Study Circle - ICAI22/11/2013
HOW
EOK Study Circle - ICAI22/11/2013
Enterprise / Business Value
Ente
rpris
e Va
lue
Net Debt#
Equity#
Fixed Assets#
Net Current Assets#
Intangibles#
Stakeholders Assets
Valu
e of
Bus
ines
s
# Based on Market Values
EOK Study Circle - ICAI22/11/2013
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
Valuation Approaches
Income Based Method
Asset Based Method
Capitalization of Earning Method
(Historical)
Discounted Cash Flow Method
(ProjectedTime Value)
Market Based Method
Comparable Companies Market Multiples Method
(Listed Peers)
Comparable Transaction Multiples
Method(Unlisted Peers)
Market Value Method (For Quoted Securities)
Book Value Method
Liquidation Value Method
Replacement Value Method
Contingent Claim Valuation
(Option Pricing)
Price of Recent Investment Method
Rule of Thumb(Multiples:
Customers, Rooms, Seats, No. of visitors
etc.) - Depends upon Industry
EOK Study Circle - ICAI22/11/2013
Fundamental Method Relative Method
Other Method
While concluding Value, all the methodologies must be considered and then weights applied
as per the facts of the case. In other words, Value conclusion should be based on the
Professional Judgement and Simple Average should best be avoided while concluding
Value.
Need of several valuation methods?
Each has strengths and weaknesses
Different methods useful in different situations
Each gives a different “take” on the value of the company’s stock
Provides a range of valuations instead of point estimates
Helps in Sanity Check
Sources of Information for Valuation
Sources of Information
Historical financial results –Income Statement, Balance
Sheets and Cash Flows
Data available in Public Domain – Stock Exchange /
MCA/SEBI/Independent Report
Data on comparable companies – SALES/EV-
EBITDA/ PAT/BV
Promoters and Management background
Data on projects planned/under implementation including future
projection
Discussion and Representation with/by the management of the
Company
Industry and Regulatory trends
EOK Study Circle - ICAI22/11/2013
CASH FLOWInvestor assign value based on the cash flow they expect to receive in the future- Dividends / distributions- Sale of liquidation proceedsValue of a cash flow stream is a function of - Timing of cash Receipt- Risk associated with the cashflow
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
That’s why DCF is most
prominent valuation
method
Need for RestructuringEOK Study Circle - ICAI22/11/2013
• 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
Value Creation
• Equity Research
• Credit Rating
• Corporate Planning
Valuation depends upon
EOK Study Circle - ICAI22/11/2013
Choice of Valuation Approaches
“Value in Valuation is a question,
and
Your choice of Method is the first step
towards answer”
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;
EOK Study Circle - ICAI22/11/2013
Choice of Valuation Approaches
• In General, Income Approach is preferred;The dominance of profits for valuation of share was emphasised in “McCathies case” (Taxation,
69 CLR 1) where it was said that “the real value of shares in a company will depend more on the
profits which the company has been making and should be capable of making, having regard to
the nature of its business, than upon the amount which the shares would realise on liquidation”.
This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s
case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.)
(122 ITR 38).
• However, Asset Approach is preferred in case of Asset heavy companies
and on liquidation;
•Market Approach is preferred in case of listed entity and to evaluate the
value of unlisted company by comparing it with its listed peers;
EOK Study Circle - ICAI22/11/2013
Company Specific Factors
• Management, Promoter Group
It is the alignment of
Company’s value via-a-
vis to its external
environment
• Operating, Capital and Corporate Finance Strategies• Competitive advantages and cost position• Product / Service offering / differentiation / pricing power•Scale & Diversification•Customer / Supplier concentration•Corporate Governance•Future prospects / Growth potential•Industry peer group•Regulatory environment
EOK Study Circle - ICAI22/11/2013
Industry Risk Analysis
• Good vs. Difficult industry
• Porter’s 5 forces
• Industry life cycle (growth)
• Industry cyclicality (earnings quality)
• Leading indicators
• Competition (ROIC)
• Pricing dynamics; Demand vs. Supply (ROIC)
• Changing business environments
• Regulation (ROIC)
• Product characteristics (earnings quality)
• Capital intensity and cost base (ROIC)
• Event risk
Following factors are required to
be considered:
EOK Study Circle - ICAI22/11/2013
Rule of Thumb
A rule of thumb or benchmark indicator is used as a
reasonableness check against the values determined by the
use of other valuation approaches.
Industry Valuation Parameters
Hospital EV/Room
Engineering Mcap/Order Book
Mutual Fund Asset under management
OIL EV/ Barrel of equivalent
Print Media EV/Subscriber
Power EV/MW, EBITDA/Per Unit
Entertainment & Media EV/Per screen
Metals EBITDA/Ton, EV/Metric ton
Textiles EBITDA depend upon capacity utilization Percentage & per spindle value
Pharma Bulk Drugs New Drug Approvals , Patents
Airlines EV/Plane or EV/passenger
Shipping EV/Order Book, Mcap/Order Book
Cement EV/Per ton & EBITDA/Per ton
Banks Non performing Assets , Current Account & Saving Account per Branch
However, Exclusive use of Rule of Thumb is not recommended
EOK Study Circle - ICAI22/11/2013
WHEN & WHO
EOK Study Circle - ICAI22/11/2013
Valuation in Indian Regulatory Environment
EOK Study Circle - ICAI22/11/2013
Inbound Investment DFCF
Gift of Unquoted Equity Shares (Min)
NAV
Outbound Investment Valuer Discretion
Gift of Unquoted Shares other than Equity Shares
Price it would fetch if sold in open market
Takeover Code/ Delisting -Infrequently Traded
Only Parameters Prescribed – Return on Net Worth, EPS,
NAV vis-a vis Industry Average
Takeover Code/ Delisting -Frequently Traded Based on Market Price
Reserve Bank of India
ESOP Tax Valuer Discretion
ESOP Accounting Option – Pricing Model
Income Tax
SEBI
CA / MB
>5Mn$ - MB, otherwise CA/MB
-
MB
MB
-
CA/MB
-
Stock ExchangesPreferential Allotment to
promoters / their relatives for consideration other than
cash
Valuer Discretion
Companies Act, 1956 Sweat Equity Valuer Discretion
CA / MB
-
Transactions Prescribed Methodologies Mandate to be done by
SNAPSHOT OF REGULATORY VALUATIONS IN INDIA
Gift of Unquoted Equity Shares from Resident
(Max)
DCF (Valuation Based on Assets, Business & Intangibles is also
acceptable)FCA / MB
Preferential Allotment to Others
Based on 26 weeks / 2 weeks Market Price -
Companies Act, 2013
any property, stock, shares, debentures, securities or
goodwill or any other assets or the net worth of the
Company or its liabilitiesTo be prescribed REGISTERED VALUER
FEMA Valuation Guidelines
EOK Study Circle - ICAI22/11/2013
FDI VALUATION
• Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals
with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside
India) Regulations, 2000.
•In terms of Schedule 1 of the Notification, an Indian company may issue equity
shares/compulsorily convertible preference shares and compulsorily convertible debentures
(equity instruments) to a person resident outside India under the FDI policy, subject to inter alia,
compliance with the pricing guidelines.
•The price/ conversion formula of convertible capital instruments should be determined upfront
at the time of issue of the instruments.
Particulars Valuation before April 21, 2010 Valuation after April 21, 2010Guidelines in Force CCI Guidelines In case of FDI Transactions:
Listed Company: Market Value as per SEBI Preferential Allotment Guidelines
Unlisted Company: DFCF
In case of ODI Transactions:No method has been prescribed
Methods Prescribed Net Assets Value (NAV)Profit Earning Capacity Value(PECV)Market Value (in case of Listed Company)
Discount 15% Discount has been prescribed on account of Lack of Marketability
No such Discount has been prescribed
Historical / Futuristic It is based on Historical Values It is based on Future Projections
Possibility of variation in Value Conclusion
As valuation is more Formulaebased, final values came standardized
As valuation is more dependent on Assumptions and choice of factors like Growth Rate, Cost of Capital etc, value conclusion may vary significantly.
FEMA Guidelines to Valuation
Note: Valuation guidelines do not apply to SEBI registered venture capitalEOK Study Circle - ICAI22/11/2013
22/11/2013
Discounted Free Cash Flow Method (DFCF)
Approaches to FDI Valuation
RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for
initial subscription); but has not provided any guidance on its technical aspects.
Though DFCF is one of the most acceptable Valuation methods used by Business
valuers worldwide; however DFCF for all FDI transactions-excluding for initial
subscription (like minority stake/start up valuation etc) may not yield Fair Value in
line with the Commercial understanding. However Law being such, suitable Logical
adjustments may be necessary on a case to case basis.
DFCF expresses the present value of the business as a function of itsfuture cash earnings capacity. In this method, the appraiser estimates thecash flows of any business after all operating expenses, taxes, and necessaryinvestments in working capital and capital expenditure is being met. Valuingequity using the free cash flow to stockholders requires estimating only freecash flow to equity holders, after debt holders have been paid off.
EOK Study Circle - ICAI22/11/2013
Forward Looking and focuses on cash generation
Recognizes Time value of Money
Allows operating strategy to be built into a model
Incorporates value of Tangible and Intangible assets
Only as accurate as assumptions and projections used
Works best in producing a range of likely values
It Represents the Control Value
Major Characteristics of DFCF Valuation
EOK Study Circle - ICAI22/11/2013
DFCF Valuation Process
Understand Business Model
Identify Business Cycle
Analyze Historical Financial Performance
Review Industry and Regulatory Trends
Understand Future Growth Plans (including Capex needs)
Segregate Business and Other Cash Generating Assets
Identify Surplus Assets (assets not utilized for Business say
Land/Investments)
Create Business Projections (Profitability statement and Balance Sheets)
Discount Business Projections to Present (Explicit Period and Perpetuity)
Add Value of Surplus Assets and Subtract Value of Contingent Liabilities
EOK Study Circle - ICAI22/11/2013
Free Cash Flows- Value Trend
Terminal Value is calculated for the Perpetuity period based on the Adjusted last year cash flows of the Projected period.
EOK Study Circle - ICAI22/11/2013
Free cash flows to firm (FCFF) is calculated as
EBITDA
Taxes
Change in Non Cash Working capital
Capital Expenditure
Free Cash Flow to
Firm
Note that an alternate to above is following (FCFE) method in which thevalue of Equity is directly valued in lieu of the value of Firm. Under thisapproach, the Interest and Finance charges is also deducted to arrive at theFree Cash Flows. Adjustment is also made for Debt (Inflows and Outflows)over the definite period of Cash Flows and also in Perpetuity workings.
Theoretically, the value conclusion should remain same irrespective of themethod followed (FCFF or FCFE), (Provided, assumptions are consistent).
FREE CASH FLOWS
Free Cash Flow calculation
EOK Study Circle - ICAI22/11/2013
DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL
Where:D = Debt part of capital structureE = Equity part of capital structureKd = Cost of Debt (Post tax)Ke = Cost of Equity
(Kd x D) + (Ke x E)
(D + E)
In case of following FCFE, Discount Rate is Ke and Not WACC
WACC
Cost of Capital calculation
EOK Study Circle - ICAI22/11/2013
DISCOUNT RATE - COST OF EQUITY
Where:Rf = Risk free rate of return (Generally taken as 10-year Government BondYield)B = Beta Value (Sensitivity of the stock returns to market returns)Ke = Cost of EquityRm= Market Rate of Return (Generally taken as Long Term average returnof
Stock Market)SCRP = Small Company Risk PremiumCSRP= Company specific Risk premium
Mod. CAPM Modelke = Rf + B ( Rm-Rf) + SCRP + CSRP
The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing
Model (Mod. CAPM)
Cost of Equity calculation
EOK Study Circle - ICAI22/11/2013
PERPETUITY FORMULA– Usually comprises a Large part of Total Value and is sensitive to small
changes
– Capitalizes FCF after definite forecast period as a growing perpetuity;
– Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows
– Gordon Formula is often used to derive the Terminal CashFlows by applying the last year cash flows as a multiple of the growth rate and discounting factor
– Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of last year projected cash flows
(1 + g)
(WACC – g)
IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation Multiples to the Terminal Year Financials and also doing Scenario Analysis.
Terminal value calculation
EOK Study Circle - ICAI22/11/2013
Pre Money or Post Money: If the effect of the money coming in Company is
taken in Projections, the Expanded capital base should be considered or else the
Equity Value should be reduced by the inflow amount to reconcile with the existing
capital base.
Terminal growth rate: Since it is tough to estimate the perpetual growth rate of a
company, it is preferred to take the perpetuity growth rate factoring in long term
estimated GDP of the Country and Historical/Projection Inflation of the Country.
Projection Validation via-a-vis Industry: Need to have Sanity check of the
projections with the trend of the industry.
Beta of Unlisted Company: It is calculated on relative basis by adjusting the
average beta of its comparable companies for differences in Capital Structure of the
unlisted company with the listed peers.
Risk Free Rate: Yield of a Zero Coupon Bond or Long Term government Bond yield
should be taken as the risk free rate since it does not have any reinvestment risk .
Tricky issues in DFCF
EOK Study Circle - ICAI22/11/2013
Adjustment of Company Specific Risk Premium or Small Company Risk
Premium: Small Companies are generally more risky than big companies. CAPM
model does not take into consideration the size risk and specific company risk as
Beta measures only systematic risk and Market Risk Premium (generally
pertaining to Sensex Companies). These risks should also be taken into account
while computing the cost of equity.
Length of Projections: The Projected Cash Flows should factor in the entire
Business Cycle of a Company.
Notional/Actual Tax: Actual Tax Liability may be worked out and replaced for the
Notional Tax Liability
Investments: Investments should be valued separately based on their
Independent Cash Flows
Surplus Assets: The Value of Surplus Assets (not being utilized for Business
purposes) should be added separately and their cash flows should be ignored
while computing the Free Cash Flows.
Tricky issues in DFCF (Cont.)
EOK Study Circle - ICAI22/11/2013
22/11/2013
Registered ValuerCompanies Act, 2013
EOK Study Circle - ICAI22/11/2013
Registered Valuers
Registered Valuers
Financial Valuer Technical Valuer
• A Chartered Accountant,
Company Secretary or Cost
Accountant in whole time
practice or retired member
of Indian Corporate law
Service or any other person
as prescribed.
• A Merchant Banker
registered with SEBI and
which has in employment
under it CA/CS/CWA for
carrying out (signing)
Valuation by such qualified
persons.
• Member of the Institute
of Engineers or Member
of the Institute of
Architects in whole time
practice.
• A person or firm or LLP or
Merchant Banker
possessing both
qualifications may act in
dual capacity.
Shall have 5 Yearsof ContinuousExperience, PostQualification
Shall have 5Years ofContinuesExperience,PostQualification
Stock, Shares, Debentures, Securities, Goodwill
Property
Persons eligible to apply for being Registered as Valuer
RegisteredValuer to beappointed byAudit Committeeor in its absenceby the Board ofDirectors.22/11/2013
Registered Valuers
Registered Valuer
Further Issue of Shares
Compromise and
Arrangements
Winding up / Liquidation
Non Cash Transactions
with Directors
Exit to Minority
Shareholders
Corporate Debt
Restructuring
Registered Valuers (Financial Valuation)
Value
Responsibilities• Valuer to make impartial, true and fair
valuation• Not undertake valuation if directly or
indirectly interested• Exercise due diligence• Valuation to be done as per rules
Upon contravention• Fine – 25,000 to 100,000
With intention to defraud• Imprisonment upto 1 year and• Fine- 1,00,000 to 5,00,000
Additionally upon contravention, torefund remuneration received and alsoliable for damages.
EOK Study Circle - ICAI22/11/2013
Section wise Requirement of Registered ValuersSection 62(1)(c) – For Valuing further Issue of SharesSection 192(2) – For Valuing Assets involved in Arrangement of Non Cash transactions involving Directors
Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a Scheme ofCorporate Debt Restructuring
Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a Scheme ofCompromise/Arrangement, a copy of Valuation Report by Expert, if any shall be accompanied
Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the transferor company is a listed
company and the transferee company is an unlisted company, for exit opportunity to the shareholders of
transferor company, valuation may be required to be made by the Tribunal
Section 236(2) – For Valuing Equity Shares held by Minority Shareholders
Section 260(2)(c) – For preparing Valuation report in respect of Shares and Assets to arrive at the ReservePrice or Lease rent or Share Exchange Ratio for Company Administrator
Section 281(1)(a) – For Valuing Assets for submission of report by Company LiquidatorSection 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency
under voluntary winding upSection 319(3)(b) – For Valuing the interest of any dissenting member of the transferor company who did
not vote in favour of the special resolution, as may be required by the Company Liquidator
Section 325(1)(b) – For valuation of annuities and future and contingent liabilities in winding up of
insolvent companyEOK Study Circle - ICAI22/11/2013
Registered Valuers (Draft Rules) – Methods of ValuationI. Before adopting methods, decide Valuation Approach-• Asset Approach
• Income Approach
• Market Approach
II. Valuer to consider following points while undertaking Valuation-
• Nature of the Business and the History of the Enterprise from its inception
• Economic outlook in general and outlook of the specific industry in particular
• Book Value of the stock and the Financial condition of the business
• Earning Capacity of the company
• Dividend-Paying Capacity of the company.
• Goodwill or other Intangible value
• Sales of the stock and the Size of the block of stock to be valued
• Market prices of stock of corporations engaged in the same or a similar line of business
• Contingent Liabilities or substantial legal issues, within India and Abroad, impacting business
• Nature of Instrument proposed to be issued, and nature of transaction contemplated by parties
Relates to IRS Revenue Ruling (1959-60),USA
Registered Valuers (Draft Rules) – Methods of ValuationIII. Registered Valuer shall make valuation of any asset in accordance with any one or more of the following methods-
a. Net Asset Value Method (NAV)
b. Market Price Method
c. Yield Method / PECV Method
d. Discounted Cash Flow Method (DCF)
e. Comparable Companies Multiples Method (CCM)
f. Comparable Transaction Multiples Method (CTM)
g. Price of Recent Investment Method (PORI)
h. Sum of the parts Valuation Method (SOTP)
i. Liquidation Value
j. Weighted Average Method
k. Any other method accepted or notified by RBI, SEBI or Income Tax Authorities
l. Any other method that valuer may deem fit provided adequate justification for use of suh method (and not
any of the above methods) is provided
IV. Registered Valuer shall make valuation of any asset as on the Valuation date and in accordance with applicable standards, if any stipulated for this purpose.
V. Contents of Valuation report shall contain information as contained in Form 17.3
Registered Valuers (Forms) – Contents of Valuation report
1) Description of valuation engagement
(a) Name of the client:
(b) Other intended users:
(c) Purpose for valuation:
(2) Description of business/ asset / liability being valued
(a) Nature of business or asset / liability
(b) Legal background
(c) Financial aspects
(d) Tax matters
(3) Description of the information underlying the valuation
(a) Analysis of past results
(b) Budgets, with underlying assumptions
(c) Availability and quality of underlying data
(d) Review of budgets for plausibility
(e) Statement of responsibility for information received
Registered Valuers (Forms) – Contents of Valuation report (4) Description of specific valuation of assets used in the business:
(a)Basis or bases of value
(b) Valuation Date
(c) Description of the procedures carried out
(d) Principles used in the valuation
(e) The valuation method used and reasoning
(f) Nature, scope and quality of underlying data and
(g) The extent of estimates and assumptions together with considerations underlying them
(5) Confirmation that the valuation has been undertaken in accordance with these Rules
(6) Further it is certified that valuation has been undertaken after taking into account relevantconditions/regulations/rules/notifications, if any, issued by the Central/State Government(s) from time to time.
(i) The valuation report must clearly state the significant assumptions upon which the value is based.When reporting there may be instances, where there are confidential figures, these must besummarized in a separate exhibit
(ii) In his valuation report, the registered valuer must set out a clear value or range of values along withthe reasoning
(ii) In case the valuer has been involved in valuing any part of the subject matter of valuation in thepast, the past valuation report(s) should be attached and referred to herein. In case a differentbasis has been adopted for valuation (than adopted in the past), the valuer should justify thereason for such differences
Some Specific Tricky Issues
EOK Study Circle - ICAI22/11/2013
Discounts
• Discount for Entity Level
Discounts & Premiums come into picture when there exist difference between the
subject being valued and the Methodologies applied. As this can translate control value
to non-control and vise versa , so these should be judiciously applied.
– Impact on entity as a whole
Key Person Discount Discount for Contingent Liability Discount for diversified company Discount for Holding Company
• Discount for Shareholders Level – Impact on specific ownership interest Discount Lack of Control (DLOC) Discount Lack of Marketability (DLOM)
• Size of distribution or dividends• Dispute• Revenue / Earning – Growth / Stability• Private Company
Tax Payout
• % stake & special rights
• Shareholders Agreement caveats
Global Studies over the years on diversified
companies and holding companies has shown
that companies trade at a discount in the range
of 20%. to 40% each.
DLOM: As per CCI Guidelines, 15%
discount has been prescribed; however
practically DLOM and DLOC depends upon
following factors:
EOK Study Circle - ICAI22/11/2013
Premium
•Control Premium - 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
Research has shown that the control premium in
India has ranged from 20% to 37% in the past few
years.
EOK Study Circle - ICAI22/11/2013
Excess Cash and Non Operating Assets
Excess cash is defined as ‘total cash (in balance
sheet) – operating cash (i.e. minimum required cash)
to sustain operations (working capital) and manage
contingencies
Key Issue: Estimation of Excess Cash ?
Non operating Assets are the Surplus assets which are not used in operations of the business and does not
reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should be
separately added to the value derived through valuation methodologies to arrive at the value of the company.
One of the solutions is to estimate average
cash/sales or total balance sheet size of the
company’s relevant Industry and then estimate if
the company being valued has cash in excess of the
industry’s average.
What is an asset is not yielding adequate returns ?
EOK Study Circle - ICAI22/11/2013
Cross Holding and Investments
Holdings in other firms can be categorized into:
Types of Cross Holding Meaning
Minority, Passive Investments If the securities or assets owned in another firm represent less
than 20% of the overall ownership of that firm
Minority, Active Investments If the securities or assets owned in another firm represent
between 20% and 50% of the overall ownership of that firm
Majority, Active Investments If the securities or assets owned in another firm represent more
than 50% of the overall ownership of that firm
Investment Value
Ways to value Cross Holding and Investments:
Dividend Yield Capitalization or DCF based on expected dividends
Seperate Valuation (Preferred)
By way of Shareholders
Agreement even less %
holding may command
control valueEOK Study Circle - ICAI22/11/2013
Accounting Practices and Tax issues
Most of the information that is used in
valuation comes from financial statements.
which in turn are made on certain
Accounting practices considered
appropriate.
• Cash Accounting v/s Accrual Accounting
• Operating Lease v/s Financial Lease
• Capitalization of Expenses
• Notional Tax vs. Actual Tax
• Treatment of Intangible Assets
• Companies Paying MAT
• Treatment of Tax benefits and Losses
EOK Study Circle - ICAI22/11/2013
Valuation Methodologies and Value Impact
Major Valuation Methodologies Ideal for Result
Net Asset Value
Net Asset Value (Book Value) Minority ValueEquity Value
Net Asset Value (Fair Value) Control Value
Comparable Companies Multiples (CCM) Method
Price to Earning , Book Value MultipleMinority Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Comparable Transaction Multiples (CTM) Method
Price to Earning , Book Value MultipleControl Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Discounted Cash Flow (DCF)
Equity Control Value Equity Value
Firm Enterprise Value
EOK Study Circle - ICAI22/11/2013
Thank YouChander Sawhney, Vice President
Corporate Professionals Capital Pvt. Ltd.
SEBI registered merchant bankerEmail : [email protected]
Mobile: 9810557353; Direct: 40622252www.corporatevaluations.in;
D-28, South Extention, Part-I, New Delhi-110049
Disclaimer:This presentation contains information in summary form and is therefore intended for general guidance only. It is not intended to be asubstitute for detailed research or the exercise of professional judgment. Neither corporatevaluations.in nor any other member of theCorporate Professionals organization accept any responsibility for loss occasioned to any person acting or refraining from action as aresult of any material in this presentation. On any specific matter, reference should be made to the appropriate advisor.
© 2013, Corporate Professionals. All rights reserved
EOK Study Circle - ICAI22/11/2013