Autumn 2016
Valuation Snapshot
Welcome to our eighth edition of Valuation Snapshot. In this regular publication we look at the trends and issues behind business valuations, and provide bite-sized advice that can help you and your clients when valuing a company.
Business as usual Probably the most noteworthy thing about the index movements since our last Valuation Snapshot is that there has been so little change. Given Brexit and the run up to the election of Donald Trump as a background one might have expected some turbulence.
Key valuation indices up to Q3 2016
However both prices as evidenced by the chart below and also volumes of transactions, per data from Experian and Bureau van Dijk, have continued with little if any discernible effect. From our experience this may be partly driven by overseas buyers enjoying something of a windfall effect from the rapid and significant fall in the value of the pound sterling.
The Mafia discount versus the willing buyer & seller
A valuation should be done taking into account the hypothetical behaviour of a willing seller and willing buyer with no special situation buyer in mind. However in one American case the court was persuaded that it made sense to take account of who might be involved when valuing a specific asset.
The Mafia discount The case involved the valuation of a part interest in a landfill site in New York City. However the asset owner who asked the valuer to come up with a figure was a senior member of a crime family (allegedly!). Unsurprisingly the valuer felt unable to refuse the assignment. The authorities argued that the gentlemen had used his mafia connections to buy his holding at an unbelievably low price. The business valuer managed to convince the court that this was a reasonable valuation by reviewing the public domain evidence over the prior 20 year period about the specific landfill site and its mob ownership. As he put it, “As a hypothetical willing buyer, you know that the other shareholders of this landfill are all high-up individuals connected with the mob. Do you really want to be that shareholder?” The Department of Justice did not challenge the valuation or the mafia discount. However the “mob-discount” has to be a
one-off. Quite apart from the absence of any obvious gangsters in our region, the fair market value definition implies willing buyers and willing sellers. For valuation purposes you can’t argue that because someone would not buy a particular shareholding it therefore must be next to worthless. Equally there’s no logic in suggesting that because a shareholder would not sell, the shares should be valued dearly. Both situations might occur in the “real world” but neither represents fair market value.
Hypotheticals Any reluctance to transact by any particular party can’t be part of a determination of the fair market value of an asset. Otherwise the behavioral requirements of the definition are not met. You might well come across a seller who wouldn’t sell because the price is “too low” or a buyer who doesn’t buy because the shares are “expensive”. But this implies analysis of the motivation of specific sellers or buyers and ignores the need to consider hypothetical sellers and hypothetical buyers.
Lake Falconer lake@pemcf.com
Loose talk costs value During the Second World War, people said that “loose talk costs lives.” In a corporate finance context, talking unreservedly about “value” can cost your clients financially. So it’s important to understand the main definitions of value.
would be reduced to £7m.
Enterprise value vs. equity value
Fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (IFRS13).
Enterprise Value (EV) is the sum of all ownership interests in a company and claims on its assets from both debt and equity holders. EV is calculated as: market capitalisation + debt + minority interest + preferred equity – cash & cash equivalents. Equity Value is the total value of all outstanding common shares of a company. For most publicly quoted companies, equity value (or “market cap”) is simply the share price multiplied by the number of common shares outstanding. In an acquisition process, advisers typically use the “Enterprise” approach when arriving at an equity value for the target company, which is as follows: enterprise value – debt – minority interest – preferred equity + cash & cash equivalents. What that means in practice is that when comparing between EV and Equity Value, the latter reduces consideration received in a transaction by the amount of net debt in the company. For example, an acquirer may offer your client £10m for their company which has £5m of debt and £2m of cash. The consideration received would be £10m if the offer was based on the equity value, however, if the offer was based on EV the total consideration received by your client
David Smith david@pemcf.com
Other definitions You may also come across Fair Value, or Net Asset Value.
Net asset value (or book value) is the value of total assets minus total liabilities recorded on a company’s balance sheet. You should note that different measurement bases are used for different asset and liability accounts. You’ll also come across adjusted net asset value - which is tweaked to reflect the fair value of assets such as plant and property which may be in the accounts at a purely historic figure.
PEM Valuations From time to time, your clients may ask you how to value their business. Such requests could be triggered by: ▪▪ ▪▪ ▪▪ ▪▪ ▪▪ ▪▪
Shareholder exit Disputes Restructuring Business planning Tax and Accounting Regulatory reasons
Yet for many advisors, valuations are not their day job. This is where the PEM Valuations team can help.
Why refer your clients to us? Focused Our valuations are produced by a specialist, multidisciplinary team with a valuations focus.
Personal We have a flat structure so clients always receive cost effective senior level attention.
Commercial Our real world experience in company sale and purchase negotiation means we don’t just claim to be commercial, we have the transaction record to prove it.
Tailored We do not use a software driven or “form-filling” approach. Our reports are based on a thorough understanding of the business to be valued, and tailored to the specific needs of the owner.
Get in touch: 01223 728 222 pemcf.com/valuations PEM Corporate Finance LLP is authorised and regulated by the Financial Conduct Authority, registered number 212875. Registered in England & Wales, company number OC302288. Salisbury House, Station Road, Cambridge, CB1 2LA. If you no longer wish to receive this publication, or if you have had a change of address, please email info@pemcf.com.