Valuation Snapshot - Spring 2020

Valuation Snapshot

Spring 2020

Welcome to the latest 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.

There may be trouble ahead Q4 of 2019 saw our index rise 2.5%.

For valuations up to 2019 there should be little or no Coronavirus adjustment.

After all it wasn’t until 31 December 2019 that China contacted the World Health Organisation (WHO) with news that cases of pneumonia of unknown cause had been detected in Wuhan.

Key valuation indices Q4 2019 to Q4 2019

Q1 2020 dominates the thinking now and early indications are that valuations will be at least 10% down. This is because for Q1 2020 valuations the question will be what was known or knowable at that time about the emerging crisis.

COVID-19 and the Expert Witness

Lake Falconer lake@pemcf.com

For most companies, it’s hoped that the impacts of COVID-19 will only be short-term, but for the foreseeable future, the task of the Courts to interpret the impacts on matrimonial assets has been made much harder.

should be taken to make sure that transaction or quoted company multiples don’t compare current market prices against historic figures.

No expert valuer has a crystal ball, but it’s important now to instruct an experienced expert who will interrogate the data and consider the effects of COVID-19 (otherwise known as Coronavirus).

An assessment of cash, or debt, and liquidity is a key step in any valuation. Post-Coronavirus businesses will have less cash and more debt. This will be a one-off hit to valuation. Just as important is the liquidity assessment often asked for by the Court in matrimonial cases.

Caution needs to be applied in assessing how much working capital a business will need as it returns to more profitable trading in the new normal.

Impact of Coronavirus on earnings Already a new acronym, EBITDAC, has been coined to denote Earnings before Interest Tax Depreciation Amortisation and Corona. This tries to measure the underlying performance of the business. A valuer must concentrate on 2019 historic performance along with an understanding of 2020 EBITDAC and scrutiny of 2021 forecasts. Forecast reviews must consider a range of different outcomes and judge what weightings are appropriate. Taking historic earnings as a starting point is no longer enough and an expert’s ability and experience at reviewing forecasts has suddenly become more important.

Multiples When applying an appropriate multiple to the adjusted earnings of a business, care must be taken to compare like-for-like. If the company being valued has already downgraded its figures, care

Cash and liquidity

Valuations could be depressed by the treble hit of the cash cost of Corona, alongside reduced forecasts and multiples. But care must be taken not to over cook this. Companies in some sectors such as pharma, software, or video conferencing are prospering through the crisis. Others will rebound quickly as the economy recovers. Valuers shouldn’t be over cautious and should take a balanced view of the upside and not just the risks.

Asset valuations, and those driven by discounted cash flow, will also be impacted by Coronavirus. In all cases it’s key to appoint a valuer who will consider the nuances of each method.

Has the Coronavirus disrupted multiples-based valuations?

The world, markets, supply chains and customer behaviours, to name a few, have changed far beyond any predictions made at the start of 2020 because of the Coronavirus pandemic.

The market-based approach to valuation is changing, and in these unusual times, it may be no longer representative to look at prior periods’ financial performance and profit generation alone to forecast a company’s future earnings.

So, what now?

A more focussed holistic view of a company is needed. This should comprise an in-depth review of the markets in which the company operates, its customers, its business model, security of income and ultimately, the quality of its earnings.

We at PEM Corporate Finance have always used ‘Value Drivers’ as part of our valuation assessments. These are, often, qualitative characteristics of a business which affect the value of the business positively or perhaps negatively.

Value drivers may be derived from questions such as: •

How is revenue generated, is it from one-off projects or from recurring subscriptions?

•

Is the product/service ‘mission critical’ to a business or customer?

•

Does the business have supplier or customer concentration issues?

•

Is there current or potential disruption in the market and if so which side of the disruption is the business?

It would be difficult to reliably value a

business based on value drivers alone.

They need to be used to give input to the earnings multiple based market approach.

Earnings multiple based valuations rely on a thoughtful and evidence-based selection of the multiple, and best practice is to benchmark against comparable transactions and comparable quoted companies.

A good valuer will have access to proprietary databases to select a sample.

And qualitative characteristics of the company need to be better understood to generate a more comparable bucket of transactions and companies rather than just looking at companies in the same sector. This approach, in theory, will result in a more applicable multiple.

Value drivers should also be considered when determining a sustainable earnings figure to apply this multiple to. So, the key question to consider is, what figure really is representative of future earnings?

Ned Brown ned@pemcf.com

PEM Valuations From time to time, your clients may ask you how to value their business.

Such requests could be triggered by: ▪ ▪ ▪ ▪ ▪ ▪ ▪

Divorce Shareholder exit Probate Restructuring Share incentive schemes Tax and Accounting Regulatory reasons

Yet for many advisers, 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 pem-businessvaluations.com PEM Corporate Finance LLP is authorised and regulated by the Financial Conduct Authority, registered number 212875.

Registered in England & Wales, company number OC302288 at 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.