Valuation for M and A

7/13/2019 Valuation for M and A

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Valuation for Mergers &

Acquisitions- Including

Case Studies

-- CACA ParagParag VedVed

December 27, 2014December 27, 2014


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M & AM & AM & AM & A IntroductionIntroductionIntroductionIntroduction

Liberalization of economy and reforms programmes have

resulted in a 'churn' in the industrial and services sector.

Companies are resorting to acquisitions as a means to

consolidate and grow rapidly.

effectively with the multinationals and exploring the world

markets.

As a result, there is a manifold increase in the level of M &

A activity.


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Corporate RestructuringCorporate RestructuringCorporate RestructuringCorporate Restructuring

It is significant modification made to the debt, operations or

structure of a company.

This type of corporate action is usually made when there are

Corporate RestructuringCorporate RestructuringCorporate RestructuringCorporate Restructuring

significant problems in a company, which are causing someform of financial harm and putting the overall business in

jeopardy.

The hope is that through restructuring,

a company can eliminate financial harm and

improve the business


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Motives for RestructuringGain BetterCompetitive

Position

Achieve GrowthAnd

Survive

Strategic Reasons

Focus onCore Activities

AchieveEconomies of

Scale

Cont


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Motives for Restructuring (cont.)Dividend

Distribution Tax

minimisation

Fund Raising

Financial Reasons

Utilisation ofExcess Cash

Tax Planning &Reducing Costs

Cont


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Motives for Restructuring (cont.)Diversification Entering into a

new segment

Bail OutTakeovers

Other Reasons

FamilySeparation

Warding-offPredators


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Modes of Restructuring

M & A

MergersAcquisitions Demergers Others

SharePurchase

AssetPurchase

Subsidiar -isation

CapitalReduction

Buy-Back

SlumpSale ItemizedSale


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Acquisitions / Takeovers:

An acquisition, also known as a takeover, is the buying of one

company (the target) by another.

Types:

AssetAssetAssetAsset PurchasePurchasePurchasePurchase:::: This type of transaction leaves the target

Acquisitions / TakeoversAcquisitions / TakeoversAcquisitions / TakeoversAcquisitions / Takeovers

company as an empty s e . t s urt er v e nto:

a) Slump Sale

b) Itemised Sale

ShareShareShareShare purchasepurchasepurchasepurchase:::: The buyer buys the shares, and therefore

control, of the target company Examples: Reliance Industries acquiring 95% in Infotel

Broadband Pvt. Ltd.

Cont


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SlumpSlumpSlumpSlump SaleSaleSaleSale:::: Section 2(42C) of the Income Tax Act, 1961 definesSlump Sale as the transfer of one or more undertakings as a

result of the sale for a lump sum consideration without valuesbeing assigned to the individual assets and liabilities.

Example: Grasim sold sponge iron unit to WelspunPower for Rs. 1030 crores.

Acquisitions / TakeoversAcquisitions / TakeoversAcquisitions / TakeoversAcquisitions / Takeovers (cont.)

ItemisedItemisedItemisedItemised SaleSaleSaleSale:::: Sale of assets & liabilities with values assignedseparately for each item of assets & liabilities.

SlumpSlumpSlumpSlump SaleSaleSaleSale vsvsvsvs.... ItemisedItemisedItemisedItemised SaleSaleSaleSale:::: In case of itemised sale, unlike

slump sale, it is possible to pick and choose assets andliabilities. Also, the consideration is identifiable against eachitem.


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A Business We Understand;

Favorable Long Term Economics;

Warren Buffetts criteria for Business

Acquisition

Able and Trustworthy Management; and

A Sensible Price Tag

Source : 2007 letter to Shareholders.


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Partner in growth

Make independent assessment

Role of Finance Team in the Process

of Acquisition

Protect interest of all stakeholders

Ensure adherence to all the laws/ regulations

Follow proper Corporate Governance


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MERGER


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Mergers:

In business or economics a merger is a combination of two

companies into one larger company.Types:

HorizontalHorizontalHorizontalHorizontalHorizontalHorizontalHorizontalHorizontal mergersmergersmergersmergersmergersmergersmergersmergers take place where the two merging

companies produce similar product in the same industry

MergersMergersMergersMergers

VerticalVerticalVerticalVerticalVerticalVerticalVerticalVertical mergersmergersmergersmergersmergersmergersmergersmergers occur when two firms, each working atdifferent stages in the production of the same good,

combine.

ConglomerateConglomerateConglomerateConglomerateConglomerateConglomerateConglomerateConglomerate mergersmergersmergersmergersmergersmergersmergersmergers take place when the two firms

operate in different industries. ForwardForwardForwardForwardForwardForwardForwardForward Merger of target into the acquirer

ReverseReverseReverseReverseReverseReverseReverseReverse Merger of acquirer into the target


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DEMERGER


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Demerger: corporate strategy to sell off subsidiaries or divisions of a company

Demergers

Pre Post

Assets, liabilitiesof

undertaking B

transferred to BLtd.

Undertaking A Undertaking BAB Ltd B LtdAB LtdUndertaking A Undertaking B


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Valuation Concept Value Price

Valuation not an exact Science, More of Art andSubjective assessment

Value varies with situations

Date specific


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Merger/Demerger

PrivateEquity

IPO/ FPO

Buyback of

Shares

Purchase /

Sale ofBusiness

WhyWhy

am y

Separation

PPA

Portfolio Valueof Investments

RegulatoryApproval

Litigation

Impairment/IFRS


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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


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Sources of Information

Historical data such as audited results

of the company Future projections

Stock market quotations

Discussions with the management ofthe company

Representation by the management

Data on comparable companies Market surveys, news paper reports


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Analysis of Company

SWOT Analysis

Profitability Analysis- Past and

vis--vis industry Ratio Analysis

P&L Ratios

Expense & Profitability ratios Balance Sheet Ratios

Quick Ratio/ Current Ratio

Turnover Ratios Liquidity Ratios

Debt Equity- of Company &

Industry


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Earning based approach

Discounted Cash Flow

Earnings Multiple Method

Principal Methods of Valuation

Market Price

Market Comparables

Asset Based Approach Net Assets Method

Replacement Value/Realisable Value


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Following adjustments may be called for:

Investments Surplus Assets

Auditors Qualification

Common Adjustments

Preference Shares ESOPs / Warrants

Contingent Liabilities/Assets

Tax concessions Findings of Due Diligence Reviews


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Considers Cash Flow and NotProfits

Cash is King

Discounted Cash Flow (DCF)

Free Cash Flow (FCF) FCF to Firm

FCF to Equity


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DCF Parameters

Cash Flows Projections

Horizon period

Growt rate

Discounting

Cost of Equity

Cost of Debt

Weighted Average Cost of

Capital (WACC)


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Cash Flows

Business

Plan

Business

Cycle

Working

Capital

CapitalExpenditure

DepreciationAmortization

Tax


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Factors to be considered for reviewing

projections:

Industry/Company Analysis

Dependence on single customer/ supplier

DCF - Projections

nsta e capac ty

Existing policy/ legal framework

Capital expenditure increasing capacities

Working capital requirements Alternate scenarios / sensitivities


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Weighted Average Cost of Capital (WACC)

DCF Discounting

D E(D + E) (D + E)

KeWACC = x Kd + x

D = Debt

E = Equity

Kd = Post tax cost of debt

Ke = Cost of equity


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DCF - Terminal value

Terminal Value is the residual value of business at the

end of projection period used in discounted cash flow

method.

Terminal Value

LiquidationApproach

Multiple

Approach

Stable GrowthApproach

29

DCF A E l


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DCF An Example(. )

201415 201516 201617 201718 201819 170 187 205 226 248

:

69 70 72 73 75

81 85 90 94 99

320 342 367 393 422

: 25 25 50 25 25

39 49 61 54 62

77 83 90 97 105

141 157 201 176 192

201617 230

3%

2,257

13.50% 0.88 0.78 0.68 0.60 0.53 0.53

158 144 113 131 122 1,198

1,866

: (350)

: (50)

: (800)

: 120

: 1,000

1,786

. 7,969,000

( . 10) 224


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Market Cap/PATPrice to Earnings

Multi le:

Earnings Multiple Method

Commonly used Multiples

Enterprise Value/EBITDAEnterprise Value

to EBITDAMultiple:

Enterprise Value/SalesSales Multiple:


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Enterprise Value/EBITDA Multiple Method

Determination of Maintainable EBIDTA

Capitalisation Rate/Multiple

Not affected by the pattern of Fundingadopted by Company/ Comparable

Companies


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Based on past performance and /or

projections

Non-recurring & extraordinary itemsexcluded

Enterprise Value/EBITDA Multiple Method

(simple or weighted). Current EBIDTA isaccorded the highest weight

Projected EBIDTA discounted for inflation

Finally appropriate multiple is applied toarrive at the value


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Multiples

Multiples to be applied represent the growth

prospects/ expectations of the Company

Factors to be considered while deciding themultiple:

Past and Ex ected Growth of the Earnin s

Performance vis--vis Peers

Size & Market Share

Historical Multiples enjoyed on the Stock

Exchange by the Company and its peers

EV/EBIDTA A E l


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EV/EBIDTA An Example & (. .)

201112 201213 201314 98 116 136

: /

28 17 18

25 15 15

4 20

7 9

10 10 10

74 51 63

: 7 8 9

15 15 15

15

10 10 10

58 32 48 92

56 113 165

: 59 63 65

: 70 75 79

185 251 309

EV/EBIDTA A E l


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EV/EBIDTA An Example

(. .) .

201112 185 1 185

201213 251 2 501

201314 309 3 927

6 1,613

269

7

,

: (350)

: (800)

: 1,000

: (50)

: 120

1,802

. 7,969,000

( . 10 ) 226


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Evaluates the value on the basis of prices quoted on

the stock exchange

Thinly traded / Dormant Scrip Low Floating Stock

Significant and Unusual fluctuations in the Market Price

Market Price Approach

It is prudent to take weighted average of quotedprice for past 6 months

Regulatory bodies often consider market value as

important basis Preferential allotment, Buyback,Takeover Code


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Market Price Method An Example

2014 30,747,312 4,009,275,753 2014 12,040,227 2,697,868,740

2014 19,663,244 3,976,264,011

2014 16,118,953 3,503,216,645

2014 18,115,567 4,767,062,216

2014 29,408,604 6,535,415,743

126,093,907 25,489,103,108

( .) 202


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Generally applied in case of unlistedentities

Estimates value by relating an elementwith underlying element of similarlisted companies.

Market Comparables

Based on market multiples ofComparable Companies

Book Value Multiples

Industry Specific Multiples

Multiples from Recent M&A Transactions.


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NAV Formula

Total Assets

(excluding Miscellaneous Expenditure and debit balancein Profit & Loss Account)

Less: Total Liabilities

The Value as per Net Asset Method is arrived as follows:

NET ASSET VALUE

Share Capital

Add: Reserves

Less: Miscellaneous Expenditure

Less: Debit Balance in Profit & Loss Account

NET ASSET VALUE

OR

NAV A E l


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NAV An Example

(. .)

700

950

() 20 , & 1,290

& (960)

330

(350)

1,650

/ ():

50

(50)

(800) 850

. ( . 10 ) 7,969,000

107


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Selection of Methods

Situation Approach

Knowledge based companies Earnings/Market

Manufacturing Companies Earnings/ Market/ Asset

Brand Driven companies Earnings/MarketA Matured company Earnings/Market

Investment/Property companies Asset

Company going for liquidation Asset

Generally Market Approach is used in Combination

with other methods or as a cross check


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Methods throw a range of values

Consider the relevance of each methodologydepending upon the purpose and premise ofvaluation

Mathematical wei hta e

Reaching a Recommendation

Professional judgment Subjective Value

F i V l


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Fair Value

( .)

( .)

(

.)

107 1 107

/ 226 1 226

224 1 224

202 2 404

5 961

( .) 192

O h V l D i


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Other Value Drivers

Final Price is a result of negotiations

D t ti


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Documentation

Appointment Letter

Purpose & Scope of Valuation

Valuation Date

Commonly used Methodologies

Timelines

Limitations Representation Letter

No material omissions on part of themanagement

Confirmation of all inputs/ information used inthe valuation

Responsibility for providing information lies

with Management

V l ti R t


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Valuation Report

Introduction/ Background

Purpose of Valuation

Key Financials

Sources of Information

Important consideration & assumptions

Valuation Workings

Fair Value Recommendation

Exclusions and Limitations


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Case Study on Valuation

or er er

Before Merger


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Shareholders of XShareholders of X Shareholders of YShareholders of Y

Before Merger

X LtdX Ltd Y LtdY Ltd

49

After Merger


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Option 1Option 1 Option 2Option 2

ShareholdersShareholdersof X & Yof X & Y



Option 3Option 3

After Merger

X LtdX Ltd Y LtdY Ltd New Co. ZNew Co. Z

Note- Based on the swap ratio, the shareholders of the transferorcompany are issued shares of transferee company

50

E h g R ti


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.

Exchange Ratio

.

Exchange Ratio


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( .)

28 1 28 30 1 30

/ 72 2 144 42 2 84

Exchange Ratio

5 298 5 200

( .) 60 40

: 3 , 2

Case Laws


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Exchange Ratio not disturbed by Courts unless objectedand found grossly unfair

Miheer H. Mafatlal Vs. Mafatlal Industries (1996) 87 ComCases 792

Dinesh v. Lakhani Vs. Parke-Davis (India) Ltd. (2003) 47SCL 80 (Bom)

Case Laws

Valuation will take into account number of factors suchas prospective yield, marketability, the general outlook forthe type of business of the company, etc. Mathematicalcertainty is not demanded, nor indeed is it possible

Viscount Simon Bd in Gold Coast Selection Trust Ltd. vs.Humphrey reported in 30 TC 209 (House of Lords)

Case Laws


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Case Laws

It is fair to use combination of three well known methods -

asset value, yield value & market value

(

Company rather than giving to outsiders who will startfrom scratch

( (

Cont

Some Issues


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Some Issues


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Valuation is not an

objective exercise.

ny preconcep ons

and biases that an analystbrings to the process will

find their way into the

value.


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Documents

Valuation for M and A