Insight of Valuation

“In the business world, the rearview mirror is
always clearer than the windshield”
Warren Buffett

20/12/2013

Corporate Valuations – Techniques &
Application

Valuation (Part – A)
What and Why

5

How

12

Valuation in Indian Regulatory Environment (Part – B)
When and Who

23

Macro Valuation Issues in M&A (Part – C)
Why Merger

58

Valuation for Merger

64

Case Study

70

Some Specific Tricky Issues (Part – D)
Tricky Issues

74

Part – A
Valuation

20/12/2013

Application

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

20/12/2013

Application

Key Facts

PRICE IS NOT THE SAME AS VALUE

VALUE VARIES WITH PERSON, PURPOSE AND TIME

TRANSACTION CONCLUDES AT NEGOTIATED PRICES

VALUATION IS HYBRID OF ART & SCIENCE

20/12/2013

Application

S Standard of Valuation
T Thesis of Valuation
E Economics of Valuation
M Methodologies of Valuation

20/12/2013

Application

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:

FAIR MARKET VALUE

INVESTMENT VALUE

INTRINSIC VALUE

FAIR VALUE

20/12/2013

Application

Standard of
Valuation

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

20/12/2013

Application

Standard of
Valuation

Valuation

Methodologies of
Valuation

Valuation across business cycle follow the law of
economics
Turnover/Profits: Drops



Declining
Cos.

`






Mature
Cos.







sti f or P / r ev onr uT

High Growth
Cos.



Growing
Cos.
Start Up
Cos.

20/12/2013













Proven Track Record: Substantial
Operating History
Method of Valuation: Entirely
from Existing Assets
Cost of Capital: N.A.

Turnover/Profits: Saturated
Proven Track Record: Widely Available
Method of Valuation: More from Existing Assets
Cost of Capital: May be High

Turnover/Profits : Good
Proven Track Record: Available
Valuation Methodology: Business Model with Asset
Base
Cost of Capital: Reasonable

Turnover/Profits: Increasing still Low
Proven Track Record: Limited
Valuation Methodology: Substantially on Business Model
Cost of Capital: Quite High

Turnover/Profits: Negligible
Proven Track Record: None
Valuation Methodology: Entirely on Business Model
Cost of Capital: Very High

Application

Time

Enterprise / Business Value

Intangibles#
Equity#
Net Current
Assets#

Net Debt

#

Stakeholders
# Based on Market Values
20/12/2013

Application

Fixed
Assets#

Assets

Standard of
Valuation

Valuation

Methodologies of
Valuation

Valuation Approaches
Fundamental Method
Income Based
Method

20/12/2013

Relative Method

Asset Based
Method

Market Based
Method

Application

Other Method

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

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.

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;

20/12/2013

Application

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;

20/12/2013

Application

Valuation depends upon

Purpose
• Mergers
• IPO
• Acquisitions /
Investment
• Voluntary
Assessment

20/12/2013

Regulatory

Dispute
Resolution

Accounting

• RBI

• ESOP

• Income Tax

• Purchase Price
Allocation

• SEBI

• Impairment /
• Stock Exchange Diminution

Value
Creation

• Company Law • Equity Research
Board/ Courts •
Credit Rating
• Arbitration
• Corporate
• Mediation

• Companies Act

Application

Planning

Sources of Information for Valuation
Historical financial results –
Income Statement, Balance
Sheets and Cash Flows

Sources of
Information

Data available in Public
Domain – Stock Exchange /
MCA/SEBI/Independent Report
Data on comparable
companies – SALES/EVEBITDA/ PAT/BV
Promoters and Management
background

Discussion and
Representation with/by
the management of the
Company

20/12/2013

Data on projects
planned/under
implementation
including future
projection
Application

Industry and Regulatory
trends

Key drivers of valuation
CASH FLOW
Investor assign value based on the cash flow they expect to receive in the
future
- Dividends / distributions
That’s why DCF is most
- Sale of liquidation proceeds

Value of a cash flow stream is a function of
- Timing of cash Receipt
- Risk associated with the cashflow

prominent

valuation

method

ASSETS
Operating 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

Need for Restructuring

20/12/2013

Application

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
20/12/2013

Application

Part – B
Valuation in Indian Regulatory Environment

20/12/2013

Application

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA
Transactions
Inbound Investment
Inbound Investment

Prescribed Methodologies

Mandate to be done by

DFCF
DFCF

CA // MB
CA MB

Valuer Discretion
Valuer Discretion

>5Mn$ - MB, otherwise CA/MB
>5Mn$ - MB, otherwise CA/MB

Gift of Unquoted Equity
Gift of Unquoted Equity
Shares (Min)
Shares (Min)

NAV
NAV

-

Gift of Unquoted Equity Shares
Gift of Unquoted Equity Shares
from Resident (Max)
from Resident (Max)

DCF (Valuation Based on Assets,
DCF (Valuation Based on Assets,
Business & Intangibles is also
Business & Intangibles is also
acceptable)
acceptable)

FCA // MB
FCA MB

Price it would fetch if sold in open
Price it would fetch if sold in open
market
market

MB
MB

ESOP Tax
ESOP Tax

Valuer Discretion
Valuer Discretion

MB
MB

Transfer Pricing
Transfer Pricing

Arm Length Price
Arm Length Price

-

ESOP Accounting
ESOP Accounting

Option – Pricing Model
Option – Pricing Model

-

Takeover Code/ Delisting Takeover Code/ Delisting Infrequently Traded
Infrequently Traded

Only Parameters Prescribed – Return
Only Parameters Prescribed – Return
on Net Worth, EPS, NAV vis-a vis
on Net Worth, EPS, NAV vis-a vis
Industry Average
Industry Average

CA/MB
CA/MB

Takeover Code/ Delisting Takeover Code/ Delisting Frequently Traded
Frequently Traded

Based on Market Price
Based on Market Price

-

Preferential Allotment to Others
Preferential Allotment to Others

Based on 26 weeks // 2 weeks Market
Based on 26 weeks 2 weeks Market
Price
Price

-

Valuer Discretion
Valuer Discretion

CA // MB
CA MB

Reserve Bank of
India
Outbound Investment
Outbound Investment

Income Tax

SEBI

Stock Exchanges

Gift of Unquoted Shares other
Gift of Unquoted Shares other
than Equity Shares
than Equity Shares

Preferential Allotment to
Preferential Allotment to
promoters / their relatives for
promoters / their relatives for
consideration other than cash
consideration other than cash

Companies Act,
1956

Sweat Equity
Sweat Equity

Companies Act,
2013

any property, stock, shares,
any property, stock, shares,
debentures, securities or goodwill
debentures, securities or goodwill
or any other assets or the net
or any other assets or the net
worth of the Company or its
worth of the Company
its
liabilities
liabilities

Valuer Discretion
Valuer Discretion

To be prescribed
To be prescribed

-

REGISTERED VALUER
REGISTERED VALUER

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.

FEMA Guidelines to Valuation
Particulars

Valuation before April 21, 2010

Guidelines in Force

CCI Guidelines

Methods Prescribed

Net Assets Value (NAV)
Profit Earning Capacity
Value(PECV)
Market Value (in case of Listed
Company)

Valuation after April 21, 2010
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

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 As valuation is more Formulae
in Value Conclusion
based, 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.

Note: Valuation guidelines do not apply to SEBI registered venture capital

Approaches to FDI Valuation
Discounted Free Cash Flow Method (DFCF)
 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 its
DFCF expresses the present value of the business as a function of its
future cash earnings capacity. In this method, the appraiser estimates the
future cash earnings capacity. In this method, the appraiser estimates the

cash flows of any business after all operating expenses, taxes, and necessary
cash flows of any business after all operating expenses, taxes, and necessary
investments in working capital and capital expenditure is being met. Valuing
investments in working capital and capital expenditure is being met. Valuing
equity using the free cash flow to stockholders requires estimating only free
equity using the free cash flow to stockholders requires estimating only free
cash flow to equity holders, after debt holders have been paid off.
cash flow to equity holders, after debt holders have been paid off.

Major Characteristics of DFCF Valuation

 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

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

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.

Free Cash Flow calculation
FREE CASH FLOWS
Free cash flows to firm (FCFF) is calculated as
Taxes
EBITDA
EBITDA

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
the value of Equity is directly valued in lieu of the value of Firm. Under
this approach, the Interest and Finance charges is also deducted to arrive at
the Free 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 the
method followed (FCFF or FCFE), (Provided, assumptions are consistent).

Cost of Capital calculation
DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL

WACC

(Kd x D) + (Ke x E)
(D + E)

Where:
D = Debt part of capital structure
E = Equity part of capital structure
Kd = Cost of Debt (Post tax)
Ke = Cost of Equity
In case of following FCFE, Discount Rate is Ke and Not WACC

Cost of Equity calculation
DISCOUNT RATE - COST OF EQUITY
The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing
Model (Mod. CAPM)
Mod. CAPM Model
ke = Rf + B ( Rm-Rf) + SCRP + CSRP

Where:
Rf =
Yield)
B =
Ke =
Rm=
of

Risk free rate of return (Generally taken as 10-year Government Bond
Beta Value (Sensitivity of the stock returns to market returns)
Cost of Equity
Market Rate of Return (Generally taken as Long Term average return

Stock Market)
SCRP = Small Company Risk Premium
CSRP= Company specific Risk premium

Terminal value calculation
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 Cash (1 + g)
Flows by applying the last year cash flows as a multiple of
(WACC – g)
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

IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation
Multiples to the Terminal Year Financials and also doing Scenario Analysis.

An Insight of Valuationwww.CorporateValuations.in

SEBI / Stock Exchange
Valuation Guidelines

Takeover Regulations
APPLICABLE LAW:
SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011
FREQUENTLY TRADED
SHARES

Traded Turnover of Shares ≥ 10%
[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]

Method of Valuation
1.Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A.
2.The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks;
3.The Highest Price paid or payable by acquirer or PAC in last 26 Weeks;
4.Volume weighted average Market Price of Shares for a period of 60 trading days

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A.
INFREQUENTLY TRADED
SHARES

Traded Turnover of Shares < 10%
[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]

Method of Valuation
1.Book value,
2.Comparable Trading Multiples;

Such other Parameters as are customary for valuation of shares of such companies

Preferential Issue (1 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009

Equity shares of issuer have been listed on recognized stock exchange for a period of 26
weeks or more as on relevant date

Method of Valuation
1.The average of the weekly high and low of the closing prices of the related equity shares quoted on the
recognised stock exchange during 26 weeks preceding the relevant date, or

2.The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during 26 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Preferential Issue ( 2 of 3)
APPLICABLE LAW:
Equity shares of issuer have been listed on recognized stock exchange for a period of less
than 26 weeks as on relevant date

Method of Valuation
1. The price at which equity shares were issued by the issuer in its IPO or value per share

arrived at in a scheme of arrangement under section 391 to 394 of the Companies Act, 1956,
pursuant to which the equity shares of the issuer were listed, as the case may be , or
quoted on the recognised stock exchange during the period shares have been listed
preceding the relevant date, or
quoted on the recognised stock exchange during 2 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Preferential Issue ( 3 of 3)
APPLICABLE LAW:
Where equity shares have been issued to promoters / their relatives for consideration other
than cash, the valuation of assets in consideration for which the equity shares are issued
shall be done by an independent valuer

Method of Valuation
No Method for Valuation has been prescribed.

Valuer
Chartered Accountant or a Merchant Banker

ESOP Accounting Valuation
APPLICABLE LAW:
SEBI (ESOS and ESPS) Guidelines, 1999
If a Company listed on recognised stock exchange in India and issued shares under an
ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing model
(Black-Scholes or a binomial model) which shall be treated as employee compensation cost
for the Company.

Method of Valuation
Black-Scholes Model

Valuer
Not Prescribed

Equity Shares Valuation
APPLICABLE LAW:
Income Tax Act – 1961 and Rule 11UA

If Individual, HUF, Firm or *closely held Company receives Equity shares of a closely held
Company – Valuation norms shall apply.

Method of Valuation
Minimum Valuation- Net Asset Value
Maximum Valuation- DCF and other methods factoring Tangible and Intangibles

Valuer
No specific Valuer prescribed for undertaking Minimum Value
FCA / Merchant Banker for determining Maximum Value

*If a Public Listed Company receives any shares or anyone receives
shares of a Public listed Company, valuation norms are not applicable if
transaction takes at market price.

Valuation of shares other than Equity Shares
APPLICABLE LAW:
Income Tax Act – 1961 and Rule 11UA

If Individual, HUF, Firm or *closely held Company receives shares other than Equity shares
of a closely held Company – Valuation norms shall apply.

Method of Valuation
Price at which such shares will fetch in the open market.

Valuer
Valuation report to be issued by Merchant Banker

ESOP Tax Valuation
APPLICABLE LAW:
Income Tax Act – 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT

To determine the value of perquisite taxable in hands of employees

Method of Valuation

No method has been prescribed

Valuer
SEBI registered category – I Merchant Banker

Transfer Pricing
APPLICABLE LAW:
Section – 92 to 92F of Income Tax Act – 1961 and Rule 10A to 10E of Income-tax Rules, 1962

Any International transaction between associated enterprises at ARM LENGTH PRICE

Method of Valuation

Arm Length Price

Valuer
Not Prescribed

Role of TPO critical. Recent cases deliberating on Valuation aspects

Registered Valuer
Companies Act, 2013

20/12/2013

Registered Valuers
Registered Valuers
Stock, Shares,
Debentures,
Securities,
Goodwill

Financial Valuer

Technical Valuer

Property

Persons eligible to apply for being Registered as Valuer
•

A Chartered Accountant,

• Member of the Institute of

Company Secretary or Cost

Engineers or Member of

Accountant in whole time

the Institute of Architects

practice or retired member

in whole time practice.

of
Shall have 5 Years
of
Continuous
Experience,
Post
Qualification

Indian

Corporate

law

Service or any other person
as prescribed.
• A

Merchant

Banker

registered with SEBI and

• A person or firm or LLP or

which has in employment

Merchant

under

possessing

it

carrying
20/12/2013

Shall have 5
Years
of
Continues
Experience,
Post
Qualification

CA/CS/CWA
out

for

(signing)

Valuation by such qualified
persons.

Banker
both

qualifications may act in
dual capacity.

Registered
Valuer to be
appointed
by
Audit Committee
or in its absence
by the Board of
Directors.

Registered Valuers
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, to
refund remuneration received and also
liable for damages.

20/12/2013

Application

Section wise Requirement of Registered Valuers
Section 62(1)(c) – For Valuing further Issue of Shares
Section 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 of Corporate
Debt Restructuring
Section

230(3)

and

232(2)(d)

–

For

Valuation

including

Share

swap

ratio

under

a

Scheme

of

Compromise/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 Reserve Price or
Lease rent or Share Exchange Ratio for Company Administrator
Section 281(1)(a) – For Valuing Assets for submission of report by Company Liquidator
Section 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency under
voluntary winding up
Section 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 company
20/12/2013

Application

Registered Valuers (Draft Rules) – Methods of Valuation
I. 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
20/12/2013

Application

Registered Valuers (Draft Rules) – Methods of Valuation
III. Registered Valuer shall make valuation of any asset in accordance with any one or more of the
following methodsa.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
20/12/2013

Application

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 relevant
conditions/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 be summarized in a
separate exhibit
(ii)In his valuation report, the registered valuer must set out a clear value or range of values along with
the reasoning
(ii)In case the valuer has been involved in valuing any part of the subject matter of valuation in the
past, the past valuation report(s) should be attached and referred to herein. In case a different basis
has been adopted for valuation (than adopted in the past), the valuer should justify the reason for
such differences

Part – C

M acro I ssues of V aluation in
M ERGERS & A CQUISITION

Capital Market Valuation
Particulars
Surplus Assets [including Cash]
Excess Debt in Capital Structure
Excess Trading Business in Manufacturing Sector
Diversified Business Model
Excess Business in Subsidiary Company
Company Performance [Operating Profits; Net Profits; New Products;
Capacity Expansion]
Increasing Cash Flows of Business
Better Corporate Governance
Better Disclosures [Investor, Analysts & Stakeholders Communication]
Regular Dividends / Bonus / Buyback
Corporate Re-organisation / M&A
Joint Ventures / Acquisitions
Market Perception

20/12/2013

Application

Effect

Market Cap

Types and Modes of M &A

M&A

Mergers

Acquisitions
NON - COURT PROCESS

COURT PROCESS

Companies Act

Asset Purchase

Stock Purchase
SEBI [TAKEOVER CODE]

(only if Listed Co. is involved)

Slump Sale

20/12/2013

Itemized Sale

Application

Key Drivers for Re-organization

Unlocking of Value and
its Sustainability

Restatement of
Balance Sheet

Business clarity to
Investors and Analysts
Improving Governance
Processes

Positioning the
businesses to be more
competitive
Making Businesswise
Fund raising possible

Business Risk
Management

Stock & Credit Rerating
Investor Relations

20/12/2013

Regulatory aspects under various statues

Takeover
Regulations
Competition
Commission
of India
Companies
Act, 2013

SEBI and
Stock
Exchanges

Income Tax
(DTC)

Indirect Tax
(GST)

FEMA

20/12/2013

Stamp Duty

Application

M&A objectives – What it means?
Synergies & Economies of Scale
Gain access to new markets, customers, products
Diversification of Risks
Access to New Technology and Knowledge
Ability to limit competition / gain market share

M&A is primarily driven with motive of achieving Inorganic growth and Synergy i.e. the potential additional value gain from
combining two firms, either from operational or financial sources.

However, certain studies have shown that most – but not all – M&A fail to deliver value and bridge the price-value gap
One of the reasons is that the aggressive promoters in consultation with eager advisors may result in pushing up the acquisition
price; Resultantly, the value often get transferred from acquirer’s shareholders to target company’s shareholders;

20/12/2013

Application

Valuation for Merger

“Valuation is generally the Starting Point of the M&A process”
Judicial Pronouncements;
WHETHER VALUATION IS REQUIRED FOR MERGER?
In the matter of Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. the Regional
Director (RD) raised an objection that no valuation report has been filed and that the
exchange ratio for amalgamation has not been worked out by an independent valuer.
“The Hon’ble High Court of Rajasthan overruled this objection and sanctioned the scheme
of amalgamation by holding that there was no legal or factual impediment to grant
sanction to the scheme of amalgamation.”

Tool for planning Stamp Duty ?

WHETHER ANY VALUATION METHODOLDY IS REQUIRED FOR MERGER?

Though there are no specific methodology prescribed for valuation under Merger,
however In Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others,
Bombay High Court “accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the
valuation was based.”

20/12/2013

Application

Valuation for Merger.. Contd..

APPLICABLE LAW FOR VALUATION FOR MERGER INVOLVING LISTED COMPANY:
1.Companies Act, 1956 [Section 391- 394];
2.Fairness Opinion [Clause 24 (h) of the Listing Agreement];
3.SEBI Notification [CIR/CFD/DIL/5/2013], dated 4 th February, 2013 and 21st May 2013 Circular

VALUATION REQUIREMENT UNDER SEBI NOTIFICATION
Valuation by independent chartered account mandatory other than those specifically exempted.
''Valuation Report from an Independent Chartered Accountant'' is not required in cases where
there is no change in the shareholding pattern of the listed company / resultant company.

After the SEBI notification, Valuation by Independent CA is required if
shares are issued under the merger and there is change in shareholding
pattern.

Why is there a Mismatch between Buyer & Seller expectations?

1. Differences in Risk Assessment arising from  Company Specific Risk
• Management capability
• Future Cash Flows
 Industry Risk - Business Cycles, Industry Outlook
2. Intangible Asset Valuations
3. Unproductive, high value fixed assets housed in target company
4. Cash and Stock Payout ratio
5. Ability to raise funding on buyer’s or target company’s b/s
6. Estimation of synergies (cost and revenue)
Need for Restructuring
20/12/2013

Application

Swap Ratio Valuation
•

In case of a merger valuation, the emphasis is on arriving at the relative values of
the shares of the merging companies to facilitate determination of the swap ratio
– Hence, the purpose is not to arrive at absolute values of the shares of the
companies

•

The key issue to be addressed is that of fairness to all shareholders
– This is particularly important where the shareholding pattern and shareholders vary
between the two companies

•

There are established legal precedence for merger valuation methodologies
– Valuer’s role is to incorporate case specific factors and use appropriate
methodologies so as to determine a fair ratio
– Usually, best to give weight ages to valuation by all methods
– Market price method and Earnings methods dominate.

20/12/2013

Application

Impact of Swap Ratio Valuation

•

If the exchange ratio is set too high, there will be a transfer of wealth from
the bidding firm’s stockholders to the target firm’s stockholders.

•

If the exchange ratio is set too low, there will be transfer of wealth from
the target firm to the bidding firm’s stockholders.

20/12/2013

Application

CASE STUDY
Calculation of
Exchange Ratio in
M&A and Independent
Buyer-Seller
perspective

20/12/2013

Application

Merger of a Unlisted Power Company into Listed Steel
Manufacturing Company
Features of Steel Company*
o Frequently Traded Listed Company
o Low Profit Margin, due to high Power Cost
o Running in Low Capacity Utilization due to poor supply of Power
Features of Power Company*
o Unlisted Company
o Company is implementing the Power Plant of 9.5 MW , The Production is expected to
start with in Year
Acquisition Rationale
o Location Advantage, both companies have their unit in same Location
o Synergistic benefits- (Captive Power Plant will reduce the Operating cost, because Steel
Industry is energy consuming)
o Tax benefit from the unabsorbed losses of Power Company
o Up the value chain
o Capacity utilization will increase in existing steel business, due easy availability of Power
20/12/2013

Application

*Common Promoter Group

Merger of a Unlisted Power Company into Listed Steel
Manufacturing Company
EXCHANGE RATIO & VALUATION –MERGER
•

Valuation on Steel Company
Valuation Method Rs
Crores

Weights

Value of
Company

Weighted Value

Market Cap

2

100

200

Income Method

2

95

190

NAV

1

150

150

Fair Value of Company

108

• Valuation on Power Company
Valuation Method Rs
Crores

Weights

Value of
Company

Weighted Value

Market Cap

2

NA

NA

Income Method^

2

90

180

NAV

1

50

50

Fair Value of Company
20/12/2013

^ considering 3 years forward earnings and 80-90% Capacity utilization basis

76.67

Pre and Post Shareholding
Pre Merger Shareholding of Steel Company
Category
Promoter

No of shares

Independent
Perspective

% Holding

5,000,000

50%

Public

5,000,000

50%

Total

10,000,000

100%

Pre Merger Shareholding of Power
Company
Category
Promoter

No of shares
5,000,000

100%

-

-

5,000,000

100%

Public
Total

% Holding

Post Merger Shareholding of Steel Company
Category
Promoter

No of shares

% Holding

12,099,074

71%

Public

5,000,000
17,099,074

Valuation of Power business on
as is basis – Rs.55 crores
Assets Method
Earnings Method (Includes
premium for the license)
Valuation of Power business
taking into account synergies
– Rs. 70 crores
An independent Buyer would
bid an amount in excess of
valuation on standalone basis
(Rs. 55 crores) and below
Synergy
valuation
(Rs.70
crores).

29%

Total

Buyer-Seller

20/12/2013

Acquisition
Price
finally
depend
Application
negotiations.
100%

would
on

Part – D

Some Specific Tricky Issues

Tricky issues in DFCF
 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 .
20/12/2013

Application

Tricky issues in DFCF (Cont.)
 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.

20/12/2013

Application

Discounts
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

• Discount for Entity Level
Key Person Discount
Discount for Contingent Liability

Global Studies over the years on diversified

Discount for diversified company
Discount for Holding Company

that companies trade at a discount in the range

companies and holding companies has shown
of 20%. to 40% each.

Tax Payout
•Discount for Shareholders Level – Impact on specific ownership interest
Discount Lack of Control (DLOC)
Discount Lack of Marketability (DLOM)
•% stake & special rights

DLOM:

As

per

CCI

Guidelines,

15%

discount has been prescribed; however
practically DLOM and DLOC depends
upon following factors:
20/12/2013

•Size of distribution or dividends
•Dispute
•Revenue / Earning – Growth / Stability
•Private Company
•Shareholders Agreement caveats

Premium
“Beauty lies in the eyes of the beholder; valuation in
those of the buyer”
•

An investor seeking to acquire control of a company is
typically willing to pay more than the current market price

Financial
Year

No. of
Transactio
ns

Median
Premium

2006

25

37%

2007

29

20%

2008

38

26%

2009

44

29%

2010

22

31%

2011

42

32%

Total

228

30%

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.
•

Control can be direct (shareholding or Authority to appoint
Board) or indirect (veto power, casting vote etc)

•

Research has shown that the control premium in India has
ranged from 20% to 37% in the past few years having
median of 30%.

20/12/2013

Application

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 ?

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.
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.
What is an asset is not yielding adequate returns ?
20/12/2013

Application

Cross Holding and Investments

Holdings in other firms can be categorized into:
Types of Cross Holding
Minority, Passive Investments

Meaning
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

Ways to value Cross Holding and Investments:
Investment Value

By way of

Dividend Yield Capitalization or DCF based on expected

Agreement

dividends
Separate Valuation (Preferred)

holding

20/12/2013

Application

Shareholders
even

may

control value

less

%

command

Accounting Practices and Tax issues
Most of the information that is used in
valuation comes from financial statements.
which

in

turn

Accounting

are

practices

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
20/12/2013

Application

made

on

certain

considered

Intangible Valuation
Identification of Intangible Assets:
• Market Related : Trade Marks, Service Marks etc.
• Customer Related : Customer Lists, Order backlogs etc.
• Artistic Related : Plays, Books, Pictures, Music, Video etc.
• Contract Related : Licensing, Royalty, Lease agreements etc.
• Technology Related : Patented Technology, Databases,
computer software's etc.

20/12/2013

Application

Intangible Valuation Cont.
Purchase Price Allocation
What is a Purchase Price Allocation?
-an acquiring entity must allocate the purchase price to the assets acquired
and liabilities assumed based on estimated fair values at the date of
acquisition;
-The excess of the cost of an acquired entity (including tangible and
intangible assets) over the net of the amounts assigned to assets acquired
and liabilities assumed is recorded as “Goodwill”;
Tangible Assets

Consideration
paid for
acquisition

Allocated to

Intangible Assets

Goodwill
20/12/2013

In
Proportion
to Fair
Value

Application

Balancing
Figure

Private Company Valuation
Valuation of Unlisted
Company..
Some Data Issues:
• Industry Misclassification
• Infrequent Collection
• Mixing Data from Different Sources
• Omission or Inclusion of Information
• Poor Data Quality
• Tiny Sample Size
Guidance Note:
The valuation of shares should be carried out on the gross profits earned by the Company, as held in
Rakhra Sports Private Limited and Ors. v. Khraithilal Rakhra and Ors. (1993) Vol. 74 CC 545
While carrying out the valuation of shares, the valuer must take into account the salaries and perquisites
paid to the directors and related party transactions.
20/12/2013

Application

Company Specific Factors
It is the alignment of
Company’s value via-avis to its external
environment
• Management, Promoter Group
• 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
20/12/2013

Application

Valuation Methodologies and Value Impact
Major Valuation Methodologies

Ideal for

Result

Net Asset Value
Net Asset Value (Book Value)

Minority Value

Net Asset Value (Fair Value)

Control Value

Equity Value

Comparable Companies Multiples (CCM) Method
Price to Earning , Book Value Multiple
EBIT , EBITDA Multiple

Minority Value

Equity Value
Enterprise Value

Comparable Transaction Multiples (CTM) Method
Price to Earning , Book Value Multiple
EBIT , EBITDA Multiple

Control Value

Equity Value
Enterprise Value

Discounted Cash Flow (DCF)
Equity

Control Value

Firm

20/12/2013

Equity Value
Enterprise Value

Application

Demerger resulted in increased shareholders value

Reliance Group

Market prices (In Rs)
Pre demerger

Post demerger

Reliance Industries

702

698

Reliance Capital Ventures

-

23

Reliance Communication
Ventures

-

292

Reliance Energy Ventures

-

43

Reliance Natural
Resource
“That is what

learning

is,

you

suddenly

18
understand

something you have understood all 702
your life, but in a 1074
new
TOTAL
way”
…………………………….. Doris Lessing

20/12/2013

Application

Chander Sawhney, Vice President
Corporate Professionals Capital Pvt. Ltd.
SEBI registered merchant banker
Email : chander@indiacp.com
Mobile: 9810557353; Direct: 40622252
www.corporateprofessionals.com;
D-28, South Extension, Part-I, New Delhi-110049

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