Tài chính ngân hàng - Valuing private companies: Factors and approaches to consider

Valuing Private Companies:Factors and Approaches to ConsiderPresenterVenueDatePublic vs. Private Valuation:Company-Specific DifferencesPrivate FirmsPublic FirmsLess matureLater in life cycleSmaller size   risk   risk premiums Larger and have access to public financingManagers often have substantial ownership positionGreater external shareholder ownershipPotentially  quality & depth of managementGreater quality & depth of managementPublic vs. Private Valuation:Company-Specific DifferencesPrivate FirmsPublic FirmsLower quality of information disclosure   risk &  valuations  pressure to make timely, detailed disclosuresShareholders have a longer-term perspectiveMore emphasis on short-term performanceGreater emphasis on tax managementLess emphasis on tax managementPublic vs. Private Valuation:Stock-Specific DifferencesPrivate FirmsPublic FirmsShares are less liquid  liquidity discountGreater number of shareholdersConcentration of controlShare ownership and control are more diffusePotential restrictions on sale of sharesPublic market for sharesReasons for Private Equity ValuationsTransaction Related Private financingIPOsAcquisitionsBankruptcyCompensationCompliance RelatedFinancial reporting Tax reportingLitigation RelatedDamagesLost profitsShareholder disputesDefinitions of “Value”Fair Market Value Tax reportingMarket Value Real estate and tangible asset appraisalFair Value Financial reporting and litigationInvestment Value Private company saleIntrinsic Value Investment analysisPrivate Valuation ApproachesIncome ApproachBased on the present value of expected future cash flows or incomeMarket ApproachBased on pricing multiples from sales of similar companiesAsset-Based ApproachBased on the value of the company’s net assets (assets minus liabilities) Earnings NormalizationReported EarningsAdjustments (For nonrecurring, noneconomic, unusual items)Normalized Earnings (Earnings capacity of the business if it is run efficiently)Example: Earnings NormalizationExampleAdjustment to Income StatementPrivate firm CEO is paid $1,200,000. Analyst estimates market rate for CEO is $800,000.Reduce SG&A expenses by $400,000.Firm leases a warehouse for $200,000/year from a family member. Analyst estimates market rate is $300,000. Increase SG&A expenses by $100,000.Firm owns a vacant building that has reported expenses of $90,000 and depreciation expenses of $15,000. The building is noncore.Reduce SG&A expenses by $90,000. Reduce depreciation expenses by $15,000.Firm may be acquired by a strategic Buyer A that expects synergies with cost savings of $230,000. Buyer B is a financial buyer.Reduce SG&A expenses by $230,000 when calculating normalized earnings for Buyer A, but not for Buyer B. Cash Flow EstimationFree Cash Flow to the Firm (FCFF)Start with normalized earningsRemove interest expenseInclude an estimate of income taxes on operating incomeAdd back depreciationSubtract a provision for capital expenditures and working capitalFree Cash Flow to Equity (FCFE)Start with FCFFSubtract after tax interest expenseAdd net new borrowingIncome Approach: Three MethodsFree Cash Flow Based on the present value of future estimated cash flows and terminal value using a risk-adjusted discount ratePV of expected future cash flows + PV of terminal valueCapitalized Cash Flow Based on a single estimate of economic benefits divided by an appropriate capitalization rateResidual Income (Excess earnings) Based on an estimate of the value of intangible assets, working capital, and fixed assetsCapitalized Cash Flow MethodVf = FCFF1/(WACC – gf)Vf = Value of the firmFCFF1 = Free cash flow for next 12 monthsWACC = Weighted average cost of capitalgf = Sustainable growth rate of FCFFVe = FCFE1/(r – gf)r = Required return on equityg = Sustainable growth rate of FCFEExcess Earnings MethodResidual income = Normalized earnings – (Return on working capital) – (Return on fixed assets)Value of intangible assets =Value of the firm = Working capital + Fixed assets + Intangible assetsWorking capital$400,000 Fixed assets$1,600,000 Normalized earnings$225,000 Required return for working capital5%Required return for fixed assets12%Growth rate of residual income3%Discount rate for intangible assets18%Example: Excess Earnings MethodExample: Excess Earnings MethodReturn on working capital = 5% x $400,000 = $20,000 Return on fixed assets = 12% x $1,600,000 = $192,000Residual income = $225,000 – $20,000 – $192,000 = $13,000Value of intangible assets = ($13,000 x 1.03) / (0.18 – 0.03) = $89,267Value of firm = $400,000 + $1,600,000 + $89,267 = $2,089,267Discount Rate Estimation IssuesSize PremiumsSize effect can increase discount rateCost DebtRelative availability may be limited  increased cost of debtHigher operating risk  increased cost of debtDiscount Rates in an Acquisition ContextShould be consistent with cash flows, not buyer’s cost of capitalProjection RiskUncertainty associated with future cash flowsLife Cycle stageClassification, early stage difficulties, company-specific riskRequired Rate of Return ModelsCAPM Rf Βi(equity risk premium) Expanded CAPM Rf Βi(equity risk premium)Small stock premium Company-specific riskBuild-Up ApproachRf Equity risk premium Small stock premium Company-specific risk Industry risk premiumRisk-free rate1.00%Equity risk premium6.00%Beta1.50%Small stock premium4.00%Company-specific risk premium1.50%Industry risk premium1.20%Example: Required Return ModelsExample: Required Return ModelsCAPM 1.00% 1.50(6%) = 10.00%Expanded CAPM 1.00% 1.50(6%) 4.00% 1.50%= 15.50%Build-Up Approach 1.00% 6.00% 4.00% 1.50% 1.20%=13.70%Market Approach: Three MethodsGuideline Public Company Based on the observed multiples of comparable companiesGuideline Transactions Based on pricing multiples from the sale of entire companiesPrior Transaction Method Based on actual transactions in the stock of the private companyGuideline Public Company MethodIdentify group of comparable public companiesDerive pricing multiples for the guideline companiesAdjust pricing multiples for relative risk and growth prospectsGuideline Transactions MethodMost relevant for valuing the controlling interest in a private companyTransaction data based on public filings by parties to the transaction or from certain transaction databasesFactors to consider in assessing pricing multiples:SynergiesContingent considerationNoncash considerationAvailability of transactionsChanges between transaction and valuation datesPrior Transaction MethodUnderlying PrincipleBased on actual transactions in the stock of the subject companyBased on either the actual price paid or the multiples implied from the transactionMost relevant when valuing the minority equity interest of a companyAdvantagesProvides the most meaningful evidence of value since it based on actual transactions in the company’s stockDisadvantagesIt can be a less reliable method if transactions are infrequentExample: Guideline Public Company MethodMarket value of debt$6,800,000.00 Normalized EBITDA$28,000,000.00 Average MVIC/EBITDA multiple 9.00 Control premium from past transactions20.00%Discount for increased risk18.00%Example: Guideline Public Company MethodPublic price multiple will be deflated by 18 percentDue to increased risk of private firmIf buyer is strategicA control premium of 20 percent from previous transactions is applied If buyer is nonstrategicNo control premium is applied Example: Guideline Public Company MethodStrategic BuyerRisk adjustment: 9.0 × (1 – 0.18) = 7.4Control premium: 7.4 × (1 + 0.20) = 8.9Value of firm: 8.9 × $28,000,000 = $249,200,000Value of equity: $249,200,000 – $6,800,000 = $242,400,000Example: Guideline Public Company MethodFinancial BuyerRisk adjustment: 9.0 × (1 – 0.18) = 7.4The control premium is not appliedValue of firm: 7.4 × $28,000,000 = $207,200,000Value of equity: $207,200,000 – $6,800,000 = $200,400,000Asset-Based ApproachUnderlying PrincipleThe value of ownership is equivalent to the fair value of its assets less the fair value of its liabilitiesRarely Used for Going Concerns Difficulty in valuingintangible assetsspecial purpose tangible assetsindividual assetsMost Appropriate forResource firmsFinancial services firmsInvestment companies (real estate investment trusts, closed-end investment companies)Small businesses with limited intangible assets or early stage companiesValuation Discounts/PremiumsDiscountsAmount or percentage deduction from the value of an equity interestLack of Control Discount (DLOC)Reflects the absence of some or all controlDLOC = 1 – [1/(1 + Control premium)]Lack of Marketability Discount (DLOM)Reflects the absence of marketabilityApplied when valuing a noncontrolling interest DLOC ExampleGiven a control premium of 19 percentValuation DiscountsEstimated Value of Equity InterestPro rata value of equity interestLack of control discountLack of marketability discountEstimated Value of Equity InterestPro rata value of equity interest x (1 – Control discount)x (1 – Marketability discount)Valuation DiscountsGiven a DLOC of 20 percent & DLOM of 16 percentValuation StandardsObjectiveTo protect third party users by promoting and maintaining a high level of trust in the appraisal and valuation practiceFunctionTo provide generally accepted and recognized standards for appraisals and valuationsTo establish requirements for impartiality, independence, objectivity, and competent performanceInternational Valuation Standards (IVS) Focus on business valuation, real estate, and tangible assetsAdopted by 53 countriesSummaryDifferences between Private and Public CompaniesCompany specificStock specificReasons for Private Company ValuationsTransactionsCompliance (financial or tax reporting)LitigationDefinitions of ValueFair market valueMarket valueFair value for financial reporting or in a litigation contextInvestment valueIntrinsic valueSummaryValuation MethodIncome approach: Free cash flow, capitalized cash flow, and residual income methodsMarket approach: Guideline public company, guideline transactions, and prior transaction methodsAsset-based approachDiscountsLack of controlLack of marketabilityValuation StandardsCover the development and reporting of valuationsProtect users and the public