basics of valuation 03 12 10

8/8/2019 Basics of Valuation 03 12 10

http://slidepdf.com/reader/full/basics-of-valuation-03-12-10 1/30

1Confidential

Basics of valuation

3rd December 2010

R. Natarajan

Chief Operating Officer

Helion Advisors



Confidential 2

Agenda

Misconceptions about valuation

Fair Value

Fair value estimation

± Quoted Investments

± Unquoted Investments

Price of recent investment

Earnings multiple

Net Assets

Discounted Cash flows

Industry valuation benchmarks

SFAS 157

Valuation at different stages

Regulatory implications



3Confidential

3

" One hundred thousand lemmings cannot be wrong"

Graffiti



4 Confidential

What is valuation?



Confidential

Its all about perception

5

Rs 1500

Rs 15,000

Rs 50,000

Rs 150,000

Rs 350,000



Confidential

A philosophical basis for Valuation

Many investors believe that the pursuit of 'true value' based uponfinancial fundamentals is a fruitless one in markets where prices often

seem to have little to do with value

There have always been investors in financial markets who have

argued that market prices are determined by the perceptions (and

misperceptions) of buyers and sellers, and not by anything as prosaic

as cash flows or earnings

Perceptions matter, but they cannot be all the matter.

Asset prices cannot be justified by merely using the ³bigger fool´theory

6



Confidential

Misconceptions about valuation

Myth 1: A valuation is an objective search for ³true´ value ± Truth 1.1: All valuations are biased. The only questions are how much and

in which direction

± Truth 1.2: The direction and magnitude of the bias in your valuation is

directly proportional to who pays you and how much you are paid

Myth 2.: A good valuation provides a precise estimate of value

± Truth 2.1: There are no precise valuations

± Truth 2.2: The payoff to valuation is greatest when valuation is least

precise

Myth 3: . The more quantitative a model, the better thevaluation

± Truth 3.1: One¶s understanding of a valuation model is inversely

proportional to the number of inputs required for the model.

± Truth 3.2: Simpler valuation models do much better than complex ones

7



Confidential

Fair value

³Valuation is nothing else than arriving at fair value for transacting parties´

³Fair value is the price that would be received to sell an

asset or paid to transfer a liability in an orderly

transaction between at the measurement date´

± I ndependent

± Knowledgeable about the asset/liability

± Able ± Willing to transact

8



Confidential

What?

Business Valuation

± Acquisition

± Assessment of merger swap ratio

± Valuation of business segments

± Restructuring ± Share purchase/ investment/ fund raising

Valuation of Intangibles

± Brand or trade names

± Customer contracts and relationships

± Non compete agreements

± Software and technology

± Intellectual property

± Human resources

9



Confidential

Know what we are valuing

Enterprise value (EV) ± the market/ fair value of economic assets

Equity value ± the market/ fair value of the shareholders¶ equity, i.e.

the market/ fair value of the Enterprise value, once the debt has been

reimbursed

In some circumstances individual tangible (e.g. capital requirement)

and/ or intangible (e.g. trademarks, parents, contracts) assets are

independently valued

Certain liabilities may also be required to be valued

10



Confidential

Fair value estimation

Determine EV of Investee Company using the appropriate valuationmethodologies

Adjust EV for surplus assets, excess/ unrecorded liabilities and other

relevant factors

Make adjustments for any financial instrument ranking ahead of the

highest ranking instrument of the Fund in a liquidation scenario that

may dilute the Fund¶s Investment to derive the Gross Adjusted EV

Apply an appropriate Marketability Discount to the Gross adjusted EV

to derive Net Adjusted EV which is apportioned between thecompany¶s relevant financial instruments according to their ranking

Allocate the amounts derived according to the Fund¶s holding in each

financial instrument, representing their FV

11



Confidential

Quoted investments

Estimating value of investments quoted on active stock markets

At their bid prices on the reporting date

When bid price is not most representative the most representative

point estimate in the bid/ ask spread can be used

Discount should not be applied to prices quoted on active markets

unless there is some legal enforceable restriction which would impact

the value realized at the reporting date

The valuer may consider an option pricing model to value the impact of

any restriction on realization

12



Confidential

Unquoted investments

Estimating the Fair value of Unquoted investments ± Price of recent investment

± Earnings multiple

± Net Assets

± Discounted Cash flows

± Industry valuation benchmarks

Valuation methods for each investment should be selected separately

based on its appropriateness to that particular investment

Preferred methods to derive FV would be those methods that are

entirely based on observable market data rather than based onassumptions

Where more than one method is appropriate for a specific investment,

a combination of methods can be applied or value based on one

particular method can be cross checked with values based on other

methodologies13



Confidential

Price of recent investment

When the investment has been made recently, its cost provides a

good indicator of its FV

In case of recent investment by other investors, price of investment

can be taken as the FV

Also suitable for Start ups, seed stage situations ± where there are nocurrent assets, short term future earnings or positive cash flows

Appropriate for all private equity investments, but only for a limited

period post investments in the investee company

The length of period for which PRI would remain appropriate will

depend appropriate will depend on market conditions internal or

external environment post investment till the reporting date

The valuer attempts to assess whether changes or events have

occurred subsequent to the date of investment impacting the FV14



Confidential

Multiples method

Preferred method of valuation

Appropriate for an investment in an established business with

identifiable stream of maintainable earnings

Multiple method based on earnings can be used for valuingbusinesses with positive earnings ± P/E ratio, EV/ EBIT and EV/

EBITDA

However for businesses in development stage and prior to positive

earnings being generated, revenue multiple can be used as a basis for

valuation

Similar transactions ± Recent transactions involving the sale of similar companies are sometimes used as a

frame of reference to derive a reasonable multiple

± Not very popular due to lack of reliable pricing information for the transactions, lack of

reported earnings of private companies15



Confidential

Net Asset Value Method

Business whose value derives mainly from the underlying fair value of its assets rather than its earnings, such as property holding companies

and investment businesses (including Fund of Funds)

In the context of private equity ± for valuing investments in loss making

companies and companies making only marginal level of profits

16



Confidential

Discounted cash flow

DCF methodology uses the present value of future free cash flows of the underlying business of the investee company by using a

appropriate discount factor to derive the FV of the investee company

In PW context DCF methodology being flexible, can be applied in

situations where other methodologies are incapable of addressing.

E.g. cases where business is going though a period of great change,

turnaround, strategic repositioning or is loss making or it is in its start

up stage

As DCF involves high level of subjectivity, DCF valuations are

generally useful as a crosscheck for values estimated under marketbased methodologies

17



Confidential

Industry Valuation Benchmark

Industry specific benchmarks are used in specific industries such ascertain information technology and service sectors where long term

contracts is a key feature

This method assumes that investors are willing to pay for turnover or

market share and the normal profitability of business of similar

companies in the industry does not vary much

Valuation benchmarks includes industry norms such as

± µPrice per subscriber¶ ± Cable and telecommunication industry

± µPrice per bed¶ ± Nursing homer operators

This method is used to derive FV only in limited situations and can be

generally used as a sense check for values derived using other

methods

18



Confidential

Valuation guidelines and principles

SFAS 157

International Private Equity and Venture Capital Valuation guidelines

(IPEVC)

Private Equity Industry Guidelines Group (PEIGG)

³ I t is not requirement of accounting principles that these

guidelines are followed. However compliance with these

accounting principles can be achieved by following theguidelines´

19



Confidential

SFAS 157«

20

Valuation techniques

Market approach - U ses prices and information

generated by market transactions involving comparable

assets/ liabilities

Income approach - Converts future amounts to a

single present discounted amount

Cost approach - Amount currently required to replace

service capacity of asset

Preference of approach depends upon relevant circumstances!!



Confidential

SFAS 157

21

Levels of inputs

Level 1: Observable market

pricesLevel 2:Observable prices

other than quoted pricesLevel 3: U nobservable inputs

Quoted prices for similar assets andliabilities in active markets

Quoted prices for similar assets andliabilities in inactive markets

Observable inputs other thanQuoted prices

Inputs derived from / that can becorroborated by observable

market data

Entity¶s reporting data

Unobservable interest rates in a specified

currency (related to foreign currency

swaps)



22Confidential

Enough of theory and books

let us move to some reality check



Confidential

Valuation at different stages of business

23

Start up Mid Stage Growth

Team Team Performance

Potential Performance Potential

Potential



Confidential

Valuation at different stages of business

24

Linear Growth Non Linear Growth



Confidential

Alignment of interest

Rachet valuation Vs Fixed valuation

Promoter stake in the company

Skin in the game ??

Exits²alignment of interest between promoter and

Investor

ESOP, Salary issues,

25



26Confidential

³Convertibles a win-win situation´



27Confidential

³$50M valuation offered by investor

can be expensive than $30M asked by

entrepreneur´

³Understanding the technicalities and

other conditions of valuations is

equally important´



Confidential

Regulatory implications

RBI guidelines ± Change from CCI pricing to DCF

Foreign investor cant buy lesser than Fair market Valuation

Foreign investor cant sell higher than Fair marker Valuation

Pricing of the capital instruments that the Indian companies can issue

under the FEMA regulations, should be ³« decided/determined

upfront at the time of issue of such instruments´ - Issues related to

valuation mismatch?

Secondary purchase/ sale between non residents is all full of

ambiguity around withholding taxes

28



Confidential 29

India Focused

Twin opportunityGrowing domesticmarket

Globaloutsourcing

Multi-stage VentureInvestment range from $2 -

10M

Dual focus themes Indian consumer-services businesses

Technology-powered businesses

Active

Capital

+

*

Helion Ventures « The Journey So Far

Started in June 2006 with $140M fund and raised another fund of $208M in

February 2008



30Confidential

Thank You

basics of valuation 03 12 10

Documents