VALUATION OF TARGET COMPANY

Valuation of a target company is a very critical step in the process of acquisition. Often, the acquirers end up valuing and paying for the target companies far more than their intrinsic value.
Valuation of Target Company is very important step in Acquisition so that the Acquisition does not end up destroying the value particularly for the shareholders of the Acquirer company. So very cautious but not pessimistic approach is required for the Valuation

BOOK VALUE
This is essentially accounting concept. Accounts are written on the basis of historical cost minus the depreciation on depreciable assets. Even the debt is recorded at its historical cost and not market value. In relation to equity shares, it means net worth divided by the number of outstanding shares.

Reinstatement or replacement value

This is an amount that a company would be required to spend if it were to replace all its existing assets by identical assets of identical capacity in the identical condition as existing assets.

Liquidation value or break-up value

This means market value of all assets of a company, if sold piecemeal after the closure of the business. This concept also ignores the value of intangibles. Further, this concept assumes the closure of business and therefore is not relevant at all for valuing a target company, wherein one needs to find out its intrinsic value on a going concern basis.

Market value
Market value of an asset or a security is the price at which it is currently being traded in the market. Market value of a company, i.e., market capitalization means number of outstanding equity shares multiplied by market price of the share. While in the long run, market price tracks the intrinsic value of a companys share, in the short run it does not represent intrinsic value.

Present value of future cash flows

Net cash flows mean cash flows from operations as adjusted for capital expenditure and changes in net working capital (NWC) or net current assets (NCA).

Enterprise value
It is the sum of the value of the stakes of all stakeholders whose funds have been deployed by the company in business. enterprise value includes value of equity shares, preference shares and secured and unsecured debt in the books of the company. It, however, does not include the value of creditors and liabilities and provisions since the same are netted out against the current/other assets while computing total funds deployed in the business.

VARIOUS METHODS FOR VALUATION OF THE TARGET COMPANY

Concept of Value of a Company Book Value Replacement Value Liquidation Value Market Value Present Value of Future Cashflows

METHODS OF ENTERPRISE AND EQUITY VALUATION

Asset Based Valuation Approach Relative Valuation Approach Capitalization of Earnings Approach Cash flow based Valuation Approach

ASSET BASED VALUATION APPROACH

Book Value Method Reinstatement Value Method Liquidation Value Method

Cont..
RELATIVE VALUATION METHOD Comparison with Industry Average Comparison with Comparable Companies

CAPITALIZATION AND CASHFLOW METHOD Capitalization of Earnings Approach Cash Flow based Valuation Approach Dividend Discount Model Enterprise DCF Model

NET ASSETS METHOD

Total Assets = Rs. 14,653 Lacs Loan Funds = Rs. 4828 Lacs Current Liabilities & Provisions = Rs. 1669 lacs No. of Outstanding Equity shares = 44 lacs Compute Net Asset value per share

Capitalization of Earnings Approach /Valuation of the firm basis P/E Ratio

A company has 4,00,000 equity shares of Rs. 100 each fully paid up. The companys expected earnings after tax is Rs.34,00,000 and its current P/E Ratio is 10. Calculate the value of the Firm.

 Valuation Method Applied Net Asset Method P/E Method Market Value

Value (Rs. Per share ) of TC 132 230 200

Value per share of Acquiring Company Net Asset Method 175 P/E Method 350 Market Value 150 Compute the swap ration basis the Net Assets method, P/E Method / Market value method

Following are the particulars of two cos A Ltd & B Ltd Particulars A Ltd BLtd EAT 2,00,000 60,000 No.of Equity shares o/s 8000 4000 EPS 25 15 P/E ratio 8 5 Market price 150 75 Calculate ---Exchange ratio based on EPS and Market price ---Value of the Firm post merger under different exchange ratio.

Acquirer

Target Rs.22 Rs.37.5 15 Rs. 2.5 8.8 330

Pre announcement stock price Rs. 30 Net Income (million) Rs. 80 Shares O/S ( million) 40 EPS Rs. 2 P/E 15 Market capitalization (million) 1200

Premium = Pt- Vt Acquirers gain = Synergies Premium Situation 1. All cash Transaction Price paid includes premium of 40%, Present value of synergies is estimated at Rs. 100 million. Calculate Premium and acquirers gain, gain loss to the shareholders of A and T.

Cont.
Case 2. If swap ratio of Vt/Va of 1.02667 is used Compute the fair value of a share of the merged firm assuming synergies of Rs. 100 million. Also compute the premium / gain to the seller and gain / loss to the acquirer.

Case 3. As offer is made up of Rs.15 cash plus .541 shares of A per share of T, assuming the synergies are Rs. 100 million. Compute the Premium, As gain / loss

CAPITAL ASSET PRICING MODEL (CAPM)

Given below the beta values for the three types of securities Security A (defensive) 0.5 Security B (moderate) 1.0 Security C (aggressive) 1.5 Risk free rate 5% Market return 15% Calculate the expected return of securities A, B&C

Dividend Discount Model

Where,
Po is the value of an equity share today, Pn is the price that is expected to be realized at the end of the holding period, n is the number of years for which the equity share is planned to be held, D1 to Dn are dividends expected to be received starting one year from now and r is the rate required by the investor for making this investment.

Case 1. When no growth is expected Po = D r Case 2 When perpetual growth at a constant rate is expected. Po = D1 (r-g)

Example
If dividend paid by XYZ Ltd last year was Rs.3 per year and it is expected that there will be no growth in the dividend for many years to come, also the investor needs 15% return to invest in the Equity shares of XYZ Ltd. the value of equity share of XYZ Ltd. today will be

 In the same example if it is expected that the dividend will perpetually grow by 10% p.a, calculate the value of equity share of XYZ Ltd. today.

Two Stage Dividend Growth Model

ABC Ltd. paid Rs 4 per share dividend last year. The dividend is expected to grow at 20% p.a for first six years and thereafter at 10% p.a perpetually. The rate of return required by the investor is 25% p.a.

Limitation of Dividend Discount Model

The Formula holds true only when g is lesser than the value of r i.e the growth rate is lower than the expected rate of return. Otherwise the formula leads to absurd results. Assumption of one single constant growth rate

Valuation Basis the Cash flow

The target Company is a small bulk drug firm that develops products which are licensed to major pharmaceutical firms. Development costs are expected to generate negative cash flows during the first two years of the forecast period of Rs. 10 and Rs. 5 Million resp. Licensing fees are expected to generate positive cash flows during years 3 to 5 of the forecast period of Rs. 5, 10 and 15 Million resp. Due to the emergence of Competitive products, cash flow is expected to grow at a modest rate of 5% annually after 5th year. The WACC for the first 5 years is estimated to be 20% and then to drop to 10% beyond the fifth year . In addition the PV of the estimated synergy by combining acquiring and target companies is 30 million. Calculate the minimum and the maximum purchase price for the target Company.