Business Valuation and Corporate Restructuring

Dr. Latha Chari

Course Coverage
Fundamentals of Business Analysis role of financial reporting, Elements of business analysis EIC approach (1) Business analysis cases (2) Business valuation models Concepts (1) Application of valuation methods Cases (3) Project and Presentation (2)

Assessment
2 Class tests 15% weightage 1 Project 20% weightage End term 50% weightage

Books - Reference
Business Analysis and Valuation Healy and Palepu Damodaran on Valuation Valuation McKinsey publication Mergers and Acquisitions Kamal Gosh Ray

Todays class
Introduction scope and EIC approach Understand Business analysis Need, Stages Understand the objectives of analysis in each stage from a equity valuation perspective

Business Analysis
Analysis of various performance dimensions of a business with objectives like Internal decision making - New project expansion, competitive strategy for the forthcoming year etc. External decision stock investment, acquisitions, mergers, PE, VC, lending decisions, rating decisions etc.

HOW THE INFORMATION NEEDS ARE MET ?

Management

External stakeholders

MIS Financial reports

Financial reporting (Measures and reports the economic consequences of business activities)

Elements of Business analysis

All business analysis is done using data available in the public domain in most cases. The Elements: Business strategy analysis Accounting analysis Financial Analysis Prospects & projections

The Importance of Strategy Analysis

Strategy drives the actions of an organization. Studying a firms strategy helps to identify the Sources of Value Creation. IT provides: An understanding of what drives risks, profitability, and competitive advantages A basis for future performance to be forecasted An idea of how to measure the success of a firms actions

Sources of Value - Multi business

Multi-business Strategy measure economic consequences of managing multiple businesses hard to practice !!! Its generally found that multi businesses trade at a discount compared to focused business Value is unlocked by spinoffs or asset sales Examples: Reliance, Godrej Industries, L&T Reasons- Multi-business decision driven by SIZE, Problem of goal congruence, alignment, capital markets find valuation difficult* ?? (*Do u agree??)

Comparative valuation ratios

Sources of Value Special resources

Brand name, proprietary know-how, Spl. Organisational processes, distribution channel Examples ARE THESE SPECIAL RESOURCES SUSTAINABLE??

Sources of Value - Acquisition

Related business Unrelated business Which of them create value??? India examples: Top deals in 2011 The Reliance BP deal, Essar exits Vodafone (Unrelated), Fortis Healthcare (India) Ltd, announced that it will merge with Fortis Healthcare International Pte Ltd.,

Industry Analysis - Key concepts

WHY Industry analysis Porters five forces Competitive strategy analysis Corporate strategy for multi business organisation

Industry affects firm

Firms strategy is affected by the Industry Environment and competitive forces within the industry affect firm Risk and return attributes of various industries vary Returns tend to vary across industries at different points in the business cycle. Industry performance (and risk) is not necessarily stable over time (industry life cycle) Industry structure and competition determines performance

Porters model Five forces

Bargaining power of suppliers

Bargaining power of Customers

Threat of new entrants

Threat of Substitutes
If there are substitutes with low prices and similar performance parameters, this can prove to be a threat to existing products.

Competitive Rivalry

Industrys sensitivity to business cycles

Low sensitivity Pharma, Utilities, Defence High sensitivity Durables, capital goods, Auto, Construction How to measure sensitivity Plot Industry sales across various time periods and compare with GDP growth, Industrial production index (SALES SENSITIVITY)

Industrys sensitivity to business cycles

Firms with greater variable (and less fixed) costs are less sensitive to business conditions Firms with high fixed costs (high operating leverage) are more risky as small swings in business conditIons have large impact on profitability. (Leverage sensitivity)

Accounting Analysis
Evaluate the appropriateness of accounting policies Assess the degree to which the firms accounting captures business performance UNDO accounting distortions

What to look for in accounting analysis?

Poor performance with unexplained changes in accounting Unexplained transactions that boost profits Increase in accounts receivables, inventory, high Gap between operating profits and operating cash flows, tax income and reported income Unexpected large asset write offs Auditors reports and related party transactions Change in accounting policy, contingent liabilities

Revisit - Financial Accounting

OWN or control resources?? Depreciation/impairment estimates intangible and tangible assets Unearned revenue understated examples Liability Loans from discounted receivables with or without recourse Lease liability distortions Warranty, pension, post retirement obligations

Financial analysis
Growth and Profitability analysis Growth Revenue, profits and assets Profitability Margin on sales and capital Asset utilization affects profitability Techniques Decomposition of drivers and analysis Common size statements

Economy Vs.Markets
Are stock returns associated with global and domestic macroeconomic conditions? Examine the association of stock prices with: Global Economy The Domestic Macro-economy Government Policies Business Cycles

Global Economy
Firms export prospects, access to FDI, competitiveness affected by global economy. Impact of financial crisis of 2007 liquidity access to finance, FDI; employment, consumer demand, foreign investments, protectionist policies. Exchange rates Investor confidence

Domestic Macro-economy
A key ingredient of company growth (which is important in the determination of cash flows) is the growth in the economy. All other things equal, any company will do better in a young, growing and prosperous economy, versus an older, over-regulated economy with a lower growth rate (that is why large companies in mature economies are always searching for new markets in economies at an earlier stage of development). Economic growth can depend on government policy which aims to fine tune the economy (boost or ease demand, control the inflation, unemployment etc) Government policy can also affect interest rates and inflation that in turn determine the required rate of return.

Demand and Supply Shocks

(Industry impact)

Oil price changes, Nilam the storm Destroys crops, etc.

What is business cycle?

Recurring pattern of recession and growth Transition points are peak and troughs

Leading and lagging indicators of business cycles

Average weekly hours of Manufacturing Weekly average number of hours worked by production personnel in manufacturing industries. Because employers typically make adjustments to work hours before expanding or reducing their workforce, this indicator leads the business cycle Employment /unemployment data

Leading and lagging indicators of business cycles

Building permits, new private housing units: Number of residential building permits issued signifies the level of construction activity, which usually precedes most other types of economic production.

Leading and lagging indicators of business cycles

Stock prices, Index Manufacturers' new orders, consumer goods and materials Manufacturers' new orders, non-defense capital goods Interest rate spread, 10-year Treasury bonds minus federal funds Corporate Advance tax

Leading and lagging indicators of business cycles

Industrial production index and manufacturing trade and sales, are coincidental indicators The lagging indicators include inventory to sales ratio, consumer credit, retailer loans etc.