Valuation of
Shares /Business
Pune West Study Circle
- CA Sujal Shah
November 14, 2010
Valuation Concept

Value – Price

Valuation not an exact Science, More of Art and
Subjective assessment

Value varies with situations

Date specific
Purchase /
Sale of
Business
Merger/
Demerger
Private
Equity
Buyback of
Shares
Test of
Impairment/
IFRS
IPO/ FPO
Why
Valuation?
Litigation
Family
Separation
PPA
Regulatory
Approval
Portfolio Value
of Investments
Steps in Valuation

Obtaining information

Management Discussion and
Industry Overview

Data analysis and review

Selection of method

Applying Method

Conducting sensitivities on
assumptions

Assigning Weights

Recommendation

Reporting
Sources of Information

Historical data such as audited results
of the company

Future projections

Stock market quotations

Discussions with the management of
the company

Representation by the management

Data on comparable companies

Market surveys, news paper reports
Analysis of Company

SWOT Analysis

Profitability Analysis- Past and
vis-à-vis industry

Ratio Analysis

P&L Ratios


Expense & Profitability ratios
Balance Sheet Ratios

Quick Ratio/ Current Ratio

Turnover Ratios

Liquidity Ratios

Debt Equity- of Company &
Industry
Principal Methods of Valuation
Earning based approach
• Discounted Cash Flow
• Earnings Multiple Method
Market Approach
• Market Price
• Market Comparables
Asset Based Approach
• Net Assets Method
• Replacement Value/Realisable Value
Common Adjustments
Following adjustments may be called for:

Investments

Surplus Assets

Auditors Qualification

Preference Shares

ESOPs / Warrants

Contingent Liabilities/Assets

Tax concessions

Findings of Due Diligence Reviews
FDI In India - Revised Pricing Guidelines
As per RBI circular dated May 4, 20101) Transfer of shares by Resident to Non-resident (i.e. to foreign
national, NRI, FII and incorporated non-resident entity other than
erstwhile OCB)
In case of listed companies- the price shall not be less than the price at
which a preferential allotment of shares can be made under the SEBI
Guidelines
In case of unlisted companies - the price shall not be less than the fair
value to be determined by a SEBI registered Category – I - Merchant
Banker or a Chartered Accountant as per the discounted free cash flow
method.
2) Transfer of shares by Non-resident (i.e. by incorporated non-resident
entity, erstwhile OCB, foreign national, NRI and FII) to Resident
The price shall not be more than the minimum price at which the transfer
of shares can be made from a resident to a non-resident as given above.
Discounted Cash Flow (DCF)

Considers Cash Flow and Not
Profits

Cash is King

Free Cash Flow (‘FCF’)

FCF to Firm

FCF to Equity
DCF – Parameters
Cash Flows

Projections

Horizon period

Growth rate
 Discounting
 Cost of Equity
 Cost of Debt
 Weighted Average Cost of
Capital (‘WACC’)

Cash Flows
Business
Plan
Business
Cycle
Capital
Expenditure
Working
Capital
Depreciation
Amortization
Tax
DCF - Projections
Factors to be considered for reviewing
projections:

Industry/Company Analysis

Dependence on single customer/ supplier

Installed capacity

Existing policy/ legal framework

Capital expenditure – increasing capacities

Working capital requirements

Alternate scenarios / sensitivities
DCF – Discounting
Weighted Average Cost of Capital (WACC)
WACC =
D
(D + E)
x
Kd
D = Debt
E = Equity
Kd = Post tax cost of debt
Ke = Cost of equity
+
E
x Ke
(D + E)
DCF - Terminal value
Terminal Value is the residual value of business at the
end of projection period used in discounted cash flow
method.
Terminal Value
Liquidation
Approach
Multiple
Approach
Stable Growth
Approach
15
DCF – An Example
Particulars
Operating PBT
Add: Inflows
Interest
Depreciation
Total Inflows
Less: Outflows
Capital Expenditure
Incremental Working Capital
Tax
Total Outflows
Free Cash Flows (FCF)
Free Cash Flow for 2014-15
Growth Rate
Capitalised Value for Perpetuity
Discounting Factor
14.00%
Net Present Value of Cash Flows
Enterprise Value
Less: Loan Funds
Less: Contingent Liabilities
Less: Preference Share Capital
Add: Surplus Funds
Add: Value of Investments
Adjusted Value for Equity Shareholders
No. of Equity Shares
Value per share (FV Rs. 10)
(Rs. In Mn)
2010-11 2011-12 2012-13 2013-14 2014-15 Perpetuity
170
187
205
226
248
69
81
320
70
85
342
72
90
367
73
94
393
75
99
422
25
39
56
120
200
25
49
62
136
206
25
61
68
154
212
25
54
75
154
239
25
62
83
169
252
0.88
175
0.77
159
0.67
143
0.59
141
0.52
131
252
2%
2,145
0.52
1,114
1,864
(350)
(50)
(800)
120
1,000
1,784
79,69,000
224
Earnings Multiple Method
Commonly used Multiples
Price to Earnings
Multiple:
•Market Cap/PAT
Enterprise Value
to EBITDA
Multiple:
•Enterprise Value/EBITDA
Sales Multiple:
•Enterprise Value/Sales
Price Earnings Capitalization Method
(PECV) - Parameters
Future Maintainable Profits
Appropriate Tax Rate
Capitalisation Rate/Multiple
PECV

Based on past performance and /or projections

Non-recurring & extraordinary items excluded

Profits of various years are averaged (simple or
weighted). Current
profit is accorded the
highest weight

Projected profits discounted for inflation

By applying effective tax rate,
maintainable profit

Finally appropriate multiple is applied to arrive
at the value
arrive at
Multiples

Multiples to be applied represent
growth prospects/ expectations of
Company
the
the

Factors to be considered while deciding the
multiple:

Past and Expected Growth of the Earnings

Performance vis-à-vis Peers

Size & Market Share

Historical Multiples enjoyed on the Stock
Exchange by the Company and its peers
PECV – An Example
Calculation of Adjusted Profit Before Taxes (PBT)
Particulars
Reported PBT
(Rs. in Mn.)
2007-08 2008-09 2009-10
98
116
136
Less: Non recurring / Non operating Income
Profit on sale of investments
Dividend Income
Profit on sale of fixed assets
Interest Income
Other income
Total of Non Recurring Income
Add: Non recurring Expenditure
VRS written off
Preliminary Expenditure
Loss on sale of fixed assets
Amortisation of Share Issue Expenses
One time settlement amount paid to third party
Total of Non Recurring Expenditure
Adjusted PBT
28
25
4
7
10
74
17
15
18
15
20
9
10
51
7
15
8
15
15
10
10
10
63
9
15
-
32
48
10
58
92
56
113
165
-
-
PECV – An Example (Contd.)
EARNINGS MULTIPLE METHOD- PE MULTIPLE
Particulars
2007-08
2008-09
2009-10
Total
Maintainable PBT
Less: Taxes
Maintainable PAT
PE Multiple
Capitalised Value
Adjustments
Add: Deferred Tax Asset
Less: Preference Share Capital
Add: Value of Investments
Less: Contingent Liabilities
Add: Surplus Funds
Equity Value
No. of Equity Shares
Value per Share (FV Rs. 10 )
Adj. PBT
Weight
56
1
113
2
165
3
6
33.22%
(Rs. in Mn.)
Product
56
225
495
776
129
(43)
86
14
1,210
20
(800)
1,000
(50)
120
1,500
79,69,000
188
Market Price Approach

Evaluates the value on the basis of prices quoted on
the stock exchange

Thinly traded / Dormant Scrip – Low Floating Stock

Significant and Unusual fluctuations in the Market Price

It is prudent to take weighted average of quoted
price for past 6 months

Regulatory bodies often consider market value as
important basis – Preferential allotment, Buyback,
Takeover Code
Market Price Method – An Example
Month
April-10
May-10
June-10
July-10
August-10
September-10
Total
Value per Share (in Rs.)
Volume
3,47,47,312
1,20,40,227
1,96,63,244
1,61,18,953
1,81,15,567
2,99,08,604
13,05,93,907
Turnover
4,60,92,75,753
1,67,78,68,740
2,47,62,64,011
2,50,32,16,645
3,03,70,62,216
5,53,54,15,743
19,83,91,03,108
152
Market Comparables

Generally applied in case of unlisted
entities

Estimates value by relating an element
with underlying element of similar
listed companies.

Based on market multiples of
Comparable Companies

Book Value Multiples

Industry Specific Multiples

Multiples from Recent M&A Transactions .
NAV Formula
The Value as per Net Asset Method is arrived as follows:
Total Assets
(excluding Miscellaneous Expenditure and debit balance
in Profit & Loss Account)
Less: Total Liabilities
NET ASSET VALUE
OR
Share Capital
Add: Reserves
Less: Miscellaneous Expenditure
Less: Debit Balance in Profit & Loss Account
NET ASSET VALUE
NAV – An Example
Particulars
Net Fixed Assets
Investments
Deferred Tax Asset (Net)
Current Assets,Loans & Advances
Current Liabilities & Provisioins
Net Current Assets
Loan Funds
Net Assets Value
Add/ (Less): Adjustments
Appreciation in value of Investments
Contingent Liabilities
Preference Share Capital
Adjusted Net Assets
No. of Equity Shares (FV - Rs. 10 each)
Net Assets Value per Share
(Rs. in Mn.)
Amount
Amount
700
950
20
1,290
(960)
330
(350)
1,650
50
(50)
(800)
850
79,69,000
107
Selection of Methods
Situation
Knowledge based companies
Manufacturing Companies
Approach
Earnings/Market
Earnings/ Market/ Asset
Brand Driven companies
Earnings/Market
A Matured company
Earnings/Market
Investment/Property companies
Asset
Company going for liquidation
Asset
Generally Market Approach is used in Combination
with other methods or as a cross check
Reaching a Recommendation

Methods throw a range of values

Consider the relevance of each methodology
depending upon the purpose and premise of
valuation
Mathematical weightage
Professional judgment
Subjective Value



Fair Value
Method
Net Assets Method
PECV Method
DCF Method
Market Price Method
Total
Fair Value per share (in Rs.)
Value per
Share (In Rs.)
107
188
224
152
Weight
1
1
1
2
5
(In Rs.)
Product (In
Rs.)
107
188
224
304
823
165
Other Value Drivers
Final Value
Final Price is a result of negotiations
Documentation


Appointment Letter
 Purpose & Scope of Valuation
 Valuation Date
 Commonly used Methodologies
 Timelines
 Fees
 Limitations
Representation Letter
 No material omissions on part of the
management
 Confirmation of all inputs/ information used in
the valuation
 Responsibility for providing information lies
with Management
Valuation Report

Introduction/ Background

Purpose of Valuation

Key Financials

Sources of Information

Methodologies of Valuation

Important consideration & assumptions

Valuation Workings

Fair Value Recommendation

Exclusions and Limitations
Case Laws
“Exchange Ratio not disturbed by Courts unless objected
and found grossly unfair”
Miheer
H. Mafatlal Vs. Mafatlal Industries (1996) 87 Com
Cases 792
Dinesh
v. Lakhani Vs. Parke-Davis (India) Ltd. (2003) 47
SCL 80 (Bom)
“Valuation will take into account number of factors such
as prospective yield, marketability, the general outlook for
the type of business of the company, etc. Mathematical
certainty is not demanded, nor indeed is it possible ”
Viscount
Simon Bd in Gold Coast Selection Trust Ltd. vs.
Humphrey reported in 30 TC 209 (House of Lords)
Valuation is not an
objective exercise.
Any preconceptions
and biases that an analyst
brings to the process will
find their way into the
value.