Evaluate the PE valuation performed by the financial manager
- Perspective of valuation
- Synergies not included if calculating minimum value to be accepted by shareholders
- Valuation should include maintainable income or expenses
- For value of the shares, have an adjustment for control- PE valuation is a minority valuation
- No indication of how premium for control was determined
- PE of XXX should not have been used as nature of business is different from YYY
- Use PE ratio of similar listed shares
- Adjust it for specific risks
- Synergies are double counted by including “after tax synergies expected” on maintainable income and adding control premium at the end
- profit is non recurring so should be deducted/what should be added back? (Add back if not incurred in future)
- If debt has no specific date of repayment should not be deducted
- If interest is included in earnings, then loan is already accounted for. Deducting it again is double counting.
- Loan considered quasi equity due to its terms?
- PE valuation is used as a sanity check
- PE ratio is less reliable as based on accounting earnings and should be used with caution
Earnings yield method
-Do not use it for a new business as growth rates are unavailable
Free Cash Flow
- Strange growth rates
-Possibility of a different rate post acquisition
-Working capital move with reasonable growth rate normally growth in revenue will approximate growth in working capital
-Anything that should have been reversed?
-What should be valued separately and deducted
-Any non operating items to be taken out and valued separately (interest income)
-What should increase in line with revenue?
-Capex can’t be less than depreciation and amortization (depreciation is historic; capex on current costs)
-high growth rates expected therefore high high CAPEX
-Consider correctness of Tax
Perpetuity:
-Has last CF been valued
-Last CF must be separately calculated
-Growth in excess of inflation
JUNE EXAM:
- MINORITY: The minority should not be removed (1). They removed the balance sheet minority amount first of all. Cannot do balance sheet value here (1), must remove at end, and then at market value, not book value. (1) Value whole company first, then remove minority at end if valuing the remainder.
- OTHER REVENUE: Correct to include if will be earned going forward. (1) There should be a tax adjustment on this adjustment. (1)
- DIRECTORS: Cannot remove all directors salaries, must only remove if there is going to be a proportionate reduction determined by the remuneration committee. (1) Also, must be after taxation effect. (1)
- TIMEVALUE: The cashflows as determined are at end of T1, as would presumably be the terminal value. Both of these must be discounted to PV.
- ASSETS: The value calculated is the value of the assets, determined using the earnings (1). If you add the assets, you are double counting. Can only add assets if they are dissimilar, and then remove earnings related to those assets from the cashflows (1). Also, cannot add these assets at book value, must be market value. (1) Value of assets is a different valuation technique, book value of assets approach (1)
- FINANCE COSTS: It is not clear whether finance costs were included in the continuing earnings figure, these should be removed there as liabilities are removed here (FCFF) (1). Also, should remove the tax deduction on the interest
- Not clear that valuation was adjusted for governance issues, additional risk, although may already be in poor performance.
- Has the effect of the reduced debt been factored into the valuation, and where is the optimal capital structure? Perhaps market values are not reflective here of forward capital structure.
- Has the full impact of the disposed non-core been factored into the valuation, removing profits, receiving cash, removing assets?
- How has COVID been incorporated into the valuation? Should be a short term effect likely to be negative, and then the new environment (digitisation) in the long term, which may benefit the company.
- How has the recapitalisation been incorporated into the valuation? Should amend the capital structure and WACC accordingly for the long-term structure.
- Also, the risk relating to the liquidity status at present. If they cannot successfully renegotiate or find alternatives finance sources, there could be a going concern issue.
Valuations considerations
- Do amounts in rep year represent only maintainable amounts
- Terminal value correctly calculated
- Non core operations correctly dealt with
- Removed non cash items and debt at market value
- Calculations for maintainance and capital expenditure correctly performed
Enterprise Value
- Less lack of marketability (25%)
- Discount smaller size (10%)
Dividend yield valuation
- DY valuation is a minority based valuation technique
- Can use it for majority interest but have to adjust for controlling premium
- It is an extension of EY methodology which is appropriate in valuing a GC
- Conclude if appropriate
Critically evaluate the cash flow forecasts
-unreasonable
-forecast growth is significantly higher than the inflation rate
-The revenue from warranties in other income is increasing faster than the
overall revenue is increasing
-cash flow forecasts as prepared do not explicitly incorporate the potential impact of Covid-19 on eg……
-consider growth forecasts for individual items and question them
Critic the CF valuation
-INDEPENDENT: The directors should perhaps engage an independent valuation expert to perform the valuation.
-PAT: Is a good starting point
-FORECAST: The company has included the current actuals, the valuation should not include actuals, only forecasts
-The actuals are only used to inform the forecasts
-WC: It is correct to adjust for working capital, and the majority of the WC items are correctly included as a movement.
-WACC: Correct to calculate the NPV using the company WACC.
-TERMINAL: The valuation has no terminal value included (1). A terminal value should be calculated once cash
flows are stable
-SYNERGY: No synergies have correctly been included in the forecasts, there perspective of the valuation is the
seller value
-WACC: The WACC of the competitor is acceptable as it should have similar risks
-INVESTMENTS: The investment income should be removed from the cash flows (1), including tax consequences cost of equity, and not their WACC (1), also there should be adjustment for any difference between the two companies (1). IT would however be ideal to us the WACC of Growthpoint and this should be determined
-DERIV: The derivative asset instruments are operational as they hedge the lease, therefore include in working capital. (1) The derivative liability instruments are speculative and different risk profile and should be removed from cash flows (1). They should be added at the end of the valuation as a dissimilar asset
-DEPRECIATION: No adjustment required for depreciation as approximates the replacement value of assets
-DEBT: Interest on debt should be removed as is included in the WACC already and remove tax portion
-LEASE: Remove straight line lease income adjustment, is not a cash element.
-BADDEBTS: Reverse expected credit losses on receivables, not cash. Incorp in working capital.
-ASSOC: Remove the unearned portion of the associate income, non cash movement.
-TRANSLATION: The translation of foreign operations is not a cash flow, has correctly not been included.
-RIGHTOFUSE: the lease liability and right of use asset should be removed and not in WACC, the interest charge and depreciation must be removed as not real assets (1), the actual lease payments should be included as cash flows
