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MBBI Breakfast Meeting

MBBI Breakfast Meeting. March 4, 2003 Stephen Pawlow American Express Tax and Business Services. Business Valuations in the M & A Market. An Overview. Agenda. Standard Setting Organizations - Where to find valuation professionals Definitions of Value The 3 Valuation Methodologies

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MBBI Breakfast Meeting

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  1. MBBI Breakfast Meeting March 4, 2003 Stephen Pawlow American Express Tax and Business Services

  2. Business Valuations in the M & A Market An Overview

  3. Agenda • Standard Setting Organizations - Where to find valuation professionals • Definitions of Value • The 3 Valuation Methodologies • Income • Market • Asset

  4. Agenda - continued • Private Company Adjustments • Financial Add Backs • Frequent Valuation Mistakes • Areas of Controversy • How to Value Synergy

  5. Major Valuation Standard Setting Bodies • Appraisal Foundation (“www.appraisalfoundation.org”) • Business Valuation Resources (“www.bvresources.com”) • American Society of Appraisers (“www.appraisers.org”) • National Association of Certified Valuation Analysts (“www.nacva.com”) • Institute of Business Appraisers (“www.instbusapp.org”) • American Institute of Certified Public Accountants (“www.aicpa.org”) • Internal Revenue Service - Taxable transactions • Department of Labor - ESOP’s

  6. What Does “Value” Mean? • Fair Market Value - the amount at which property would change hands between a willing buyer and a willing seller when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts (Revenue Ruling 59-60, 1959-1 CB 237) • assumes hypothetical parties • accounts for valuation discounts

  7. What Does “Value” Mean? • Fair Value - statutory standard of value which is granted particularly in dissenting shareholders matters in most states’ business corporation act. • no universal definition of fair value • common “definition” is the value of the dissenting shareholders interest immediately prior to the transaction which gave rise to the dispute without considering the impact the transaction might have on the corporation’s shares • state by state, regulatory and case law definition of value

  8. What Does “Value” Mean? • Investment Value - value to a particular investor based on individual investment requirements, as distinguished from the concept of market value, which is impersonal and detached. • Intrinsic Value - value based on the perceived characteristics inherent in the investment, not tempered by the characteristics peculiar to any one investor.

  9. What Standard of Value Applies? • Gift and Estate Taxes - Fair Market Value • ESOPS - Fair Market Value • Financial Acquisitions - Fair Market Value • Strategic Acquisitions - Investment Value • Dissenting Shareholders - Fair Value • Buy-Sell Agreements - Anything the parties choose to agree on

  10. Valuation Approaches -Income Approach • Income Approach -- directly values a company based upon its sustainable, normalized cash flow capabilities • capitalized historical cash flow • discounted future cash flow • Discount Rate -- quantifies the risk of investing in the subject company • quantify after tax cost of debt • quantify cost of equity (i.e., capital asset pricing model) • determine appropriate weighting of the capital structure (i.e., mix of debt and equity) • considers sustainable long-term growth of company

  11. Income Approach - Continued • Measures of Income Used to Establish the Value of Shareholders Equity and Business Enterprise Value: • Net Free Cash Flow • EBITDA • Less: depreciation and amortization • Less: Interest expense • Less: taxes • Plus depreciation and amortization • Less: capital expenditures • Plus / minus: Changes in working capital • Plus / minus: Additions / Repayments of Debt • Equals: Net Free Cash Flow • Appropriate discount rate: Cost of Equity • Calculation result: • Fair market value of equity • Plus debt • Equals: Business Enterprise Value

  12. Income Approach - Continued • Measures of Income Used to Establish the Value of Shareholders Equity and Business Enterprise Value: • Debt Free Cash Flow • EBITDA • Less: depreciation and amortization • Less: taxes • Equals: debt free net income • Plus: depreciation and amortization • Less: capital expenditures • Plus / minus: Changes in working capital • Equals: Debt free cash flow • Appropriate discount rate: Weighted Average Cost of Capital • Calculation result: • Business Enterprise Value • Less: debt • Equals: Fair market value of equity

  13. Valuation Approaches -Market Approach • Market Approach -- values a company compared to other similar companies • compares market multiples of similar publicly traded firms; • compares market multiples of merger and acquisition transactions of similar firms; and, • actual transaction prices of the company’s own stock • May be difficult to apply if no comparable firms can be found

  14. Valuation Approaches -Market Approach • Sources of Market Data • Bloomberg Financial Services • Compustat • Pratt Stats • IBA • Done Deals • BizComps • BVMarketdata.com

  15. Valuation Approaches -Asset Approach • Asset Approach -- values a company by “marking-to-market” its assets and liabilities. Identifies and values any off-balance sheet items. • Going Concern - Fair market value or net asset value • Non-Going Concern - Orderly liquidation value or forced liquidation value • Does not capture the value of intangible assets.

  16. Valuation Approaches -Reconciliation • Probable that the different approaches will result in different results. • Therefore, need to reconcile the results. • Need to look at the credibility of the different approaches

  17. Private Company Adjustments 1. Financial Statement Adjustments - Cash flow should reflect the state of affairs as if the company was being managed by a non-owner management team. Therefore, consider: Excess or deficient owners compensation and perquisites Inadequate or excess working capital Transactions involving company insiders Rent not at fair market value Interest not at fair market value Transfer pricing between affiliated entities Unusual or one-time items of income or expense 2. Excess or Deficient Operating Assets May need to adjust positively or (negatively) the valuation by the amount of the excess (deficient) working capital levels 3. Non-Operating Assets or Liabilities also impact the valuation by the amount of the excess or deficient assets

  18. Most Frequent Valuation Mistakes • Incorrectly calculating cash flow • objective is to determine sustainable future cash flow (and as properly calculated) • Applying the wrong discount rate to the cash flow stream • Incorrectly calculating the discount rate or multiple • Incorrectly applying discounts and premiums • Not accounting for differences in size and risk when comparing a small company to a larger company

  19. Most Frequent Valuation Mistakes • Incorrectly calculating the new per share value after injections of equity • Incorrectly calculating the terminal value in the discounted cash flow approach

  20. Areas of Controversy • Whose discount rate to use in an acquisition: • Target’s or Buyer’s? • Do buyers “value” seller’s add-backs? • Who should benefit from synergy? • Target’s shareholders; • Acquirer's shareholders, or, • a little of both. • the data suggests strategic buyers consistently pay higher multiples than financial buyers

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