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AMC Owners as Buyers and Sellers – Two Perspectives 2013 AMC Institute Loews Don Cesar Beach Resort Thursday, February

AMC Owners as Buyers and Sellers – Two Perspectives 2013 AMC Institute Loews Don Cesar Beach Resort Thursday, February 14, 2013 St. Petersburg Beach, Florida. Overview of Today’s Topics. Gregory Cowhey Pots of Gold – Help for Sellers Basic Overview of Valuation Concepts & Principles

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AMC Owners as Buyers and Sellers – Two Perspectives 2013 AMC Institute Loews Don Cesar Beach Resort Thursday, February

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  1. AMC Owners as Buyers and Sellers – Two Perspectives2013 AMC Institute Loews Don Cesar Beach ResortThursday, February 14, 2013St. Petersburg Beach, Florida

  2. Overview of Today’s Topics • Gregory Cowhey • Pots of Gold – Help for Sellers • Basic Overview of Valuation Concepts & Principles • Current Observations of the Private Equity Market • Scott Hermansen • Skeltons in the Closet – Buyer Beware • Pricing, Due Diligence, Relationships & Deal Structure • Questions & Answers

  3. Pots of GoldHelp for Sellers

  4. Standards of Value Fair Market Value Willing Buyer Willing Seller No Compulsion To Act Knowledgeable Parties Hypothetical Buyer/ Seller Transaction Based Business Valuation Issues and Considerations

  5. Standards of Value Investment Value Specific Buyer Strategic Value to A Specific Investor Based on Individual Investment Fair Value Specific Use – Legal Concept Dissenters’ Shareholders suits Intrinsic Value Analytical Judgment Perceived Characteristics of the Investment Business Valuation Issues and Considerations

  6. Premise of Value Going Concern Assemblage of Assets Orderly Liquidation Forced Liquidation Business Valuation Issues and Considerations

  7. SELECTING THE VALUATION METHODOLOGY Asset Approach Market Approach Income Approach Capitalization of Cash Flow Method Discounted Cash Flow Business Valuation Issues and Considerations Asset Accumulation Method Guideline Comparable Companies Comparable Transactions Treasury Method

  8. Intangible Assets Seen in Most Businesses Identification Customer related intangible assets Contract related intangible assets Human capital related intangible assets Location related intangible assets Goodwill related intangible assets Patents and other intellectual property Below Market Leases Business Valuation Issues and Considerations

  9. Income Approach Direct Capitalization Yield Capitalization Cost Replacement Cost Reproduction Cost Research and Development Market Approach Relief from Royalty Method Valuing Intangible Assets

  10. Type 1 – Unusual/Non-Recurring Adjustments The first type are adjustments that eliminate one-time gains or losses, other unusual items, non-recurring business elements, expenses of non-operating assets and the like. Type 2 - Discretionary (Control) Expense Adjustments The second type of normalization adjustment involves adjustments that normalize officer/owner compensation and other discretionary expenses that may be eliminated by an owner motivated to maximize profits and provide the greatest return to its stockholders. Adjusting Reported Income Statements

  11. Must consider the size of, and level of control associated with, the Subject Interest in determining whether to make Type 2 Control Adjustments. The use of minority cash flows in the income approach produces a minority interest value. Minority cash flows are those cash flows without any adjustments for prerogatives of control by the controlling shareholder (e.g. excess compensation and perquisites) Type 2 Control Adjustments

  12. Remove Non-Operating Income Analyze Cost of Goods Sold/Inventory Considerations Excessive or Understated Officer’s Compensation Family Members/Related Party Transactions Travel and Entertainment Related Party Rent Professional Fees Examples of Type 2 Normalizing Adjustments

  13. Conventional Audit Trail

  14. By definition, is a Type 2 Control Adjustment Often referred to as “normalized compensation” or “reasonable compensation allowance” Pertains to replacement compensation to replace (or retain) the owner/operator for the services performed. Separate and distinct from the owner’s return on investment in the form of dividends/distributions Trading current income (ordinary tax) for capital gains income (Cap gains tax) Replacement Compensation

  15. Discount and Capitalization Rate Calculation The Bigger The Risk – The Bigger The Required Return Rate Reflective of the Risk of The Investment Rate Must Match Economic Income Stream Build Up Method - Example Risk Free Rate 4.92% Equity Risk Premium 6.14 Small Stock Premium 6.41 Industry Risk Premium 1.43 Other Risk Considerations 2.00 Discount Rate 20.90% Capitalization Rate = Discount Rate Less Long Term Growth Rate Measuring Risk in Business Valuations

  16. Levels of Value Synergistic (Strategic) Value Value of Control Shares * Control Premium Minority or Discount Value of minority shares if freely traded on an active public market (“Publicly traded equivalent value or Stock Market Value Discount for Lack of Marketability Value of non-marketable minority (lack of control) shares

  17. Tax Ramifications of Closely-Held Businesses

  18. Underlying Theory Applied to Business Valuation A hypothetical willing buyer would discount the price which would be paid for a stock in a corporation with trapped in gains (TIG). Similarly, a hypothetical seller will accept a lower price for a stock that is subject to trapped in gains. ABC Corporation holds $5 million worth of assets and has no trapped in capital gains. XYZ Corporation holds $5 million of identical classes of assets, but has trapped in capital gains of $3 million due to depreciation recapture and market appreciation of its assets. All other things being equal, a hypothetical buyer would pay less for an interest in XYZ Corporation than in ABC Corporation due to the trapped in capital gains. Trapped In Gains (TIG) in Business Valuations

  19. Observations From Current Market Data

  20. Three Aspects of Private EquityFundraising, Investment & Exits Trends

  21. PE Fundraising Tentative in 2010Number of Funds Closed and Total Capital Raised by Year

  22. Fundraising Moving in Right DirectionUS Private Equity Fundraising by Quarter

  23. Record Levels of Dry Powder; $400BCapital Overhang for US-Focused Funds Raised by US Investors

  24. Mid-Sized Funds Make Their Mark Percentage of US PE Funds (Count) by Size

  25. Smaller Funds Dig into Big Fund MarketPercentage of Capital Raised by Size – US Funds

  26. GF Data Resources Survey Private sponsored deals reported by 174 PE firms and 1,431 deals since 2003Q1 Reporting data for 1,147 transactions that exhibited pricing multiples of 3-10x EBITDA [80% of total universe] Size of transaction Smaller deals $10-$25 M value trade at 5.0-5.4x EBITDA Larger deals $100-$250M value trade at 7.0-8.5x EBITDA Leverage model turned upside down Pre-2006: typical model was 20% “real money” by PE firm with 80% bank debt Post-2007: “new model” has averaged 50/50, with Seller taking back debt Flight to quality Inferior performers command lower pricing multiples Recent Performance for $10-$250 MM Deal Range

  27. GF Data Resources Survey 2010-2012 Statistics 2010-H1 – 60 deals at pricing multiples in the 5.5x EBITDA range 2010-H2 – 102 deals at pricing multiples in the 6.1x EBITDA range 2012-Q1 – 29 deals, still in the 6.1x EBITDA range Election results – Democrats could not pass tax legislation P/E Firms have “Dry Powder” Need to invest or return GP paid on %AUM and carried interest Lack of success from 2007-2009 creates cautionary approach Above average performance needed to attract attention Financing Deals Deal multiples – 6.1x EBITDA Senior Debt – 2.2x EBITDA Total Debt – 3.0x EBITDA --- Sellers need to keep “skin in the game” P/E Firm Equity – 3.1x EBITDA Recent Performance for $10-$250 MM Deal Range

  28. Small Deals Dominate VolumePercentage of Deal Volume (count) by Deal Size Range

  29. Median Valuation Continues 2009 TrendPE Deal Activity (count) and Median Valuations by Year

  30. Median Amount Rebounding in 2010PE Deal Activity (count) and Median Deal Amounts by Year

  31. Secondary Deals Return, Strategics DominantUS PE Exit Activity (Exit Type Percentage) 41% 25% 59%

  32. Exits Up, IPOs Reemerge in 4QQuarterly PE Exits by Corporate Acquisition, IPO and Secondary Sale Percentage of capital invested by industry

  33. Skeletons in the ClosetHelp for Buyers

  34. Buyer beware – there are skeletons everywhere. Seller will give a great song and dance. Independent appraisal is good, but need to determine what you think it’s worth. Remember, most appraisals are MAI (made as instructed). If deal sounds too good to be true---watch out. Everyone uses data rooms these days --- they don’t tell the whole story What is presented can be very filtered. There’s nothing like hearing someone explain something. Overview

  35. Determine if asking price is FV. Look at 5 year history of earnings. Do 1 or 2 clients make up the total book of business? Prepare pro-forma statements: Staffing costs/savings Overhead savings vs. overhead increases Cost to relocate Determine worst case/best case Reasonable return on investment Pricing

  36. Depends on the deal structure – will be discussed later. Can end up with less business than projected. Value of business can go down. Liability

  37. You need a NDA, LOI and/or contract in place first. Not always objective, can be very subjective. Review client contracts: Assignability of contracts Out clauses of contracts Have most clients been around awhile or do they turn What is likelihood clients will stay. What synergies can be realized. Due Diligence

  38. What is the current ownership structure? Are the current owners active in organization? Logistics: Does office need to be in a certain city How hard is it to relocate/consolidate Relationship between staff and clients Relocation of current key players Why does current ownership want out? Relationships

  39. Stock – sellers love them, buyer beware Sellers get easy capital gain treatment for taxes Buyer gets very limited ability to deduct anything for taxes Since no deductions to help fund deal, want lower asking price Assume any and all Corporate liabilities, including staff issues Pure merger New ownership Consolidate locations Consolidate staffing Book of business – contracts Contingency payments Deal Structure

  40. You may need to kiss a bunch of frogs before you find a prince. Determine what you are really buying Do you really want all the clients? Are you just getting the inside track when the RFP goes out? This could be an easy way to increase client base. Factor in tax consequences, but don’t let them drive the deal. Not every deal is priced right or a good fit Don’t fall in love Be willing to work Don’t settle Conclusions

  41. Questions&Answers

  42. Contact Data Gregory Cowhey Managing Director – Forensic & Financial Services CBIZ MHM, LLC 401 Plymouth Road, Suite 200 Plymouth Meeting, PA 19462 Direct: 610-862-2227 gcowhey@cbiz.com

  43. Contact Data Scott M. Hermansen, CPA Chief Financial Officer Applied Measurement Professionals, Inc. Phone: 913-895-4600 shermansen@goamp.com 43

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