Uttar pradesh cooperative sugar factories federation limited

The DCF methodology is the most appropriate methodology in the following cases:

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  Where the business is being transferred / acquired on a going concern basis;
  
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  Where the business possesses substantial intangibles like brand, goodwill, marketing and distribution network, etc;
  
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  Where the business is not being valued for the substantial undisclosed assets it possesses.
  

Being fundamentally driven by future business plan of the company and associated cash flows, a prudent DCF valuation should be able to capture the capital costs for renovation and modernization of plant and machinery. The    age and condition of assets like plant and machinery and their replacement value would be relevant for estimating expenditure on their replacement whenever necessary. This expenditure will reduce cash flows and DCF value. Valuation of plant and machinery would be a relevant item that would influence the DCF valuation. For example, a person acquiring a company operating a fleet of taxis would examine the conditions of vehicles for valuation of the company. If the vehicles need    replacement of a low cost item like hub caps, the impact on DCF will be less than if they need to replace gear boxes in a high proportion of vehicles. The person would also calculate DCF with reference to the demand for taxis, the average mileage, cost of maintenance etc. Valuation of plant and machinery is not a simple addition to DCF, but a factor to be taken into account while calculating DCF. In such calculation, plant and machinery may be a net negative factor in the DCF if replacement costs are high. Where surplus land would be sold this would be a positive factor. If the sale of land can cover the cost of plant replacement the net effect would be neutral on DCF.

For a going concern, various intangibles like brand equity, market share, competition, etc have a significant bearing on the valuation of the company. One cannot place a money value for these factors. They have no financial value of their own that can be measured in money terms. Hence, there is no way of evaluating them in any other methodology. DCF is the only methodology, which takes into account these factors by incorporating them intrinsically in estimated cash flows. In calculating DCF, different assumptions will be made of market share, competition from imports etc, which are translated into financial terms. Sensitivity analysis can also be made for different assumptions. The Financial Advisor and the Seller should exercise the judgment on the most likely financial impact of the intangible assets the company possesses, on cash flows and also on the discount rate to be applied while arriving at the optimum DCF value, as strong intangible assets would help reduce the overall risk perception of the company.

In a strategic sale, the bidders take into account not only DCF valuation, but also a premium for management control.     Premium for management control would be a subjective item for each bidder and will be reflected in the competitive bids. Therefore, the seller, while calculating the Reserve Price, should not incorporate this premium in the valuation amount separately. Since there is no scientific method to quantify the control premium, it may be arbitrary to add control premium while arriving at the Reserve Price. In the book, “Corporate Valuation: Tools for Effective Appraisal and Decision Making” by Bradford Cornell, it is stated “Without knowing why premiums are paid it is impossible to determine whether it is reasonable to apply a premium (or the associated discount) to the appraiser target. In this respect both research and common sense support the proposition that a buyer is willing to pay more than the market price for a controlling interest in a company only when the buyer believes that the future cash flow of the company, and thereby the value of the company, can be increased once it is under his/her control.” Further, it states, “…if the appraiser cannot identify what a buyer of the appraiser target would change to increase cash flow, then there is no reason to assume that a control premium exists.”

In the broad conclusions, Reserve Price should not include Control Premium.

Balance Sheet method

The Balance sheet or the Net Asset Value (NAV) methodology values a business on the basis of the value of its underlying assets. This is relevant where the value of the business is fairly represented by its underlying assets. The NAV method is normally used to determine the minimum price a seller would be willing to accept and, thus serves to establish the floor for the value of the business. This method is pertinent where:

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  The value of intangibles is not significant;
  
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  The business has been recently set up.
  

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  When the financial statement sheets do not reflect the true value of assets, being either too high on account of possible losses not reflected in the balance sheet or too low because of initial losses which may not continue in future;
  
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  Where intangibles such as brand, goodwill, marketing infrastructure, and product development capabilities, etc., form a major part of the value of the company;
  
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  Where due to the changes in industry, market or business environment, the assets of the company have become redundant and their ability to create net positive cash flows in future is limited.
  

This method takes into account the traded or transaction value of comparable companies in the industry and benchmarks it against certain parameters, like earnings, sales, etc. Two of such commonly used parameters are:

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  Earnings before Interest, Taxes, Depreciation & Amortisations (EBITDA).
  
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  Sales
  

The EBITDA multiple or the earnings method is based on the premise that the value of a business is directly related to the quantum of its gross profits. The net profits are adjusted to reflect the operating recurring profits of the business on a standalone basis (i.e. after deducting extraordinary or unusual items, or items of a non-recurring nature). Further, the profits are adjusted for non-cash items (including depreciation and amortisation) and other factors, such as interest and taxation (which vary from business to business) to derive EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortisations).

The EBITDA multiple method takes into account the value or consideration paid by acquirers of similar businesses, and is computed by dividing the total consideration paid (after adjusting for any debt assumed) by the EBITDA to derive a multiple, which can be applied to the EBITDA figure of the business being valued. i.e. adjusted maintainable EBITDA are capitalised by an appropriate factor ("capitalisation factor") to arrive at the business value.

EBITDA multiple = Enterprise Value / EBITDA

Where:

Enterprise Value (EV) = Market value of Equity + Market value of Debt

The sales multiple techniques are based on a similar analysis of relevant acquisitions and are the ratio of Enterprise Value to the current sales (net of excise duty, sales tax and non-recurring extra-ordinary income). It is calculated as follows:

Sales multiple = Enterprises Value / Net sales of the current year

To illustrate, if we are valuing Company X with sales of Rs. 500 million and in a similar transaction EV/Sales has been 4 (Sales multiple) then EV of Company X would be worked out as Rs. 2000 million. Then debt would be deducted to arrive at the equity value of Company X.

The Transaction Multiple methodology suffers from the following drawbacks:

Actual money required to earn the maintainable profits / sales of the business as a going concern (for instance, future capital expenditure) are not considered.

This methodology does not take into account the time value of money.

Notwithstanding these limitations, these multiples are widely used by investors to arrive at benchmark values for a company.

The asset valuation methodology essentially estimates the cost of replacing the tangible assets of the business. The replacement cost takes into account the market value of various assets or the expenditure required to create the infrastructure exactly similar to that of a company being valued. Since the replacement methodology assumes the value of business as if we were setting a new business, this methodology may not be relevant in a going concern. Instead it will be more realistic if asset valuation is done on the basis of the new book value of the assets. The asset valuation is a good indicator of the entry barrier that exists in a business. Alternatively, this methodology can also assume the amount which can be realized by liquidating the business by selling off all the tangible assets of a company and paying off the liabilities.

The asset valuation methodology is useful in case of liquidation/closure of the business. In this case certain adjustments may have to be made to the equity value arrived at by this method including settlement of all borrowings on the company’s balance sheet on the date of valuation and settlement of employee dues. These adjustments should include all the process related cost involved in closure and liquidation. For example, in the case of the settlement of the employee dues, the assumed severance packages may have to be calculated based on the latest available VRS schemes for the PSU or other such modes that help in determining the most appropriate amount of settlement that the employees will have to be paid in the event the PSU shuts down its operations. The following example demonstrates the value of Company X based on asset valuation methodology:

Figure 8 : Asset Valuation of Company X Rs million

Although the aforesaid valuation methodologies being followed are broadly based on the best market practices, it is necessary to standardize the valuation methodology for all Sugar Mills so that there are no variations from case to case. Therefore, all the four methodologies for valuation should be followed for all Sugar Mills, with further improvements in respect of DCF Method and Asset Valuation Method as detailed below, for arriving at a range of valuation figures, to arrive at the indicative Benchmark or Reserve Price.    

  In the DCF method, while computing the cash flows, cash out flows for renovation and modernization of plant and machinery should also be discounted for arriving at realistic figures. Since non-core assets are not reflected in the cash flows, the Asset Valuation Method should separately value the non-core assets and they should be added to the valuation figure arrived at by the DCF method.    

  In general, the approach should be used primarily to value the non-core or surplus fixed assets, whose value are not appropriately accounted for in the valuation by DCF or other approaches. However, in cases, where the entity has significant non-core assets and where the application of Asset Valuation approach to the enterprise is deemed necessary, following should be noted:

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  The Asset Valuation would be more realistic, if we compute the value of only the realizable amount, after discounting the non-realizable portions. The realizable market value of all real estate assets, either owned by the company as freehold properties or on a lease/rental basis will be determined, assuming a non-distress sale scenario. The value would be assessed after taking into account any defects/restrictions/encumbrances on the use/lease/sublease/sale etc. of the properties or in the title deeds etc.
  

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  Since Asset Valuation normally reflects the amount which may need to be spent to create a similar infrastructure as that of a business to be valued or the value which may be realised by liquidation of a company through the sale of all its tangible assets and repayment of all liabilities, adjustments for an assumed capital gains tax consequent to the (hypothetical) outright sale of these assets as also adjustments to reflect realization of working capital, settlement of all liabilities including VRS to all the employees will have to be made.
  

1. 
   The status of title of a company over land and building
   
2. 
   Any restrictive covenants incorporated in the title documents imposing on the use or transfer of property or any other restriction
   
3. 
   Any restrictions pertaining to the use or the transferability of the property or other restrictions arising out of any civic regulations or Master Plan or other reason
   
4. 
   The values at which transactions have taken place in the recent past for properties of comparable nature, in terms of use, size, location and other parameters
   
5. 
   Valuation parameters currently in use by Authorities for determination of stamp duty and other taxes
   
6. 
   Assessment of demand and supply of comparable properties at given locations
   
7. 
   The state of maintenance and depreciation of the property, and evaluation of expenditure, if any, required repairing and renovating the property to suit the intended use.