Business valuation: Relative valuation methods – Issues and challenges

Latha S Chari

What we will cover?Basic valuation conceptsPurpose of valuationMethods of valuation – Trading

comparables, Transaction comparables and DCF method of valuation using MS excel financial model

Valuation: Meaning, ConceptMeaning: ascertaining value – real,

intangible and financial assetsValue – Price Value differs based on Purpose/Utility:

Trading value (Value without control, value of minority interest)

and Transaction value (Value with control)

Value differs with time

Why Valuatio

n ?

Valuation of Business Vs. Value of Equity

Value of the operational business i.e Enterprise Value

Value of debt (less cash)

Bondholder value

Enterprise value (Value of Business)

Value of Equity

Shareholder value

- =

EV & Balance Sheet - a comprehensive picture

Cash +Cash

equivalents +

Non controlled Investments +

Non-core assets +

Enterprise value (net operating assets: EV)

FinancialInvest-Ments, Invt in associates

-

Debt (MV)Preference

SharesMinority

interest (MV –PE)

Ordinary Equity value

=Land banks

Valuation Methods

Asset based

Earning based

Market price basedMar

ket Price/Pri

ce multiples

Market Co

mparables / transaction

multiple

DDM

DCF

Economic profit

EV Multiples

Net Asset

Replacement value

Liquidation value

Asset based – Net assets Method

Net Asset = Total Assets (other than miscellaneous expenses and losses) – Total External Liabilities

Net assets = Shareholders funds(other than revaluation reserve) – Miscellaneous expenses and losses

Asset based method – Replacement value, Liquidation value

Replacement value = Replacement cost of assets - External liabilities

Liquidation value = Sale value of assets – External liabilities.

Earning based Approach Dividend Discount models – Walter and

Gorden models, One stage, two stage models single period and perpetuity models.

Future expected dividends are discounted at opportunity cost of capital to investors to arrive a value of equity.

Earnings based approach - DCF

Earning capacity of operating assets - Free cash flow to firm or Free cash flow to equity is ascertained. The same is discounted at CC to arrive at value of operating assets

Earning capacity of operating assets is arrived at using Economic profit or concept of EVA and the same is discounted to arrive at value of operating assets

Multiple based methodBased on linking VALUE/PRICE with its DRIVERS.Multiple ratio of what you pay/what you get.

Earnings

•EBIT•EBITDARe

venue

•Sales•Sales growth

Non

Financial

•Employees•Production quantity etc.

Enterprise value or Price of equity

Most popular multiplesPrice earnings (PE) : Ratio of price per

share and earnings per share.Price to book value (PBV): ratio of price

per share to book value per sharePrice to Sales(PS): ratio of price per share

to sales value per share.By replacing price by enterprise value we

can get 3 more ratios, where

EV = Market value of equity + market value of debt - cash

Understanding the multiplesDefine – understand its calculationDescribe – cross section distributionAnalyse – drivers of the multiplesApply – easily said than done

Understanding multiples – an exampleMean multiples of the pharmaceutical sector for the period 200503-201003

PE, EV_PBIT AND EV_PBITDA fall within a range of 13-25 for the sector. However, PBV, Mcap_sales and EV_sales are distributed in a range of 3.25-4.97. In the last four quarters from 2009-03 to 2010-03 the entire sectors mean multiples have shown consistently increasing trend

Steps in relative valuation

Peer Group •Arrive at comparable companies•(Size, nature, growth, margin, risk)

Financial and non financial data •Annual reports, direct discussion with the company•Share price data, market and industry data

Arrive at benchmark multiple and value

•Choice of multiple – PE, PBV, P-sales, EV/EBIT, EV/EBITDA, EV/Sales, EV/tonne, EV/subscriber etc.•Mean, median and harmonic mean, or regressions.

Relative valuation an example – Basic facts

Company Name Abbott India Ltd

Astrazeneca Pharma India Ltd Lupin Ltd Merck Ltd

Abbott India Ltd

Astrazeneca Pharma India Ltd Lupin Ltd Merck Ltd

YYYYMM 200502 200503 200503 200503 201002 201003 201003 201003BSE_Close_Price 645.25 294.21 55.31 428.65 904.4 860.6 324.91 621.95

Quarter Period 1 1 4 1 1 1 4 1Sales 417.06 196.0908 1185.92 367.1156 821 414.1109 3641.08 480.4059PBIDT 94.55 50.3198 145.79 108.2103 122.48 86.4423 818.61 113.0119PBIT 79.35 45.8146 85.27 99.6353 113.27 80.4515 708.66 105.388PAT 60.17 28.38 84.36 66.0118 75.24 52.9568 648.93 72.2348Yearly_EPS 43.1 11.352 4.1 38.96 55.01 21.18 15.108 43.41Market_Cap 985.94 735.53 2220.14 722.76 1237.22 2151.50 14448.75 1032.40

NO OF SHARES 1.53 2.50 40.14 1.69 1.37 2.50 44.47 1.66EV_calculated 988.13 735.53 2660.78 722.76 1237.22 2151.50 15355.56 1032.40BookValue 123.22 38.21 24.94 147.2 198.51 57.81 56.90 281.50DEBT 2.19 0 440.64 0 0 0 906.81 0ROE 0.3196 0.2970 0.1686 0.2660 0.2771 0.3664 0.2564 0.1546Margin 0.19 0.23 0.07 0.27 0.14 0.19 0.19 0.22

Relative valuation an example – Basic facts

Company Name YYYYMMBSE_Close_Price PE PBV

Mcap_sales EV_sales EV_PBIDT EV_PBIT

Abbott India Ltd 201002 904.4 16.44 4.56 1.51 1.51 10.10 10.92Astrazeneca Pharma India Ltd201003 860.6 40.63 14.89 5.20 5.20 24.89 26.74Lupin Ltd 201003 324.91 21.51 5.71 3.97 4.22 18.76 21.67Merck Ltd 201003 621.95 14.33 2.21 2.15 2.15 9.14 9.80

Median 18.97 5.13 3.06 3.18 14.43 16.30Mean 23.23 6.84 3.20 3.27 15.72 17.28harmonic 19.83 4.37 2.54 2.57 13.25 14.43

Relative valuation - projections

Company Name YYYYMMBSE_Close_Price actual Yearly_EPS BookValue Sales PBIDT PBIT

Lupin Ltd 201103 415.35 18.158 70.6558 4420.86 975.6 845.63

Company Name YYYYMM PE PBV Mcap_sales EV_sales EV_PBIDT EV_PBITLupin Ltd Median 201103 344.5160182 362.6654696 304.0658063 296.0536 296.1737516 289.4812687Lupin Ltd - Mean 201103 421.7490029 483.3298783 318.608818 304.40696 324.5031637 308.2489189

Lupin Market data as on 31 March 2011 Open 417, H- 422, L- 409, C - 405

Lupin Market data as on 13 Jan, 2012: Lupin NSE: 52 week high – Rs.494, 52 week low – Rs.393

Issues & ChallengesHow to arrive at comparable companies?Which multiple to use for valuation –

company specific.How to arrive at the benchmark multiple

for the next period?Dynamic nature of drivers.Weak market efficiency

Thank You.