The World is Not Flat!corporatevaluation.ca/resources/2012-06-20 NACVA... · 2 please set pagers, cell phones, etc.on vibrate mode or turn them off.. please complete and hand in the

CONSULTING SPECIALTIES

James Catty, MA, CA, CPA, ABV, CFA, CFE

Brandi Ruffalo, MBA, AVA, CBA

The World is Not Flat! An Overview of What

US Valuation Practitioners Need to

Know About International Business

Valuation

6/15/2012 Valuation & Forensic Partners, LLC Copyright 2012 © All Rights Reserved 1

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6/15/2012 Valuation & Forensic Partners, LLC Copyright 2012 © All Rights Reserved

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6/15/2012 Valuation & Forensic Partners, LLC Copyright 2012 © All Rights Reserved

WHY? WHAT DO WE DO? WHERE WE GO FROM HERE?

THE WORLD IS NOT FLAT


5 6/15/2012 Valuation & Forensic Partners, LLC Copyright 2012 © All Rights Reserved

VIDEO

OUTSIDE WORLD – DO NOT IGNORE US COMPANIES ARE NOT DOMESTIC ONLY. THEY HAVE MANY

INTERNATIONAL CUSTOMERS INTERNATIONAL OPERATIONS INTERNATIONAL SUPPLIERS INTERNATIONAL COMPETITORS INTERNATIONAL INVESTORS


(1) The Millionaire Next Door, Thomas J. Stanley and William D. Danko

BUSINESSES OFTEN PERCEIVED TO BE DOMESTIC COMPANIES

INTERNATIONAL COMPANIES ARE HERE


OUTSIDE WORLD – DO NOT IGNORE INTERNATIONAL COMPANIES COME TO AMERICA FOR

US CUSTOMERS US OPERATIONS US SUPPLIERS US INVESTORS US IDEAS


UN’S WORLD ECONOMIC SITUATION AND PROSPECTS 2011(1)

“COMPANIES FROM THE EAST ARE EXPECTED TO DOMINATE THE IPO PIPELINE BY 2025.”

80% OF RESPONDENTS EXPECT CHINA TO BE THE DOMINANT

STOCK MARKET FOR NEW ISSUES AND $ RAISED BY 2025.

INDIA VOTED SECOND IN TERMS OF NEW ISSUES AND THIRD IN TERMS OF CAPITAL RAISED.

OUTSIDE WORLD - DO NOT IGNORE


(1) Capital Markets in 2025. The Future of Equity Capital Markets. PriceWaterhouseCoopers LLP. 2011.

CONSUMER SPENDING POWER IS DRIVING GROWTH IN NEW MARKETS AND ADDITIONAL RISK TAKING(1)

− 40% OF US CEOS PLAN TO COMPLETE A CROSS-BORDER ACQUISITION

− 71% OF CEOS OUTSIDE THE US ARE LOOKING TO INCREASE THEIR CUSTOMER BASE IN THE US

TRANSACTIONS ARE HAPPENING


(1) PwC, 15th Annual Global CEO Survey, 2012.

WHAT IS DRIVING YOUR M&A STRATEGY? GROW CUSTOMER BASE

BUILD MANUFACTURING CAPACITY

ACCESS MATERIAL OR COMPONENTS

ACQUIRE INTELLECTUAL PROPERTY

BUILD RESEARCH AND DEVELOPMENT CAPACITY

OTHER


REASONS FOR CROSS-BORDER TRANSACTIONS


ANNUAL TRANSACTIONS

Source: CapitalIQ Acquisitions Reported through 6/14/2012.

-

5

10

15

20

25

30

35

40

45

50

2003 2004 2005 2006 2007 2008 2009 2010 2011 YTD2012

Thou

sand

s

VALUE NOT REPORTED < $10 M $10 -$25 M $25 -$100 M $100 M+

36%

50%

10%

2%2%

44%

31%

18%

3% 4%

40%

36%

19%

3%3%


TRANSACTIONS – SELLER GEOGRAPHY


2003 2011 2008

EUROPEU.S. AND CANADA ASIA/PACIFIC

LATIN AMERICA AND CARIBBEAN

AFRICA/MIDDLE EAST

UNREPORTEDMULTIPLE GEOGRAPHIES


TRANSACTIONS – BUYER GEOGRAPHY

51%

29%

8%

9%

2%1%1%

30%

39%

15%

12%

3% 2%1%

34%

33%

16%

13%

2%2%1%


2003 2011 2008

EUROPEU.S. AND CANADA ASIA/PACIFIC

LATIN AMERICA AND CARIBBEAN

AFRICA/MIDDLE EAST

UNREPORTEDMULTIPLE GEOGRAPHIES

RESTAURANTS CONSTRUCTION STEEL DISTRIBUTORS GAS STATIONS HOTELS COMMERCIAL REAL ESTATE

SMALL COMPANIES ARE NOT EXEMPT


DOMESTIC VALUATIONS MUST CONSIDER THE INTERNATIONAL BUYER INTERNATIONAL COMPANIES ARE ACQUIRING DOMESTIC

OPERATIONS

DOMESTIC COMPANIES ARE ACQUIRING INTERNATIONAL OPERATIONS

INTERNATIONAL BUYERS OFTEN HAVE DIFFERENT OBJECTIVES, EXPANDED OPPORTUNITIES

ALL VALUATIONS SHOULD INCLUDE THIS POTENTIAL

INTERNATIONAL BUYERS


VALUATION THEORY

STANDARDS AND DEFINITIONS

MARKET PARTICIPANTS

HISTORY OF MARKET TRANSACTIONS / PERFORMANCE

SPECIFIC CHARACTERISTICS OF SUBJECT INTEREST

INDUSTRY, ECONOMIC, AND OTHER ENVIRONMENTAL FACTORS

DIFFERENT MODELING METHODS CAN MATERIALLY IMPACT VALUE

ALL VALUES DEPEND ON


Used on limited basis where liquidation probable or where market and income approach not available.

Market

Cost

Income

US

In many countries replacement cost used as the primary method.

INTERNATIONAL

Public comps used for larger companies and established industries. Private databases available via subscription.

Public comps available on a limited basis depending on the size and maturity of the local share markets. Very limited data available for private transactions in smaller companies.

Most common approach used. Absence of established cost of capital data and lack of formal valuation education results in limited use.

VALUATION METHODS


CAPITALIZED EARNINGS VALUATION FORMULA


COUNTRY RISKS/BUSINESS ENVIRONMENT TRANSACTIONAL DATA CUSTOMS / BUSINESS ENVIRONMENT LANGUAGES DATA AVAILABILITY, INTEGRITY, COMPILATION MARKET SIZE / DEMOGRAPHICS LAWS, REGULATIONS AND ENFORCEMENT

INTERNATIONAL INPUTS IMPACTED BY



VIDEO

COUNTRY BUSINESS RISKS TAXATION INFLATION STATE ECONOMY CURRENCY NATURE OF REGULATION

COUNTRY POLITICAL RISKS STABILITY OF GOVERNMENT ALLOCATION OF POWERS DEGREE OF FREE MARKET ENTERPRISE CRONY CAPITALISM

INTERNATIONAL IS “FOREIGN”


CULTURAL IMPACTS ETHICS / US STANDARDS CUSTOMS / RELIGION LANGUAGES ENFORCEMENT OF LAWS AND CONTRACTS RELIGION


INTERNATIONAL IS “FOREIGN”


VIDEO

ASSET PRICE BUBBLES POLITICAL CORRUPTION INEQUALITY OF INCOME INFLATION COLLAPSE IN EXPORT DEMAND FROM DEVELOPED WORLD FAILURE TO INCREASE DOMESTIC CONSUMPTION INFRASTRUCTURE PROBLEMS INCREASING PROTECTIONISM

EMERGING MARKET RISKS


Globalization Survey 2011, Ernst & Young, p. 10.

United States Germany India Population 312 million 82 million 1,200 million Distribution 82 % urban 88 % urban 32 % urban Languages National: English

Regional: Spanish Official: German Regional: 12 Immigrant: 5+

Official:Hindi/English Regional: 31

Regions 50 + 1 territory 16 28 + 7 territories Median Age

36.9 44.9 26.2

Life Expectancy 78.5 years 80.2 67.1


INTERNATIONAL IS FOREIGN


VIDEO



US Low Neutral High

Germany Low Neutral High

India Low Neutral High

Hierarchy

Informal Meeting

Contracts

Verbal Agreements

Risk Averse

Quality

Relationships/Family

Time Spent Locally

Gender

Disagreements


INTERNATIONAL IS FOREIGN MANY LEGAL SYSTEMS:

COMMON LAW US AND BRITISH EMPIRE

CIVIL LAW (INVOLVES CODIFICATION, MOST WIDESPREAD) MUCH OF EUROPE, LOUISIANA, QUEBEC, CHINA, SOUTH AMERICA

RELIGIOUS LAW SHARIA IN MIDDLE EAST

MIXED (QUITE NORMAL) EGYPT USES A COMBINATION OF ALL THREE NIGERIA - RELIGIOUS (SHARIA) IN NORTH AND COMMON LAW IN

SOUTH



TAXES CAN BE VERY DIFFERENT: GERMANY – SPECIAL REGIONAL TAXES/SURCHARGES FOREIGN TAX CREDITS TAX HOLIDAYS – SINGAPORE / SAUDI ARABIA / MINES /

PETROLEUM SPECIAL RULES ON DEDUCTIBILITY OF EXPENSES DEPRECIATION – ACCOUNTING LIFE, ACCELERATED,

FREE, LIMITED, INTANGIBLE CAPITAL GAINS, INDEXING ISRAEL/BRAZIL INTEREST DEDUCTIBILITY

CROSS-BORDER CAPITALIZED EARNINGS FORMULA


CHOICE OF LOCAL CURRENCY OR IN DOLLARS INFLATION OUTLOOK FOR COUNTRY CONSIDER ADDITIONAL NORMALIZATION

ADJUSTMENTS BIG DIFFERENCES IN TAX ASSUMPTIONS

IMPACTS ON SUSTAINABLE CASH FLOW


POSSIBLE MANIPULATION OF LOCAL SHARE MARKETS AND REPORTED RESULTS

DEGREES OF LIQUIDITY WHERE THERE ARE LIMITED OR NO MARKETS

PREMIUM OVER GOVERNMENT BONDS

DEBT AVAILABILITY’S IMPACT ON CAPITAL STRUCTURE

PROJECTED LONG-TERM INFLATION IN DIFFERENT CLASSES OF COSTS

FACTORS AFFECTING REQUIRED RETURNS




COST OF CAPITAL REFLECTS EXPECTATIONS ABOUT THE RISK-FREE RATE AND INFLATION (TIME VALUE COMPONENTS), AND UNCERTAINTY ABOUT THE CONDITIONS AFFECTING SUBJECT INTEREST

NOT APPROPRIATE TO ADJUST FOR PERCEIVED ISSUES WITH OPTIMISTIC OR PESSIMISTIC CASH FLOWS – FIX THEM

SMALL CHANGES IN DISCOUNT RATES GENERATE MATERIAL DIFFERENCES IN VALUES – DON’T TAKE NUMBERS FROM A BOOK, SPEND TIME ON THE RATE

AVAILABILITY AND QUALITY OF DATA FOR COUNTRY SPECIFIC RISK PREMIUMS

VOLATILITY IN RATES FOR EMERGING MARKETS

ALL FOREIGN MARKETS ARE NOT THE SAME


National 10 yr Bonds(1)

Equity Risk Premium(2)

Rate of Return

Inflation Rate (CPI)

PV 100k Equalized

Cash Flow

Germany 1.26% 5.4% 6.7% 2.1% 2,192,982$ China 2.85% 9.4% 12.3% 3.4% 1,129,944$ India 8.52% 8.5% 17.0% 10.4% 1,510,574$ Spain 6.43% 5.9% 12.3% 2.1% 977,517$ Ghana (t-bills) 6.50% 18.5% 25.0% 10.0% 666,667$ South Africa 7.75% 6.3% 14.1% 6.1% 1,257,862$ Japan 0.82% 5.0% 5.8% 0.5% 1,879,699$ Russia 8.71% 11.0% 19.7% 3.6% 620,732$

“Applied Mergers & Acquisitions,” Robert F. Bruner (2004).

IMPROVING CASH FLOW PROJECTIONS


FOR BUYERS, STUDIES SUGGEST − 30% TO 40% OF TRANSACTIONS FAIL TO RETURN THE COST OF CAPITAL(1)

IMPROVING CASH FLOW PROJECTIONS


VALUATION REQUIRES THE USE OF EXPECTED CASH FLOWS

PROJECTED CASH FLOWS SHOULD BE A PROBABILITY WEIGHTED AVERAGE OF REASONABLY FORESEEABLE UPSIDE AND DOWNSIDE SCENARIOS

ACHIEVABILITY OF ANY SCENARIOS/PROJECTIONS SHOULD NOT BE CONDITIONED ON EVENTS EXCLUDED FROM THE PROJECTIONS – THEY SHOULD BE UNCONDITIONAL


VIDEO

50% Most Likely

• Stable political environment • Stable local economic environment • US retail recovery expected in 2 years • US production as a % of world production continues to fall • Company continues growth and levels off in year 5

20% • Scenario #1 but US retail recovery takes six years

20% • Scenario #2 but company gets bad press and incurs higher labor costs and more CAPX

10% Failure • Local Government is overturned

PROBABILITY WEIGHTED SCENARIOS IMPROVING CASH FLOW PROJECTIONS


Downside

Slow Growth



RISK SHOULD BE USED TO ACCOUNT FOR UNFORESEEABLE OUTCOMES

UNCERTAINTY OF ACHIEVING PROJECTIONS / EXPECTED OUTCOMES

WEIGHING CASH FLOWS DOES NOT ELIMINATE THE RISK OF UNFORESEEABLE OUTCOMES

ESTIMATING COST OF CAPITAL REQUIRES CONSIDERATION OF THE COUNTRY, INDUSTRY, AND SPECIFIC PROJECT AS WELL AS RECOGNITION OF BOTH THE VALUATION FORMULA’S NUMERATOR AND DENOMINATOR AND HOW EACH MAY REFLECT SPECIFIC RISK ISSUES HAVE BEEN FACTORED INTO THE FORMULA.

JUDGMENT IS INHERENT TO THIS PROCESS


ATTITUDES TOWARDS RAPID-GROWTH MARKETS

Note: Total Base = 992; ratings on scale of 1 to 5 where 1 = strongly agree and 5 = strongly disagree; Scores shown = percentage of respondents rating 4 or 5 (gray) vs. 1 or 2 (yellow)

Return on Investments Require Much Longer Time Horizons

The Cost of Investing Has Been Much Greater Than We Expected

Western Executives Overestimate the Long-Term Growth Potential in Rapid-Growth Markets

If Economic Conditions Deteriorates Markedly We Would Withdraw Our Investment

Surprised by Speed to Generate a Return on Investments in Rapid-Growth Markets

54%-25%

49%-17%

46%-27%

43%-33%

43%-19%

Source: Globalization Survey 2011

DATA SOURCES


INTEREST RATES ECONOMIST FINANCIAL TIMES INTERNET SEARCHES WALL STREET JOURNAL

EQUITY RISK PREMIUM IBBOTSON DUFF AND PHELPS

COUNTRY POLITICAL RISK POLITICAL RISK SERVICES MOODY’S INVESTOR

SERVICES INSTITUTIONAL INVESTOR STANDARD AND POOR’S

INTERNATIONAL COST OF CAPITAL IBBOTSON CREDIT SWISS

TALK TO CLIENTS ABOUT LOCAL, NATIONAL AND INTERNATIONAL COMPETITORS

EVALUATE BROAD BASE OF POTENTIAL ACQUIRERS AND “REASONS” FOR ACQUISITIONS

USE KNOWLEDGE OF PROPER AND SOPHISTICATED VALUATION TECHNIQUES TO POSITION YOUR CLIENTS TO MAXIMIZE TRANSACTION VALUES


NEXT STEPS

EXPAND INDUSTRY RESEARCH SOURCES TO INCLUDE INTERNATIONAL DATA

EVALUATE COMPANIES TRADING ON INTERNATIONAL EXCHANGES

INCREASE YOUR AWARENESS OF GLOBAL EVENTS


NEXT STEPS

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The World is Not Flat!corporatevaluation.ca/resources/2012-06-20 NACVA... · 2 please set pagers, cell phones, etc.on vibrate mode or turn them off.. please complete and hand in the