Wednesday 26 January 2022
The year 2021 was a blockbuster for global IPOs (initial public offerings). The IPO volumes (number of deals) rose 64% and proceeds (US$453 billion) rose by 67% year on year according to a study by Ernst & Young. The technology sector saw the highest number of IPOs, followed by health care and industrial sectors.
One of the most significant calculations when a company comes up with an IPO is determining its price or value. The fair value may also need to be determined for other reasons, for example, acquisitions, management buyouts, rights issue, tax litigation, corporate recovery or for accounting requirements i.e., fair value in IFRS. The transaction related valuations are generally performed by investment bankers, compliance related valuations by accounting and tax experts and litigation related valuations by experts in the legal setting and specific jurisdictions.
So, what are the steps involved in, and the different approaches to corporate valuation?
The starting point for valuation is knowing what we need to value. Is it enterprise value (value to providers of debt and equity), equity value (controlling or non-controlling interest), debt instrument on a stand-alone basis, an asset, liability or break-up value of the company?
The next step is to collect and analyse all information relevant to the valuation, which may include but not be restricted to:
- Nature of the business
- Historical financial information and future outlook
- Economic factors affecting the company’s business
- Nature and condition of the relevant industries that have an impact on the business
- Stock market information, if applicable
- Similar transactions undertaken by the company or its competitors in the past
Though the financial statements do not provide an indication of the value of the company, they are a useful starting tool for valuation.
“Managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.”
We may need to adjust the financial statements for:
- Use of current values as opposed to historical book values
- Revenues and expenses to be reasonably representative of continuing results
- Non-operating assets, liabilities, revenues and expenses.
A suitable valuation approach must be chosen, which could be market-based approach, income approach or cost approach. Either one or both of the following may be undertaken:
- Intrinsic valuation which relates the value to the intrinsic characteristics e.g., capacity to generate cash flows and risk in the cash flows. For example, discounted cash flow valuation with the value being the present value of the expected future cash flows (also income-based approach).
- Relative valuation which requires a comparable company or group. For example, compare price to earnings ratio, book value, sales or cash flows per share to determine whether the subject company is under-valued, over-valued or fairly valued compared to the peer group.
The value of a company is not objectively fixed. It is subject to the approach used, as well as the assumptions applied, for example, expectations of future cash flows, likely variations in cash flows and discount rates in discounted cash flow method. Since there are different possible approaches and scenarios, the valuation generally points towards a range rather than a fixed amount.
The valuation of a company may also depend on the investor. An M&A investor acquiring a controlling stake may be willing to pay a high premium due to the benefits of synergies that may be realised post-acquisition. On the other hand, in a small family business, the owners may be more inclined to hold on to the business and put less weightage on the premium. There are also specific valuation considerations depending on the sector in which the company operates.
In today’s dynamic world, it is important for preparers and users (both management and external reviewers) of financial statements, to understand the key issues in IFRS accounting, evaluate areas involving use of judgements and estimates, analyse and interpret financial statements, and understand the drivers of company valuation.
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21th – 25th March 2022
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About the Author
Saket Modi is an IASeminars instructor on IFRS and IPSAS based in London. He has designed and facilitated courses on IFRS for delegates from over 50 countries in UK, Europe, Africa, Middle East and Asia. He is a qualified accountant and CFA® charterholder.