ABOUT US THIS WILL BE PROVIDED BY SIR

DECYPHERING THE VALUATION CODE PAGE 1 INTRODUCTION Valuation is the process of determining the economic value of a business or company.

The first step while attempting any valuation exercise is to collect relevant and optimal information required for valuing Share or Business of a company. Such information is obtained from one or more of the following sources:

Management & Promoter Group Future prospects and growth potential Competitive Environment Industry Peer Group Regulatory Environment Analysis of financial statements Historical and Future Projections Variance analysis The Minority discounts and control premium Margin analysis Market Surveys, Other Publicly available data Stock Market quotations

1.

What is valuation?

Valuation is the process of arriving at the current monetary value of an asset. The valuation of any company rests on a few key drivers, which will vary from company to company. Valuation of a company reflects the performance of the company both its past performance as well as expectations of its future performance. Based on the facts and assumptions of these two broad time frames, one attempts to understand what the company is currently worth. Do you know what a share in Reliance or Infosys is really worth? What about the office premise that you own? Should you bother? Knowing the value of an asset may not be a prerequisite for successful investing, but it does help you make more informed judgements.

2.

How is a business valuation done?

There are dozens of valuation models, but only two valuation approaches: intrinsic and relative. The intrinsic value of an asset is determined by the cash flows that the asset is expected to generate over its life, keeping in mind the certainty of such cash flows. Assets with high and predictable cash flows should be worth more than assets with low and volatile cash flows. In relative valuation, assets are valued by looking at how similar assets are priced by the market and performing a comparative analysis. When you determine what to pay for a property, you do so by comparing the prices of similar properties in the market.

3.

Is Value same as Price of a Business?

Warren Buffet describes Price is what you pay & Value is what you get . Value of a business is not the selling price of the business. Let us decode this further: A sound investment is one where an investor does not pay more for an asset than it is worth. Others may argue that value is in the eyes of the beholder, and that any price can be justified if there are other investors willing to pay that price. Remember the Facebook IPO? Did you pay a price too high for the value that you received? 4. If Value is not the same as Price, then how does a transaction finalize?

Value of a business can be arrived at by using objective analysis, but the transaction is finalized at the negotiated price at which the Seller is willing to sell and the Buyer is willing to buy.

PAGE 2 METHODS OF VALUATION

Need to change the diagram design.

I.

Asset Based Method

The asset approach to business valuation is based on the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility. The value of assetbased analysis of a business is equal to the sum of its parts. The value of a companys intangible assets, such as goodwill, is generally impossible to determine apart from the companys overall enterprise value. For this reason, the asset -based approach is not the most probative method of determining the value of going business concerns. In these cases, the asset-based approach yields a result that is probably lesser than the fair market value of the business. In considering an asset-based approach, the valuation professional must consider whether the shareholder whose interest is being valued would have any authority to access the value of the assets directly. Shareholders own shares in a corporation, but not its assets, which are owned by the corporation. A controlling shareholder may have the authority to direct the corporation to sell all or part of the assets it owns and to distribute the proceeds to the shareholder(s). The non-controlling shareholder, however, lacks this authority and cannot access the value of the assets.

As a result, the value of a corporation's assets is not the true indicator of value to a shareholder who cannot avail himself of that value. The asset based approach is the entry barrier value and should preferably to be used in businesses having mature or declining growth cycle and is more suitable for capital intensive industry. 1. i. Net Asset Value/Book Value Method It is a type of business valuation that focuses on a company's net asset value, or the fair-market value of its total assets minus its total liabilities. Valuation of net assets is calculated with reference to the historical cost of the assets owned by the company. Such value usually represents the minimum value or a support value of a going concern. It is usual to ignore market value of the operating assets for the simple reason that under the going concern valuation, it is not the intention to sell the assets on a piece meal basis. While the historical cost is adopted in respect of the assets that are to continue as a part of the going concern, it is necessary to adjust the market value of non-operating assets like unused land which are capable of being easily disposed of without affecting the operations of the company.

The value as per Net Assets Method is arrived at as follows: Net Assets value represents equity value which is arrived at after reducing all external liabilities and preference shareholders claims, if any, from the aggregate value of all assets, as valued and stated in the Balance Sheet as on valuation date. Net Assets Value = Total Assets (excluding Miscellaneous Expenditure & Debit balance of Profit & Loss account) Total Liabilities Or Net Assets Value = Share Capital + Reserves (excluding revaluation reserves) Miscellaneous Expenditure Debit Balance of Profit & Loss Account ii. Situations Where Net Assets Method May Be Adopted

Net Assets Method may be adopted in the following cases: In case of start-up companies (which are capital intensive in nature), where the commercial production has not yet started. In case of Investment Companies as Earnings Value based on its income in the form of dividend and/or interest may not reflect its true value. In case of companies, which do not have a sustainable track record of profits and has no prospects of earning profits in future. In case of manufacturing companies, where fixed assets has greater relevance for earning revenues. It would also be appropriate to use Net Assets Method for valuation in case of companies operating in the industry, which is capital intensive and is relevant to revenues in an industry, where norms are related to the capital cost per unit. In case of companies, where there is an intention to liquidate it and to realise the assets and distribute the net proceeds.

iii.

Adjustments to NAV - A measure of a company's valuation after liabilities, including off-balance sheet liabilities, and assets are adjusted to reflect true fair market value.

The Net Asset Value (NAV) as arrived at by using the above-mentioned formula may be adjusted depending upon circumstances of a particular case. The list given below showcases some of the adjustments commonly made:

Contingent Liabilities

The amount of Contingent Liabilities as disclosed in the financial statements of the entity needs to be adjusted from the value of net assets. The managements perception of such liability materialising should be considered and a detailed assessment for the same should be carried out and if necessary, an expert opinion regarding sustainability of claims or contingent liabilities should be called for. Some examples of Contingent liabilities are: 1. Income tax demands 2. Excise demands 3. Sales tax/ Entry Tax demands 4. Entertainment tax 5. DPCO claim for pharmaceutical companies 6. Claims from customers 7. Matters referred to Arbitrations 8. Labour related issues Investments

Investments, whether trade or non-trade should be considered at their Market value while arriving at the Adjusted Net Assets value as they can be sold in the market on a piece meal basis without affecting the operations of the company. For this, notional adjustment should be made for any appreciation/ depreciation in the value of investments on a net of tax basis.

Contingent Assets

If the company has made escalation claims, insurance claims or other similar claims, then the possibility of their recovery should be carefully made on a fair basis, particularly having regard to the time frame in which they are likely to be recovered. The likely cost to be incurred for realizing the amount needs to be adjusted.

Qualifications & Notes to Accounts

Qualifications in the Auditors Report and Notes to Accounts should also be given due consideration. If it calls for any adjustment, the same should be carried out while arriving at the Net Assets Value. Example - diminution in the value of long term investments not provided for, provision for gratuity and leave encashment not made, provision for doubtful debts not made, etc. Surplus Assets

The market value of surplus assets such as land and building not used for the business of the company should be considered. The appreciation or depreciation in the value of surplus assets adjusted for the tax liability or the tax shield on such appreciation or depreciation would be added/deducted from the Net Assets Value. This is more of a notional adjustment. Market value of such assets could be based on the report of a technical valuer or on the estimates of the Management. Care should be taken if the title of the assets is not clear or the possession of the property under consideration is not with the owner. ESOPS, Warrants and Convertible instruments

Where the Company has issued warrants/ ESOPS or any other convertible instruments which are likely to be exercised, appropriate adjustment needs to be made for the amount receivable on the exercise of such options and resultant increase in share capital base.

2.

Liquidation Value Method

i.

This approach is similar to the book valuation method, except that the value of assets on liquidation is used instead of the book or market value of the assets. The liquidation value of a business is the price that can be obtained for a business that is, or will soon be, ceasing operations. Where the business of the company is being liquidated, its assets have to be valued as if they were individually sold and not on a going concern basis. Because there is no longer a customer base, there is no value in goodwill and the value of assets is lower. Using this approach, the liabilities of the business are deducted from the liquidation value of the assets to determine the liquidation value of the business. You should also consider liabilities which will arise on closure such as retrenchment compensation, termination of critical contracts, etc. Regard should also be made to the tax consequences of liquidation. Any distribution to the shareholders of the company on its liquidation, to the extent of accumulated profits of the company is regarded as deemed dividend. Dividend Distribution tax will have to be captured for such valuation.

ii.

iii.

3. i.

Replacement Value Method Replacement value is different from Book Value/Liquidation Value as it uses the replacement value of assets, which is usually higher than the book valuation. The term replacement cost refers to the amount that a company would have to pay, at the present time, to replace any one of its existing assets. Replacement value includes not only the cost of acquiring or replicating the assets, but also all the relevant costs associated with replacement. Liabilities are deducted from the replacement value of the assets to determine the net replacement value of the business.

ii.

iii. Asset Based Method may not be relevant in case of Companies operating in an industry where human knowledge and creativity are more relevant as compared to physical assets in value creation. In the case of valuation for a going concern, since the replacement methodology assumes the value of business as if a new business is being set up.

II.

INCOME BASED METHOD

1.

PROFIT EARNING CAPITALISATION VALUE METHOD (PECV) i. Capitalization of Profit Earnings Method determines the business value using a single measure of the expected business economic benefit as the numerator. This is divided by the capitalization rate that represents the risk associated with receiving this benefit in the future. Capitalization refers to the return on investment that is expected by an investor for taking on the risk of operating the business (the riskier the business, the higher the required return). The earnings figure to be capitalized should reflect the true nature of the business, such as the last three years average, current year or projected year excluding the impact of any extraordinary items not expected to accrue in future.

ii.

iii. Valuation as per PECV involves determining of the future maintainable earnings (after tax) from normal operations. These earnings are then capitalised at an appropriate rate to arrive at the Equity Value. PECV = Future Maintainable Profit after Tax/Capitalization Rate Or PECV = Future Maintainable Profit after Tax* PE Multiple

2.

DISCOUNTED FREE CASH FLOW METHOD

DCF is a method of valuing a company, typically a going concern by estimating the cash flows & adjusting it for the time value of money. In this method, all future cash flows of the company are estimated and discounted by an appropriate discount rate (to cover riskiness or expectation) to give their present values (PVs). There are two main variants of this method: i. The Equity Method - The equity version values just the equity stake in the business. So, this applies to all equity shareholders in the company. ii. The Firm Method - The Firm variant values the entire business, which includes both the shareholders and all the other claimholders of the firm especially lenders to the company.

Free Cash Flow to Equity (FCFE) Let us explain this in simple terms. A company sells products and earns revenues, say R. It costs C to make these products and a further E as ancillary expenses (advertising, marketing, clerical staff, company off-sites, etc.). What is left is EBITDA (R-(C+E)). EBITDA = Earnings Before Interest, Tax, Depreciation & Amortization Now, it has to pay interest on its debt and taxes to the government. What is left can be distributed to the shareholders > this is the cash flow to equity. Firm Valuation Method (Free Cash Flow to Firm - FCFF) The value of the firm is obtained by discounting expected cash flows to the entire firm. That is the cash flows after meeting all operating expenses and taxes, but prior to debt payments. This is discounted at the weighted average cost of capital (WACC) > Cost of Equity plus Cost of Debt. Weighted Average Cost of Capital (WACC) WACC is the calculation of a firm's cost of capital. Each category of capital is proportionately weighted. The categories include: Common Stock Preferred Stock Bonds Any other Long Term Debt

III.

MARKET BASED METHOD

In this method, value is determined by comparing the asset with similar assets. Example Comparing a company against its peer group companies which are in the same industry of the same product line and scale. This is also known as Relative Valuation Method.

1. Comparable company market multiples method Comparable Company Market Multiple uses the valuation ratio of a publicly traded company and applies that ratio to the company being valued.

First, you find out a set of companies that are listed (and thus have all sorts of information available in public domain) and are similar in nature of business to the company that you are valuing. This set of companies is called the peer-set. A peer set is ideally a list of companies in the same geographical area, in the same business, having the same target market and with revenues and profitability in the same range as the company being valued. Such a strictly comparable set of companies is usually not available. Thus, you have to settle for companies which are only similar, not same, in all these respects. You have to be usually OK with companies that are larger or smaller in size, have a higher or lower profitability, have more business lines or fewer than the company in focus. The valuation ratio typically expresses the valuation as a function of a measure of financial performance or Book Value: Earnings/Revenue Multiples Book Value Multiples Industry Specific Multiples Multiples from Recent M&A Transactions

This technique hinges upon the efficient market theory which indicates that the price of exchanged securities reflects all readily available information, as well as the supply and demand effects of educated and rational buyers and sellers. And since the methodology is based on the current market stock price, it is generally viewed as one of the best valuation metrics.

2. Comparable transactions multiple method

A Comparable transaction is one of the conventional methods to value a company for sale. The main approach of the method is to look at similar or comparable transactions where the acquisition target has a similar business model and similar client base to the company being evaluated. With the transaction multiple method, similar acquisitions or divestitures are identified, and the multiples implied by their purchase prices are used to assess the subject company's value. The difficulty with this approach is the limited availability of financial data regarding past transactions between private companies.

3. Market Value Method (For Quoted Securities)

The Market Price Method evaluates the value on the basis of prices quoted on the stock exchange. Average of quoted price is considered as indicative of the value perception of the company by investors operating under free market conditions. To avoid chances of speculative pressures, it is suggested to adopt the average quotations of sufficiently longer period.

PAGE 3 WHY SHOULD YOU GO FOR VALUATION?

i.

Determining the consideration for Acquisition/ Sale of Business or for Purchase/Sale of Equity stake Accurate business valuation is one of the most important aspects of M&A as valuations like these will have a major impact on the price that a business will be sold for. Investors in a company that are aiming to take over another one must determine whether the purchase will be beneficial to them. In order to do so, they must ask themselves how much the company being acquired is really worth. Naturally, both sides of an M&A deal will have different ideas about the worth of a target company: its seller will tend to value the company at as high of a price as possible, while the buyer will try to get the lowest price that he can. A valuation will assist the business owners in determining the value of their business and even maximizing value when considering a sale, merger, acquisition, joint venture or strategic partnership. Having a professional and independent valuation performed can be very helpful. For sellers a valuation report can be used to help validate and support the asking price of your business which will ultimately maximize your return on investment. For buyers an independent valuation report can potentially be very helpful when negotiating the final sales price and terms of a business acquisition.

ii.

Determining the swap ratio for Merger/Demerger Swap Ratio is an exchange rate of the shares of the companies that would undergo a merger. This is calculated by the valuation of various assets and liabilities of the merging companies. The swap ratio determines the control that each group of shareholders of the companies shall have over the combined firm. It is an indicator of relative values of financial and strategic results of the company. In case of a merger valuation, the emphasis is on arriving at the relative values of the shares of the merging companies to facilitate determination of the swap ratio. Hence, the purpose is not to arrive at absolute values of the shares of the companies. The key issue to be addressed is that of fairness to all shareholders. This is particularly important where the shareholding pattern and shareholders vary between the two companies.

iii.

Corporate Restructuring Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to a crisis or major change in the business such as bankruptcy, repositioning, or buyout. One of the major aspects of a corporate restructuring deal is to determine the correct value of the organization.

iv.

Sale/ Purchase of Intangible assets including brands, patents, copyrights, trademarks, rights Intangible assets are wealth creating resources and a competitive edge for the firm. They are identifiable, non-monetary assets that contribute in generating monetary benefits for the firm that control these intangible assets. Hence it is necessary to value the intangible assets for: Transaction pricing and structuring Financing collateralization and securitization

Taxation planning and compliance Regulatory compliance and corporate governance Bankruptcy and reorganization Financial accounting and fair value reporting Forensic analysis and dispute resolution Strategic planning and management information

v.

Determining the value of family owned business and assets in case of Family Separation Valuation is required in planning for the division/transfer of business in case of family separation/next generation. It may be a case where the existing business it to be sold to employees holding other closely related businesses. It may also be a case of third party transfer.

vi. vii. viii.

Determining the fair value of shares for Listing on the Stock Exchange/Going Public Determining the Portfolio Value of Investments by Venture Funds or Private Equity Funds Liquidation of company Valuation of a company about to be liquidated gives a fair picture of the proceeds that can be generated from the liquidation. It is determining the total worth of a company's physical assets when it goes out of business or if it were to go out of business. Liquidation value is determined by assets such as the real estate, fixtures, equipment and inventory a company owns. Intangible assets are not included in a company's liquidation value.

ix.

Voluntary Assessment

The management may opt for a voluntary assessment of the company to know the fair value of the business. This is generally done for internal management purpose and future decision making.

x.

Dispute Resolution

Valuations are an increasingly important aspect of many commercial disputes. Before deciding on how to manage a dispute, it is a good idea to understand: The likelihood of a successful outcome The currency amount involved

A valuation expert can assist by providing an early stage, high level indication of the values involved.

xi.

Regulatory Mandate

Need to change design for diagram.

PAGE 4

VALUER VIEWPOINT i. Justifying key assumptions and business model

Assumptions are the key to valuation. However, more the assumptions, more is the risk of errors in valuation. A valuers responsibility lies in formulating a business model built upon the right key assumptions such as revenue growth projections, capex, etc. A common error is that of extrapolation Adequate facts and figures need to be collected from apt resources to substantiate the above assumptions and projections. ii. Evaluate the current stage of the business cycle

Your business is changing. With the passage of time, your company will go through various stages of the business life cycle. A business goes through stages of development similar to the cycle of life for the human race. Parenting strategies that work for your toddler can not be applied to your teenager. The same goes for your small business. The company will have different cash flows at the various business cycles and it is important to change the discount rate as the stage of operation in the business cycle changes. The discount rate factors in the risk involved in operating the business. iii. Making sense of the financial data

The problem that we face in financial analysis today is not that we have too little information but that we have too much. Making sense of large and often contradictory information is part of analysing companies. A valuer needs to select the right data set, account for non-recurring events, and chose the right manner in which to use the data individual data, summarized data, etc. iv. Choosing the right valuation model

There are many valuation models. Selecting the right model is the key to arriving at the true value of the business. A valuer has to factor in many points before choosing the right model. A valuer has to define the objective of the analysis: Is it to value the entire business or only the equity? Whether the company is in a new industry (sunrise) or an existing one? There are many such perspectives that are considered before choosing the valuation model.

v.

Minimize the impact of bias from valuation Any valuation model is subject to biasness. It is the responsibility of the valuer to account for the biasness in the valuation process and minimize its impact in arriving at the fair value of the business.

CHECKPOINTS IN VALUATION

i.

Non-recurring items/ Extraordinary items/Other Income Business transactions that are non-recurring, but have substantial impact on the financials in the year in which they occur, should not be included in the valuation as may not have an impact in the future earnings projections. Non-recurring other income (such as rental income for a company that is into non-rental business) should be excluded from the valuation process. In case the Other Income component is recurring over a period of three years or more, then the valuer may include the same in the valuation of the business.

ii.

Non-operating assets/ Excess cash Neither do Non-operating assets generate cash flows, nor does excess/idle cash add to any operations of the company. The valuer needs to account for these in arriving at the true value of the business.

iii.

Impact of Seasonal events Valuation of a company is done on the basis of data on a particular date. Any seasonal events like bad monsoons, raw material price fluctuation, etc., may have substantial impact on the valuation. It is important to select the correct set of financial data for valuation that has not been impacted by such temporary seasonal events.

iv.

Off Balance sheet Items The financial statements do not reveal the complete picture about the company being valued. The off-balance sheet items are the invisible items that need to be factored in while arriving at the value. The hidden, untraceable liabilities may outweigh the glossy picture presented by the visible financial statements.

v.

Intangible asset valuation Critics of valuation analysts, in particular and quantitative valuation models, in general, argue that we miss intangible assets because we are so focused on the bottom line - earnings and cash flows. It is important to ensure that companies go through a robust identification and valuation process to make certain that the fair value of the intangible assets are accurately reflected in the financial statements and that the remaining useful life assigned to each category of asset reflects its nature and importance to the business.

vi.

Consistency in Accounting Practices The valuer needs to ensure that the company has followed the conventions of accounting issued by the Recognised Accounting bodies. In case of discrepancies or inconsistency in following accounting policies, the financial data may need adjustments and normalization.

vii.

Corporate Governance & Transparency A company that is transparent and complaint with corporate governance should command a greater value than a similar peer company which is less transparent and complaint in terms of corporate governance. Operational Environment Legal and Tax

viii.

The valuer should take into account the operating environment of the company being valued whether the company is operating in a SEZ, tax-free zone or any other relevant exemptions. The valuer also needs to check for the period for which such exemptions are valid i.e. how long will the company continue to enjoy such benefits and if there are any future tax/legal implications that may have substantial impact on the financial of the company.

ix.

Discounts & Premiums : Discounts in terms

Discounts in terms of illiquidity discounting, in order to capture the risk associated with companies that are not listed. Premiums in case of highly liquid stock, in order to capture the liquidity associated with such companies. Control Premium - An amount or percentage by which the pro-rata value of a controlling interest exceeds the pro-rata value of a non-controlling interest in a business enterprise to reflect the power of control. Discount on Lack of Control (DLOC) - An amount or percentage deducted from the pro-rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control. Discount on Lack of Marketability (DLOM) - An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.

PAGE 5 VALUATION - THE LAW OF DIMINISHING RETURS

Need to change the diagram design; we will put the text in tabular form.

PAGE 6 PURCHASE PRICE ALLOCATION (Will be provided by Sir) PAGE 7 REPLICATE FROM THE REFERENCE WEBSITE

OUR OFFERINGS

I AM CURRENTLY WORKING ON THIS SECTION. IT WILL BE READY BY MONDAY (10/06/2013)

CLIENT PORTFOLIO THIS PAGE WILL BE THERE BUT NOT INITIALLY. INFORMATION CAF ALL THE SUB-SECTIO NS NEED TO BE REPLICATED FROM THE REFERENCE WEBSITE BUT FOR NOW WE WILL INCLUDE THE FOLLOWING: ASK THE EXPERT GLOSSARY FAQS USEFUL LINKS KINDLY REPLICATE THE ABOVE. THE OTHER PARTS WILL BE INCLUDED LATER CONTACT US REPLICATE FROM THE REFERENECE WEBSITE