June 2018 Review

Income Tax Returns 2017

It is high summer with temperatures hitting 30 degrees, and the filing of 2017 Income Tax returns might not be high on the agenda for those thinking of holidays, but it is worth remembering that there are just 4 months to go to the 2017 filing deadline.

If you have not already done so, get your information together and avoid the stress that comes with filing close to the deadline.

You can enjoy the holidays all the more once it’s done!

PAYE Modernisation – the preparations continue

 We hear that over the coming months Revenue will be inviting employers to submit lists of their employees to enable Revenue to validate the data against their own records.

Employers will be requested to submit this information via ROS on a phased basis.

If you need any assistance with requests you receive don’t hesitate to contact us.

PAYE MODERNISATION WILL BE EFFECTIVE FROM 1 JANUARY 2019 

Aspects of valuation 2 – Approaches to valuing a business

Overview

This is the second in a series of articles where we will examine different aspects of company valuation. The purpose of the series is to make you aware of the Keogh Ryan Tierney expertise and approach to valuation. In this article we’ll look at the different approaches to valuation.

How businesses are valued

There are several approaches to valuation of a business, an expert valuer will normally review the different methodologies and select the most appropriate for the specific circumstances. It is recognised however that business valuation is not an exact science and expert valuers can legitimately arrive at different valuations for the same business.

The most common approaches to business valuation are as follows:

1.    Net Assets Approach

2.    Sales/Turnover based Approach

3.    Dividend based Approach

4.    Earnings based Approach

5.    DCF based Approach

1.    Net Assets Approach

The value of the net assets (i.e. the assets less the liabilities) as shown in the financial statements of the business or the market value of the nets assets less taxes and expenses on disposals. It is based on the balance sheet of the business rather than the future income / profits of the business.

Valuations, which incorporate the valuations of the underlying assets are useful where the business has significant tangible or intangible assets which may not be generating significant income but have an intrinsic value – e.g. property holding companies.

The approach is also used if a business is being valued on a liquidation basis.

The advantage of the approach is its simplicity but it ignores the cash generating capacity of the company assets.

2.    Sales/Turnover based approach

Valuing a business by applying an industry sales valuation yardstick or “rule of thumb” – e.g. consulting, legal and accounting practices are sometimes valued based on a multiple of turnover.

All the relevant factors will be taken into account in an open market transaction, in an independent valuation of a practice the valuer will derive a benchmark figure based on the rule of thumb, but the final agreed price will take into account other factors such as synergies, staff, and location which are individual to the practice.

Therefore the “rule of thumb” is effectively the starting point for a discussion on value, the final agreed price can vary considerably. It is useful in a market with a significant number of transactions and where the costs in the business tend to be consistent across the participants.

3.    Dividend based Approach

The dividend yield basis of valuation is often used to value a minority shareholding i.e. a shareholding of less than 50% of a business. It acknowledges that a minority shareholder on its own cannot influence the decisions of the company, for example the level of profits to be distributed by the company.

The value is based on expected dividend receipts, using a discounted cashflow technique to generate a present value from expected dividend receipts. When the dividends paid are divided by this capital value the yield i.e. the dividend yield can then be compared with the dividend yield of a comparable publicly quoted company.

4.0 Earnings based approach – Introduction

4.1 Enterprise Value (EV) V Equity

Usually discussions about the valuation of a company refer to the value of the equity or shares:

Market Value of Equity = share price X the total number of shares (for listed companies)

However corporate finance transactions are frequently expressed by reference to EV rather than the equity value. EV is an economic measure reflecting the market value of a business. It focuses on the value of the underlying business on a debt free cash free basis.

EV = Equity Value + Debt – Cash

Equity Value = EV – Debt + Cash

If an investor wishes to acquire a business on a debt free, cash free basis, contracts for the sale of a business express the contract price as say €10M on a debt free cash free basis. At the close date any outstanding debt is deducted from the contract price and any cash is added to arrive at the settlement figure. The advantage of EV is that the distortions cause by significant debt positions are reduced.

4.2 Keogh Ryan Tierney Methodology

Enterprise multiples that measure Enterprise Value relate the total value of a company to a measure of operating earnings generated, such as earnings before interest, taxes, depreciation and amortization (EBITDA).

At Keogh Ryan Tierney we most commonly use an earnings based approach when valuing private companies. Based on our knowledge and research of the market place we determine what multiple of earnings (most often a multiple of Ebitda), is being paid in the market and apply the multiple to future maintainable profit to give the Enterprise Value (EV).

When assessing a business for valuation purposes we would look at the following aspects of the business, this list is not exhaustive and the analysis may be curtailed by the amount of information we are able to access. We use publicly available information and information from transactions we are aware of through our own practice.

Industry and business capacity – we review the wider market in which the business operates to assess the trends in the market and then the business’ capacity to keep up with market changes and capitalise on new opportunities.

Market for product / service within the industry – we look at the market for the particular product / service to assess whether the trends will impact on turnover. We assess whether the product or service is at an early or late stage in the product lifecycle and whether the business in dependent on one income stream.

Position of the business in the market – we review whether the business has any unique contracts, a unique selling point, the capacity for change and the capacity to expand.

Competition – we review the competition and the potential for the business to compete in terms of price and service.

Spread of Turnover – we review the customer of the business to see if there is a high dependence on one or more customers, what the impact on the business would be if they lost a customer? We will also analyse the income into recurring and non-recurring to determine the stability of turnover.

Trading results – we review trading results to compare with similar businesses and see how the business has performed in comparison, whether there is scope for efficiencies, or if the margins are unusually high or low and how are these explained.

Forecasts – we review forecasts of turnover and profitability prepared by the management to try to establish the future maintainable profits of a business.

Management team and staff profile – we review whether the company is particularly dependent on key management or staff, what would the impact on the business be if the key people departed after purchase? Can the key staff member be replaced? A question for a new owner would be whether they can expect to the trade to continue if the former owners / management are not retained in the business.

This analysis allows us to evaluate the future maintainable earnings, we normally use a weighted average earnings, giving the most recent trading results the most weight when calculating the average.

The analysis above also influences the Multiple. Having researched the market established a yardstick i.e. the multiples commonly being paid for private companies in recent market transactions we will adjust the multiple up or down based on the risk factors outlined above.

Rather than arriving at a set valuation for a business we may report in ranges. Usually the range will be the difference between applying a multiply of say 5 or 6.

There is some debate over whether a multiple of Ebitda or a multiple of Net Profit after tax (Npat) is more appropriate in valuing businesses. Analysts can use both, often when commenting on the price at which a publicly traded company sold for the analyst will calculate the multiple of Ebitda that was paid. The analyst is not indicating that this is how the price was agreed but it’s a yardstick to use to compare with other transactions. The BDO UK PCPI (private company price index) is a good example it “tracks the relationship between Enterprise Value (EV) to Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) multiple (EV/EBITDA) paid by trade and private equity buyers…The PCPI is an average measure and a guide, not an absolute measure of value, as there are many other factors that can have an impact on value.”

BDO also refers to the distortions in profits that can occur in privately owned companies, some expenses may be non-recurring under a new owner e.g. Directors Salaries, these may be adjusted for when estimating future maintainable profits before applying a multiple.

4.3 Earnings based approach – The Multiple

Valuation multiples can be broken into 2 broad categories:

EV compared to operational variables

·         EV / Sales = Enterprise Value / Sales

·         EV / EBITDA = Enterprise Value / EBITDA

·         EV / EBIT = Enterprise Value / EBIT

Equity Value compared to a measure of equity return

·         P / E = Equity value / Earnings (PAT)

·         P / B = Equity value / book value (per balance sheet)

At Keogh Ryan Tierney we generally favor the EV / EBITDA multiple because this multiple is commonly quoted in the corporate finance industry when analyzing both public and private business sales. These publicly quoted figures can be adjusted up or down depending on the circumstances of the business being valued following analysis of the business.

We can also reference multiples to private deals we are aware of through our practice, to transactions reported in the press and to published data on multiples.  For example the morning briefings by stockbrokers such as Davys regularly quote the implied EV / EBITDA multiple when commenting on recent trades in publicly quoted companies, while American sectoral multiples can be found at Damodaran online – the research website of Aswath Damodaran at the Stern School of Business at New York University. Closer to home BDO UK publish a quarterly private company price index. The Index tracks the EV to EBITDA multiples paid by trade and private equity buyers when purchasing UK private companies.

5. Discounted Cashflow (DCF) Approach

In discounted cashflow (DCF) models a company’s forecast future free cash-flows are discounted by its weighted WACC. However, due to the inherent uncertainties involved in forecasting long-term cash-flows, analysts tend to adopt a range of both WACC and terminal values within the DCF models, producing a range of alternative valuations.

The typical steps to a DCF valuation are as follows:

1.    Project operating cashflows – e.g. 5 years

2.    Determine the cost of capital – e.g. 7.5%

3.    Discount the cashflows to present value using the cost of capital

4.    Calculate terminal value of the cashflows based on the discount rate less the growth rate

5.    Calculate the present value of the terminal cashflows.

6.    Add the PV of the cashflows to the PV of the terminal value to arrive  at Enterprise Value

7.    Equity Value = EV – debt – debt like items + cash + cash like items

8.    The Equity value divided by the number of shares gives the value per share.

The model is based on projections and assumptions but is regularly used by analysts to estimate company value of acquisitions and for buy/sell recommendations. Given the level of assumptions and the variability as a result of changes in key inputs (garbage in, garbage out!) we have not seen this method used regularly in private company valuations, it is more useful when comparing two or more investments and these typically would be in large scale companies.

Even the investment houses get it wrong at times. In April of 2017 Morgan Stanley Morgan Stanley published an equity research note on Snap (Snapchat), the social media company it helped take public, putting a $28 price target on the stock. That’s 23% above where the shares ended trading the week before, and the bank’s advice to clients was to buy. Almost a day later, the bank issued a correction, changing a range of important metrics in its financial model but not the $28 price target.

Morgan Stanley’s revised numbers cut Snap’s adjusted EBITDA for 2021 through to 2025. In 2025 alone, the change amounted to a cut of $1.7 billion in estimated adjusted EBITDA. A lower earnings estimate, then, ought to lead to a revision in the price target, even by a small amount.

It didn’t work that way in Snap’s case because Morgan Stanley also corrected some other assumptions in its model. In the updated research report, Morgan Stanley said:

“We have also corrected our discounted cash flow calculation so that it is consistent and comparable across our US internet coverage. More specifically, we are lowering our SNAP equity risk premium from 5.59% (an estimated pre-IPO rate) to 4.29% (consistent with other companies in our group). This change lowers our WACC to 8% (from 10%). On an aggregate basis, our price target is unchanged at $28/share.”

However when considering an acquisition forecasting future growth and operating cashflows is a useful exercise and sensitivity analysis on the DCF valuation can give useful information to a business owner as to the impact on the key variables on the value of the business.