Valuation in Indian Regulatory Environment with focus on Tricky Issues: the presentation given by Mr. Chander Sawhney, Vice President (chander@indiacp.com) of Corporate Professionals at the CKF Masterclass "Corporate Valuations- Techniques and Applications"...

1. What has never been doubted has never
been
proven..
Valuation in Indian
Regulatory Environment
(With focus on tricky issues)
By:
Mr. Chander Sawhney
Vice President
Corporate Professionals Capital Private Limited

2. Agenda 3)
Valuation in Indian
Regulatory
Environment
2)
Tricky Valuation
Issues
1)
Stem of Valuation

3. S Standard of Valuation
T Thesis of Valuation
E Economics of Valuation
M Methodologies of Valuation
Corporate Valuations – Techniques and Application

4. FAIR MARKET VALUE
INTRINSIC VALUE FAIR VALUE
INVESTMENT VALUE
Standard of
Valuation
Thesis of Valuation Economics of
Valuation
Methodologies of
Valuation
Standard of Value is the hypothetical conditions under which a business is valued.
While selecting the Standard of Value following points is to be taken care of
 Subject matter of Valuation;
 Purpose of Valuation;
 Statute;
 Case Laws;
 Circumstances.
Types of Standard of Value:
Corporate Valuations – Techniques and Application

5. Standard of
Valuation
Thesis of Valuation Economics of
Valuation
Methodologies of
Valuation
Thesis of Value is Premise of value which relates to the assumptions upon which
the valuation is based.
Premise of Value
 Going Concern – Value as an ongoing operating business enterprise.
 Liquidation – Value when business is terminated . It could be „forced‟ or „orderly‟.
 Value-in-use
 Value-in-exchange
Corporate Valuations – Techniques and Application

6. Growing
Cos.
 Turnover/Profits: Increasing still Low
 Proven Track Record: Limited
 Valuation Methodology: Substantially on Business Model
 Cost of Capital: Quite High
High Growth
Cos.
 Turnover/Profits : Good
 Proven Track Record: Available
 Valuation Methodology: Business Model with Asset Base
 Cost of Capital: Reasonable
Mature
Cos.
 Turnover/Profits: Saturated
 Proven Track Record: Widely Available
 Method of Valuation: More from Existing Assets
 Cost of Capital: May be High
Declining
Cos.
`
 Turnover/Profits: Drops
 Proven Track Record: Substantial
Operating History
 Method of Valuation: Entirely
from Existing Assets
 Cost of Capital: N.A.
 Turnover/Profits: Negligible
 Proven Track Record: None
 Valuation Methodology: Entirely on Business Model
 Cost of Capital: Very High
Start Up
Cos.
Turnover/Profits
Time
Valuation across business cycle follow the law of
economics
Standard of
Valuation
Thesis of Valuation Economics of
Valuation
Methodologies of
Valuation
Corporate Valuations – Techniques and Application

7. Standard of
Valuation
Thesis of Valuation Economics of
Valuation
Methodologies of
Valuation
Valuation
Income Based
Method
Market Based
Method
Asset Based
Method
Other Methods
Capitalization of
Earning Method
(Historical)
Discounted Cash
Flow Method
(Projected
Time Value)
Comparable
Companies Market
Multiples Method
(Listed Peers)
Comparable
Transaction Multiples
Method
(Unlisted Peers)
Market Value Method
(For Quoted
Securities)
Book Value Method
Liquidation Value
Method
Replacement Value
Method
Contingent Claim
Valuation
(Option Pricing)
Price of Recent
Investment Method
Rule of Thumb
(Multiples:
Customers, Rooms,
Seats, No. of visitors
etc.) - Depends
upon Industry
Corporate Valuations – Techniques and Application

8. CASH FLOW
Investor assign value based on the cash flow they expect to receive in the
future
- Dividends / distributions
- Sale of liquidation proceeds
Value of a cash flow stream is a function of
- Timing of cash Receipt
- Risk associated with the cashflow
ASSETS
Operating Assets
- Assets used in the operation of the business including working capital, Property, Plant &
Equipment & Intangible assets
- Valuing of operating assets is generally reflected in the cash flow generated by the
business
Non - Operating Assets
- Assets not used in the operations including excess cash balances, and assets held for
investment purposes, such as vacant land & Securities
- Investors generally do not give much value to such assets and Structure modification
may be necessary
Key drivers of valuation
That’s why DCF is most
prominent valuation
method
Need for Restructuring
Corporate Valuations – Techniques and Application

9. Tricky Valuation Issues
Corporate Valuations – Techniques and Application

10. • Mergers
• IPO
• RBI
• Income Tax
• ESOP
• Companies Act
• SEBI
• Stock Exchange
Purpose Regulatory Accounting
• Purchase Price
Allocation
Dispute
Resolution
• Company Law
Board/ Courts
• Impairment /
Diminution
• Arbitration
• Mediation
• Acquisitions /
Investment
• Voluntary
Assessment
Value
Creation
• Equity Research
• Credit Rating
• Corporate
Planning
Valuation depends upon
Corporate Valuations – Techniques and Application

11. Choice of Valuation Approaches
“Value in Valuation is a question,
and
Your choice of Method is the first step
towards answer”
Applicability of a particular approach depends upon:
On whose behalf? – one buyer vs another buyer, buyer vs seller;
For what purpose? – independent strategic acquisition, group company consolidation, cross
border transaction;
When? – distress situation, industry downturn, boom etc;
Corporate Valuations – Techniques and Application

12. Choice of Valuation Approaches
• In General, Income Approach is preferred;
The dominance of profits for valuation of share was emphasised in “McCathies case” (Taxation,
69 CLR 1) where it was said that “the real value of shares in a company will depend more on the
profits which the company has been making and should be capable of making, having regard to
the nature of its business, than upon the amount which the shares would realise on liquidation”.
 This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s
case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.)
(122 ITR 38).
• However, Asset Approach is preferred in case of Asset heavy companies
and on liquidation;
•Market Approach is preferred in case of listed entity and to evaluate the
value of unlisted company by comparing it with its listed peers;
Corporate Valuations – Techniques and Application

13. Enterprise / Business Value
EnterpriseValue
Net Debt#
Equity#
Fixed
Assets
Net Current
Assets
Intangibles
Stakeholders Assets
ValueofBusiness
# Based on Market Values
Corporate Valuations – Techniques and Application

14. Valuation Methodologies and Value Impact
Major Valuation Methodologies Ideal for Result
Net Asset Value
Net Asset Value (Book Value) Minority Value
Equity Value
Net Asset Value (Fair Value) Control Value
Comparable Companies Multiples (CCM) Method
Price to Earning , Book Value Multiple
Minority Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Comparable Transaction Multiples (CTM) Method
Price to Earning , Book Value Multiple
Control Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Discounted Cash Flow (DCF)
Equity Control Value Equity Value
Firm Enterprise Value
Corporate Valuations – Techniques and Application

15. Discounts
• Discount for Entity Level
Discounts & Premiums come into picture when there exist difference between the
subject being valued and the Methodologies applied. As this can translate control value
to non-control and vise versa , so these should be judiciously applied.
– Impact on entity as a whole
 Key Person Discount
 Discount for Contingent Liability
 Discount for diversified company
 Discount for Holding Company
• Discount for Shareholders Level – Impact on specific ownership interest
 Discount Lack of Control (DLOC)
 Discount Lack of Marketability (DLOM)
• Size of distribution or dividends
• Dispute
• Revenue / Earning – Growth / Stability
• Private Company
 Tax Payout
• % stake & special rights
• Shareholders Agreement caveats
Global Studies over the years on diversified
companies and holding companies has shown
that companies trade at a discount in the range
of 20%. to 40% each.
DLOM: As per CCI Guidelines, 15%
discount has been prescribed; however
practically DLOM and DLOC depends upon
following factors:
Corporate Valuations – Techniques and Application

16. Premium
•Control Premium - An investor seeking to acquire control of a company is typically
willing to pay more than the current market price of the
company. Control premium is an amount that a buyer is usually
willing to pay over the fair market value of a publicly traded
company to acquire controlling stake in a company
Research has shown that the control premium in
India has ranged from 20% to 37% in the past few
years.
Corporate Valuations – Techniques and Application

17. Excess Cash and Non Operating Assets
Excess cash is defined as „total cash (in balance
sheet) – operating cash (i.e. minimum required cash)
to sustain operations (working capital) and manage
contingencies
Key Issue: Estimation of Excess Cash ?
Non operating Assets are the Surplus assets which are not used in operations of the business and does not
reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should be
separately added to the value derived through valuation methodologies to arrive at the value of the company.
One of the solutions is to estimate average
cash/sales or total balance sheet size of the
company’s relevant Industry and then estimate if
the company being valued has cash in excess of the
industry’s average.
What is an asset is not yielding adequate returns ?
Corporate Valuations – Techniques and Application

18. Cross Holding and Investments
Holdings in other firms can be categorized into:
Types of Cross Holding Meaning
Minority, Passive Investments If the securities or assets owned in another firm represent less
than 20% of the overall ownership of that firm
Minority, Active Investments If the securities or assets owned in another firm represent
between 20% and 50% of the overall ownership of that firm
Majority, Active Investments If the securities or assets owned in another firm represent more
than 50% of the overall ownership of that firm
Investment Value
Ways to value Cross Holding and Investments:
Dividend Yield Capitalization or DCF based on expected dividends
Seperate Valuation (Preferred)
By way of Shareholders
Agreement even less %
holding may command
control value
Corporate Valuations – Techniques and Application

19. Accounting Practices and Tax issues
Most of the information that is used in
valuation comes from financial statements.
which in turn are made on certain
Accounting practices considered
appropriate.
• Cash Accounting v/s Accrual Accounting
• Operating Lease v/s Financial Lease
• Capitalization of Expenses
• Notional Tax vs. Actual Tax
• Treatment of Intangible Assets
• Companies Paying MAT
• Treatment of Tax benefits and Losses
Corporate Valuations – Techniques and Application

20. Intangible Valuation
Identification of Intangible Assets:
• Market Related : Trade Marks, Service Marks etc.
• Customer Related : Customer Lists, Order backlogs etc.
• Artistic Related : Plays, Books, Pictures, Music, Video etc.
• Contract Related : Licensing, Royalty, Lease agreements etc.
• Technology Related : Patented Technology, Databases,
computer software's etc.
Corporate Valuations – Techniques and Application

21. Intangible Valuation Cont.
Choice of Valuation Approaches and Methodologies
Income Approach
• Excess Earnings
• Relief from Royalty
• Discounted Cash Flow
• Comparative Business
Valuation
Cost Approach
• Historical Cost
• Replacement Cost
Market Approach
• Based on sale
of similar license
/ intangible asset
Other Approach
• Option Pricing
Model
Corporate Valuations – Techniques and Application

22. Purchase Price Allocation
What is a Purchase Price Allocation?
- an acquiring entity must allocate the purchase price to the assets
acquired and liabilities assumed based on estimated fair values at the
date of acquisition;
- The excess of the cost of an acquired entity (including tangible and
intangible assets) over the net of the amounts assigned to assets
acquired and liabilities assumed is recorded as “Goodwill”;
Consideration
paid for
acquisition
Allocated to
Tangible Assets
Intangible Assets
Goodwill
In Proportion
to Fair Value
Balancing
Figure
Intangible Valuation Cont.
Corporate Valuations – Techniques and Application

23. Private Company Valuation
Some Data Issues:
Valuation of Unlisted
Company..
• Industry Misclassification
• Infrequent Collection
• Mixing Data from Different Sources
• Omission or Inclusion of Information
• Poor Data Quality
• Tiny Sample Size
Guidance Note:
The valuation of shares should be carried out on the gross profits earned by the Company, as held in
Rakhra Sports Private Limited and Ors. v. Khraithilal Rakhra and Ors. (1993) Vol. 74 CC 545
While carrying out the valuation of shares, the valuer must take into account the salaries and perquisites
paid to the directors and related party transactions.
Corporate Valuations – Techniques and Application

24. Rule of Thumb
A rule of thumb or benchmark indicator is used as a
reasonableness check against the values determined by the
use of other valuation approaches.
Industry Valuation Parameters
Hospital EV/Room
Engineering Mcap/Order Book
Mutual Fund Asset under management
OIL EV/ Barrel of equivalent
Print Media EV/Subscriber
Power EV/MW, EBITDA/Per Unit
Entertainment & Media EV/Per screen
Metals EBITDA/Ton, EV/Metric ton
Textiles EBITDA depend upon capacity utilization Percentage & per spindle value
Pharma Bulk Drugs New Drug Approvals , Patents
Airlines EV/Plane or EV/passenger
Shipping EV/Order Book, Mcap/Order Book
Cement EV/Per ton & EBITDA/Per ton
Banks Non performing Assets , Current Account & Saving Account per Branch
However, Exclusive use of Rule of Thumb is not recommended
Corporate Valuations – Techniques and Application

25. Company Specific Factors
• Management, Promoter Group
Fundamental to any
valuation
• Operating, Capital and Corporate Finance Strategies
• Competitive advantages and cost position
• Product / Service offering / differentiation / pricing power
•Scale & Diversification
•Customer / Supplier concentration
•Corporate Governance
•Future prospects / Growth potential
•Industry peer group
•Regulatory environment
Corporate Valuations – Techniques and Application

26. Industry Risk Analysis
• Good vs. Difficult industry
• Porter’s 5 forces
• Industry life cycle (growth)
• Industry cyclicality (earnings quality)
• Leading indicators
• Competition (ROIC)
• Pricing dynamics; Demand vs. Supply (ROIC)
• Changing business environments
• Regulation (ROIC)
• Product characteristics (earnings quality)
• Capital intensity and cost base (ROIC)
• Event risk
Following factors are required to
be considered:
Corporate Valuations – Techniques and Application

27.  Pre Money or Post Money: If the effect of the money coming in Company is taken in Projections, the
Expanded capital base should be considered or else the Equity Value should be reduced by the inflow
amount to reconcile with the existing capital base.
 Projection Validation via-a-vis Industry: Need to have Sanity check of the projections with the trend
of the industry.
 Terminal growth rate: Since it is tough to estimate the perpetual growth rate of a company, it is
preferred to take the perpetuity growth rate factoring in long term estimated GDP of the Country and
Historical/Projection Inflation of the Country.
 Adjustment of Company Specific Risk Premium or Small Company Risk Premium: Small
Companies are generally more risky than big companies. CAPM model does not take into consideration
the size risk and specific company risk as Beta measures only systematic risk and Market Risk
Premium (generally pertaining to Sensex Companies). These risks should also be taken into account
while computing the cost of equity.
 Length of Projections: The Projected Cash Flows should factor in the entire Business Cycle of a
Company.
 Notional/Actual Tax: Actual Tax Liability may be worked out and replaced for the Notional Tax Liability.
In perpetuity tax should be computed at full rate
Some other tricky issues in valuation
(From DCF perspective)
Corporate Valuations – Techniques and Application

28. Valuation in Indian Regulatory
Environment
Corporate Valuations – Techniques and Application

29. Inbound Investment DFCF
Gift of Unquoted Equity
Shares (Min)
NAV
Outbound Investment Valuer Discretion
Gift of Unquoted Shares
other than Equity Shares
Price it would fetch if sold in
open market
Takeover Code/ Delisting -
Infrequently Traded
Only Parameters Prescribed
– Return on Net Worth, EPS,
NAV vis-a vis Industry
Average
Takeover Code/ Delisting -
Frequently Traded
Based on Market Price
Reserve Bank of
India
ESOP Tax
Valuer Discretion
ESOP Accounting
Option – Pricing Model
Income Tax
SEBI
CA / MB
>5Mn$ - MB, otherwise CA/MB
-
MB
MB
-
CA/MB
-
Stock Exchanges
Preferential Allotment to
promoters / their relatives
for consideration other than
cash
Valuer Discretion
Companies Act Sweat Equity Valuer Discretion
CA / MB
-
Transactions Prescribed Methodologies Mandate to be done by
SNAPSHOT OF REGULATORY VALUATIONS IN INDIA
Gift of Unquoted Equity
Shares from Resident
(Max)
DCF (Valuation Based on
Assets, Business &
Intangibles is also
acceptable)
FCA / MB
Corporate Valuations – Techniques and Application

30. IRS Revenue Ruling (59-60),USA
• Revenue Ruling (RR) 59-60 is one of the oldest guidance available on Valuation in the world
but still most relevant for Tax Valuations specifically for Valuing closely held common
stock. It is the most widely referenced revenue ruling, also often referenced for Non Tax
Valuations.
• While Valuing , it gives primary guidance on eight basic factors to consider-
• Nature of the Business and the History of the Enterprise from its inception
• Economic outlook in general and outlook of the specific industry in particular
• Book Value of the stock and the Financial condition of the business
• Earning Capacity of the company
• Dividend-Paying Capacity of the company.
• Goodwill or other Intangible value
• Sales of the stock and the Size of the block of stock to be valued
• Market prices of stock of corporations engaged in the same or a similar line of business
Corporate Valuations – Techniques and Application

31. Any Specific Valuation Query may be mailed @
info@corporatevaluations.in / chander@indiacp.com
M: +91 9810557353; Ph: 011-40622252
W: www.corporatevaluations.in;
corporateprofessionals.com
Mr. Chander Sawhney
(FCA, ACS, Certified Valuer (ICAI)
Disclaimer:
This presentation contains information in summary form and is therefore intended for general guidance only. It is not intended
to be a substitute for detailed research or the exercise of professional judgment. Neither corporatevaluations.in nor any other
member of the Corporate Professionals organization accept any responsibility for loss occasioned to any person acting or
refraining from action as a result of any material in this presentation. On any specific matter, reference should be made to the
appropriate advisor.
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