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Challenges in Valuation
Challenges in Valuation
Value of a share may also differ for large and small shareholders
Absent control considerations, a larger stake may be more difficult to monetize Liquidity and control are seldom
independent
Challenges in Valuation
Share value may also differ for institutional vs. individual shareholders
Tax treatments are different, which affects the liquidity
A share can also be more valuable for a founding interest family due to emotional
Challenges in Valuation
Value of Control
Range of Control
100 % Equity Ownership Position
Value of Control
Find out status quo value Revalue the company with a hypothetical optimal management team Difference is value of controlling
SAP is a business software manufacturing company, headquartered in Germany. It has a well-deserved reputation for good management, especially when it comes to new investments; it reinvested 57.42% of its after-tax operating income back into the company and generated a return on capital of 19.93%. On both dimensions, it did considerably better than its peer group. The management is, however, extremely conservative When it comes to the use of debt and has a debt ratio of 14%; its resulting cost of capital is 8.68%.
Contd..
An aggressive management can change the financing mix and move the firm to its optimal debt ratio of 30% At a 30% debt ratio, the cost of capital is minimized at 7.95% Restructured Valuation with this change and arrive at a value of 118.70 Euros per share Value of control 12.6 Euros/share (12%)
Solution
Expected value per share = Status Quo Value + Probability of control changing * (Optimal Value Status Quo Value) $ 9.50 = $ 5.13 + Probability of control changing ($12.47 - $5.13) The market is attaching a probability of 59.5% that management policies can be changed.
Solution
Value per non-voting share = Status Quo Value/ (# voting shares + # nonvoting shares) = 12,500/(242.5+476.7) = 17.38 $/ share Value per voting share = Status Quo value/sh + Probability of management change * (Optimal value Status Quo Value) = 17.38 + 0.2* (14,700-12,500)/242.5 = 19.19 $/ share
Quantification of VP
Estimates of the voting premium have been found to range widely across countries:
510% in the U.S. (Zingales, 1995), 80% in Italy (Zingales, 1994).
Mergerstat Review published annually and quarterly Houlihan, Lokey, Howard and Zukin, Inc. (HLHZ) Control Premium Study Quarterly SEC
Minority Discount
Quantification of MD
Value of Liquidity
Less liquid Investments should trade for less than more liquid similar investments
Empirical Evidences
Pre-IPO studies
Siber (1991)
Illiquid Discounts
Over $200 M
Total Net Income Negative $0-1M $1-10 M Over $10M
13.0%
Average Discount 22.5% 26.0% 18.1% 06.3%
Private Placements
Bajaj et al,
Damodaran (2000) regressed the bid-ask spread against annual revenues, with a dummy variable for positive earnings (DERN: 0 if negative and 1 if positive), cash as a percent of firm value and trading volume. Spread = 0.145 0.0022 ln (Annual Revenues) -0.015 (DERN) 0.016 (Cash/Firm Value) 0.11 ($ Monthly trading volume/ Firm Value) Plugging in the corresponding values with a trading volume of zero for a private firm should yield an estimate of the synthetic bid-ask spread for the firm. This synthetic spread can be used as a measure of the illiquidity discount on the firm.
Other Discounts
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