Innovation and Entrepreneurship

Company Valuation - 11

Company Valuation 11.1

 Valuation – Setting

Consumer
Factor Inputs Market for
Output
Products and
Capital Firm with Services
Land Productive
Assets
Labour
Technology Short Term Traded
Securities
Fixed
Intangible
Capital Market
Goodwill for Stocks and
Bonds

Company Valuation 11.2

 Valuation – Three Major
Techniques
• Asset Valuation Approach: Asset
side of the Balance Sheet

• Income Valuation Approach: Profit

and Loss Statement

• Market Multiple Valuation

Approach: Liability side of the
Balance Sheet
Company Valuation 11.3
Valuation – Asset Based Approach
• Company valuation as a special
case of asset valuation
• Analyze the “Asset” side of the
balance sheet
• Assets are where company has
already spent the money and
assets will give cash flows in
future
• Company’s value depends upon
the size and reliability
Company Valuation of these 11.4

future cash flows

 Occasions for Valuation
• Equity analysis
• Merger and Acquisition
• Employment (when ESOPs are
involved)
• IPO, restructuring, divestiture
• Exit of a Joint-Venture partner
• Equity investment (VC Financing)
• Loan decision by a banker (financial
health estimation and default
probability estimation)
Company Valuation 11.5
• Management Buyout, internal share
Type of Companies being Valued
• Listed companies – market price
(consensus of active traders,
quarterly statements, guidance,
forecasts)
• Companies with assets which
are mostly physical –
depreciation, appreciation,
obsolescence
• Examples – transport operator,
mechanical ancillary
Company Valuation units 11.6
Type of Companies being Valued

Knowledge-based companies have

huge intangible assets
• Patents, trademarks, Copyright
(Software source code)
• Processes, quality and development
methodology,
• Goodwill, brand, customer base,
relationships
• Team (education, experience,
skills) Company Valuation 11.7
Difficulties in Valuing Early Stage
Companies
• Immediate earnings are
negative
• No past history
• No comparable
companies
• No market prices
• Asymmetric information
• Management efficacy
yet to be established
Company Valuation 11.8
 Asset Valuation

• Cost of acquisition
• Depreciated value (book
value)
• Appreciated value
• Replacement value
(example: laptop)
• Liquidation value
Company Valuation 11.9
Assets in Combination (Synergies)
• Intellectual Property and Team
• Individual valuation difficult and
problematic
• Combination valuation is
meaningful
• Replacement costs are better to
use as they are marked to
market.
• Example: Outright sale of some
Company Valuation 11.10
Major Methods of Asset Valuation
• Discounted Cash Flow (DCF)
• Market multiples
• Comparable companies (or assets)
• Comparable deals
• Ad hoc – illiquidity, intangibility

• Market as a great place – not only a

place for exchange, it is a place for
fair price determination
Company Valuation 11.11
Discounted Cash Flow Analysis
• Mathematics of compounding
and discounting
• Time value of money: One rupee
later is not worth one rupee
today (inflation, uncertainties).
What baskets of goods and
services that rupee will buy
• Future Value (FV), Present Value
(PV), Net Present Value (NPV)
Company Valuation 11.12
Net Present Value (NPV) of an
Investment
• Horizon of interest: Typically 4 –5
years
• Expected future cash flows:
Dividends, interests
• Residual value at the end of
horizon: Market price
• Risk-free rate of return:
Government bonds
• Risk premium: Investor
Company Valuation 11.13
NPV for an Investment with Annual
Cashflows
NPV = CF1 / (1.0 + r) + CF2 / (1.0 + r) 2 + CF3 / (1.0+r) 3

+ RV / (1.0 + r) 3
Where
r = Expected rate of return
CF i = Cash flow at the end of i th year
RV = Residual value of the asset

Caveats: Expected rate of return is dependent on risky

nature of the project and risk-aversion of the investor.
Also “residual value” is hard to estimate.

Company Valuation 11.14

Comparable Companies and Deals

• Price/Earning Ratios: vary

between 4 to 30
• Price/Sales Ratios: Vary between
0.8 to 10
• Return on Investment and
prevalent interest rates in the
economy (when RBI Governor or
FRB reduces the benchmark
interest rate, Company
stock market goes
Valuation 11.15
Market Multiples of Three IT Majors
Infosys Wipro Satyam
Sales 6986 8254 3544
PAT 1904 1628 750
Capital Employed 5421 5370 3226
Net Profit Margin 0.27 0.20 0.21
Return on Investment 0.35 0.30 0.23
EVA 1036.64 768.80 233.84
Equity (Rs Cr) 135 280 64
Share face value (Rs) 5 2 2
Outstanding shares (Cr) 27 140 32
Book Value Per Share (Rs) 200.8 38.4 100.8
Market price per share 2440.0 380.0 540.0
Earning Per Share 70.5 11.6 23.4
Price/EPS 34.6 32.7 23.0
Price/Book 12.2 9.9 5.4

Company Valuation 11.16

 Range of Ratios

Ratio Conservative Aggressive

Net Profitability 0.2 0.4
Price/Earning ratio 7.5 25
Price/Sales ratio 2.5 6
VC's expected IRR 0.35 0.5
Discounting factor 1.35 1.5

Company Valuation 11.17

 Example: Projected P&L of a
Startup
All figures in Rs Lakhs
Item Head Y1 Y2 Y3 Y4 Y5

Sales 100.0 170.0 560.0 1016.0 1726.0

Net Profit 40.0 68.0 224.0 406.4 690.4
Valuation1 from P/E 300.0 510.0 1680.0 3048.0 5178.0
Valuation2 from P/S 250.0 425.0 1400.0 2540.0 4315.0

Valuation1 discounted to Y1 1154.8

Valuation2 discounted to Y1 962.3

Company Valuation 11.18

Buyer’s Valuation and Seller’s
Valuation
• All assets are not relevant to a
buyer, but the seller has spent
good bit of money to acquire
them

• Coca-Cola vs Parle

• Parle’s assets: bottling plants,

distribution network,
warehouses, brands (Thums
Company Valuation 11.19
Buyer’s Strategic Intent and its
Impact
• Sale of hotels by ITDC
• Buyers do the valuation
 Existing hoteliers
 Real estate developers
 Cash-rich corporates
willing to diversify in the
hospitality segment
Company Valuation 11.20
 Qualitative Fine Tuning
• Company’s reputation
• Management capabilities
• Competitive environment
prevailing in the industry
• Industry’s relationship with
the economy
Company Valuation 11.21
 Exercises in Valuation

• Look at financials of many types

of companies and do the valuation
• Hotels, steel plants, auto
manufacturers, media companies,
IT companies
• See by how much the market
capitalization deviates from the
“fair value” that was calculated
from DCF / PE multiple / PS
Company Valuation 11.22