VALUATIONS

What is value?

- opinion

- relative concept

- variable

What is fair market value?

- willing buyer and seller

- in a open and rational market

- fully informed

- under no compulsion to transact

- acting at arms length

What about "cost"?

What about "value-in-use"?

What about "price"?

When is the valuation to be performed?

- time value of money

Valuation is an expression of an OPINION -

risky - NB that it must be SUPPORTABLE -

need justification and rationale.

Valuer's job is to value at valuation date future sums of

money owner can expect to receive, ie. benefit to be

derived from ownership = PV of future income streams.

NET PRESENT VALUE (NPV)

= Pt (l-(l +i)-n

)

i

PV = Fv (l + i) -n

VALUE - Amount that makes expected

income a FAIR RETURN

VALUE - EXPECTED INCOME

- FAIR RETURN

You can value ANY INCOME STREAM,

INCLUDING - Debentures / Loan Stock - Pref Shares

- Ordinary Shares

- Minority Holding

- Majority Holding

- Partnerships / Sole Traders

- Etc.

Misconceptions:

Doesn't the stock market determine value? Not always:

* large parcel / associate / key holding

* take over

* volume traded

Unlisted shares

* no active market

Businesses

* no active market

Estate duty

* special considerations

Dispute

Shareholders agreement

Divorce / Exchange Control / Litigation

Value less than NAV?

LARGE RESERVES DISTRIBUTED IN FUTURE?

Value plus NAV

TERMINOLOGY

Expected income / cash flows

Fair return

Yield

Earnings yield

PE (price earnings ratio)

Dividend yield

Dividend cover

Market capitalisation

Yield to maturity (YTM)

Yield = Income

Price (%)

Earnings

Yield = E.P.S.1

M. Price2 (%)

P.E.

Ratio = M. Price

E.P.S. (Times)

Dividend

Yield = Dividend

M. Price (%)

Dividend

Cover = E.P.S.

Dividend (Times)

(NOTE: Total earnings can be used instead of EPS and

Total Price can be used instead of M. Price/share)

Market

Capitalisation = Issued Ord Shares

x M. Price per Share (Rand)

YIELD TO MATURITY (Y.T.M.)

VALUE = Earnings divide earnings yield

= Dividend divide dividend yield

MARKET INDICATORS Example: Share Price R80

Earnings (EPS) R12

Dividend (DPS) R6

E YIELD 12 x 100 = 15%

80

D YIELD 6 x 100 = 7.5%

80

DIVIDEND COVER IS (12:6) TWICE

PRICE EARNINGS RATIO IS 80 = 6,7

12

RELATIONSHIP BETWEEN EARNINGS YIELD & PE RATIO?

P.E. RATIO = SHARE PRICE divide EARNINGS

TOTAL EARNINGS = E. YIELD x SHARE PRICE

P.E. RATIO =

= 1 = 1 = 6,7

E. YIELD 0,15

MORE TERMS!

Share/stock

Linked unit

Deferred share

N Share

Preference share

Debenture

Convertible preference share / debenture

Option

Warrant

Strike price

In the money/Out of the money

Gilt

Loan stock

Bond

Long bond

Government stock

Points

BA

LIBOR

Prime

Nil paid letters

Renounceable rights

STILL MORE TERMS!

Nominal value

Coupon

Cum div / interest

Ex div / interest

LDR

NAV

Tangible NAV

Trade at premium or discount

Historic

Forward

Bull

Bear

Stag

Index

Sector

GENERAL APPROACH

Basis

Expected Income

Fair return

Valuation

Reasonable?

VALUATION BASES

Market based

Income based

Asset based

Market based

JSE values

Capitalisation of earnings methods

Earnings yield/PE

Which earnings level?

Dividend yield method?

Income / cash flow based

Discounted cash flow

Super profits

Free cash flow

EVATM

Asset based

Net asset value

Liquidation basis

Replacement cost

PREVAILING RETURNS &

INDICATORS

2 years

ago

Year

ago

NOW

"Risk free" rate

-

-

Call rate

Prime overdraft

Mortgage bond

Credit card

LIBOR / US

Gold price

All share index

R / $

PE E YIELD DIV YIELD

JSE Overall (All share)

JSE (Industrials)

IT

Telecoms

Building Construction &

Engineering

Food

PE Dividend

Yield

Market

Capitalisation

Anglo

Sasol

Nedcor

Standard

Liberty

SAB Miller

Ellerine

Woolies

Richmond

M Cell

Pick 'n Pay

Old Mutual

ABSA

Didata

HOW DETERMINE

Expected income

- fixed amount?

- timing?

- historic precedent

- what is expected in the future?

Fair Return

- comparative

- adjust for specific instrument being

valued

- adjust for risk inherent in the

expected income (interest / dividend /

earnings / cash flow) which is different to

the comparative / benchmark

DEBENTURES / LOAN STOCK / PREFS

Basis

Discounted cash flow

Expected income - determine from:

- coupon

- redemption terms

- conversion

Fair return - determine from:

- rate for similar investment

- adjust for dissimilar risk factors:

- assurance of cash flows

- negotiability

- security

METHODS TO BE USED

Debentures- future cash flows based on income and capital to be received

* if not redeemable - capitalisation of expected interest at fair rate of return

* if redeemable - present value of annual interest till redemption + present value of

redemption proceeds

* if convertible - present value of dividends till redemption + value of ordinary shares at

date of conversion discounted to present value (depending on likelihood of conversion) at

rate of original instrument

* if participating - capitalisation of expected preference dividends at fair rate of return +

value of participation appropriately calculated

Conversion / Redemption

Company option - financial comparison and

availability of cash

other uses of cash

cost of new funds

EPS / M price affect

Holders option - financial comparison DEBENTURES USUALLY TRADE AT HIGHER RATE IN MARKET

THAN PREF SHARES – WHY?

VALUATIONS OF SHARES

Minorities

Basis - div yield?

Expected income - projected future

dividend

Fair return - JSE comparative

- Adjust

Marketability?

Transferability?

Growth vs JSE

Div Cover

Strength of underlying earnings

History

MINORITY HOLDING -

ORDINARY SHARES EXPECTED INCOME

1 Special rights or constraints

2 Dividends in the past

3 Dividend policy

4 Maintainable dividends

Ultimately dependant on ....?

FAIR RETURN

Div yield on similar shares

THEN compare risk

Marketability

Dividend cover

Growth vs market

Inflation vs market

MAJORITY HOLDINGS

Selection of basis

Capitalisation of earnings (earnings

yield)

Super profits

Valuation of business "as a whole"

Free cash flow

EVA

Net asset value

Liquidation basis

MAJORITY VALUATION

CONTROL

METHODS

* capitalisation of earnings

* super profits

* business as a whole

* liquidation

* net asset value

* other .. FCF .. EVA .. etc!

NB : TO USE APPROPRIATE BASIS OF

VALUATION

- DIV YIELD

- CAP OF EARNINGS

- SUPER PROFITS

- Etc.

HOW TO SELECT BASIS OF

VALUATION

* Available information re Company

* Quality of information available

* Available market & other info

* Historic performance

* Expected future performance

* Nature & size of holding

(does it confer control)

* Time available

(LOGICAL & JUSTIFIABLE)

Special requirements:

- Agreement ? Instruction?

- Estate Duty ? Other ?

CAPITALISATION OF EARNINGS BASIS

* Maintainable Earnings

(expected income)

capitalised at an appropriate

* Earnings Yield

(fair rate of return)

SUPER PROFITS METHOD

Determine goodwill - then add to tangible

NAV

* Expected income (Rand return in excess

of the norm)

capitalised at an appropriate

* Earnings yield (fair return)

Normal return Rx

Actual return Ry

Super profit (for finite period) Rz

NPV of Rz xxx

Tangible net asset value xxx

Valuation Rxxx

SUPER PROFITS

Net Tangible Assets (A-L) xx

Less: listed shares (investments) (x)

pref share capital (x)

Plus: revalued assets (excess) x

NAV attributable to ords xx

x FR% = F return (R)

vs

Maintainable Earns (R)

= SUPER PROFIT (EXCESS)

NPV = GOODWILL

+ TANGIBLE NAV

+ VALUE OF INV.

(R) VALUATION OF ORDS

VALUATION OF BUSINESS ‘AS A

WHOLE i.e. ignore how financed’

VALUE OF OPERATING INCOME

STREAMS

LESS VALUE OF DEBT

Maintainable

Earnings =

Final

NP +

Pref

Divs +

After

tax +

interest

(Div

rec)

VALUE =

ME

% R

xxx

+ Investments x

- Value of debenture (x)

- Value of prefs (x)

VALUE OF ORDS

(R)

What about using EBITDA or some other level of

earnings?

FREE CASH FLOW BASIS OF VALUATION

VALUE = NPV OF FUTURE CASH FLOWS

FCF MODEL:

After tax pre interest income - exclude deferred tax

LESS retention required to finance expansion = capex

less depreciated plus increase in w/capital

EQUALS free cash flow

Model uses future income projections (based on past

growth etc.)

ie. not an achieved historic figure

Discount rate used based on weighted average cost of

capital (debt & equity)

Determine value of business, then deduct debt

ECONOMIC VALUE ADDED / MARKET VALUE

ADDED

- PV of increments to shareholder value

- Increment to shareholder value

Return on Cap Emp > WACC

operating profit (%) weighted average

pre-interest (%) cost of capital

- Total Capital Employed x (ROTC-C)

- Value - NPV of future EVA

- Change the accounting numbers, eg.

- capitalise advertising & promotion

- lengthen / vary depreciation

- no goodwill writeoff

- capitalise restructuring costs

- etc.

- Primarily used as a performance measure, ie. size of

EVA & increment in EVA

VALUATIONS

MAINTAINABLE EARNINGS

Adjustments for:

* non-recurring income or losses

* effects of anticipated internal changes -

enhancement or dilution

* effects of external influences

AFTER TAX

MAJORITY : ORDINARY SHARES

EXPECTED INCOME

Maintainable profits

This involves an investigation of the business

1 Last five years (maximum) + Forecasts, R & D,

reports, budgets, capital expenditure

2 Basis of valuation of assets / provisions

3 Accounting policies

4 Adequacy of working capital

5 Replacement of existing loans

6 Non-recurring income / expenditure

7 Assurance of supply of raw mats

8 Changes in staff / expertise

9 Competition

10 Effect of change in ownership

11 Market related remuneration

WHICH CHANGES TAKEN INTO ACCOUNT IN

DETERMINING VALUE?

FAIR RATE OF RETURN

EARNINGS YIELD ON SIMILAR INVESTMENT

THEN EVALUATE RELATIVE RISK

1 Negotiability

2 Relative prospects within industry

3 Relative size within industry - major / minor

player?

4 Asset backing

5 Liquidity

6 Nature of assets

7 Special skills dependency

8 Other partners / shareholders

9 Gearing - other than usual

10 Growth - " " "

11 Inflation

12 Reliability of profit forecasts AND financials

13 Tradeability

14 Quality of management

15 Licence agreements

16 Competition

17 S.W.O.T.

ILLUSTRATION

Maintainable earnings

Net income after tax 1 000

Outside shareholders ?

Preference dividend - 50

Before extraordinary items

* Adjust for abnormal items ?

* Adjust for rent ?

Adjust for dividends received ?

* Adjust for salaries for manager ?

* Adjust for royalties ceasing ?

Adjust for structural changes

* new / redeemed debentures ?

new / redeemed pref shares ?

* = after tax

VALUATIONS

FAIR RETURN

Risks relate inter alia to -

* reliability of management

* reliance on individuals

* market shares

* potential competition

* continued supply

* customer loyalty

* licensing agreements

* group support

* forex fluctuations

* type of product or service

VALUATIONS

ILLUSTRATION

Fair rate of return - earnings yield

JSE sector earnings yield 9.5%

Sector fit +-1.0

Transferability / marketability +2.0

Key personnel +0.5

Market share +-1.0

Monopoly +-0.5

Expansion - capacity +-1.0

- market +-1.0

Multi-use / special product +-1.0

Customer base / loyalty +-0.5

Raw material supply -0.5

New competitors +-1.0

Options / conversions -0.5

Forex risk - importer +1.5

- exporter -1.5

Fair rate of return, say 13.5%

HISTORICAL vs. FUTURE EARNINGS

If growth : historic P.E. > forward P.E.

SO? ...

CONSIDER:

* How far into new year

* Future flows more important

* but risk ? ... FAIR RETURN?

* Traditional view - achieved earnings, forward

prospects account for in earnings yield

* Current thinking

* Past projections vs. actuals

* When was forecast prepared

* Basis of preparation NB!!

* How refined / sophisticated

* Nature of business

MAINTAINABLE EARNINGS

HISTORICAL FIGURES?? FUTURE??

HOW MANY YEARS RELEVANT?

TREND?

INFLATION?

* AVERAGE

* WEIGHTED AVERAGE

* EXTRAPOLATION - NEXT YEAR INCOME –

HOW?

Budget

Linear

Exponential

Compound growth

* USE OF FORECAST

HISTORIC P.E. vs FORWARD P.E.

DETERMINANTS OF THE VALUE OF GOODWILL

ARE INTANGIBLE

1 Superior management team

2 Outstanding sales organisation

3 Above average strength in technical skills

4 Weakness of competition

5 Effective advertising

6 Good labour relations

7 Strategic location

8 Market dominance

9 Favourable economic environment etc. etc.

10 Good leases

11 Production efficiencies

12 Access to finance

13 Strong controls

14 Strong finance

ASSET BASED VALUATIONS

N.A.V.

LIQUIDATION BASIS (NPV of expected net

realisation)

REPLACEMENT COST?

When use asset based valuation?

- Investment company

- Property company (using fair value of underlying

assets)

- No reliable profit history / projection

- Loss making

- Very low returns

- Not a going concern

FINAL CONSIDERATIONS / ADJUSTMENTS

* Tax - Distributable reserves

- Type of income receivable

* Dividends outstanding - cum / ex div

* Key Holding?

* Excess / redundant assets

VALUER'S REPORT

For who

Asset valued

Purpose of valuation

Scope of work

Limitations

Special instructions

Valuation:

- Basis of valuation

- Maintainable earnings

- Earnings yield (fair return)

- Calculation

- Reasonableness test

Opinion

INVESTIGATION REPORT/DUE DILIGENCE

Matters affecting risk and price. Cover inter alia:

- competitive position

- operating efficiency

- management

- financial strength: structure/liquidity/gearing/

profitability

- labour

- marketing

- manufacturing

Memorandum

Financial statements, budgets

Audit report

Contracts - capital & revenue

Contingent liabilities

Employee contracts

Condition of operating assets

* replacement dates

* replacement costs

Personal guarantees by directors

Overdraft facilities

Loans - renegotiation

Stock, work in progress, debtors

FIVE BASIC STEPS

STEP 1 : BASIS OF VALUATION

STEP 2 : MAINTAINABLE EARNINGS /

FUTURE FLOWS

STEP 3 : FAIR RATE OF RETURN

STEP 4 : CALCULATION OF VALUE

STEP 5 : REASONABLENESS TEST

DETERMINANTS OF GOODWILL

* Superior management

* Superior sales

* Superior technical skills

* Location

* Labour relations

* Market dominance, etc. etc.

WHY PAY MORE THAN APPARENT

VALUE?

* Cash generator ("COW")

* Value of listing

* Assessed losses

* Leases

* Start up costs - tangible

- intangible

* Established infrastructure

* Synergies

* "FAT"

* Once off?

* Strategic - supply?/customer?

* Excess assets

* Eliminate competition

* Management

ISSUES / PROBLEMS

VALUE < NAV

50/50

(Pty) MINORITIES

LOSS MAKING ENTITIES

EXCESS BORROWINGS

NO COMPARABLE COMPANY

DEFERRED TAX

WARRANTED PROFITS

INTEREST RATE MOVEMENTS

PROFESSIONAL PRACTICES

MIXED BASES

EXCESS ASSETS / EXCESS CASH

RELIABILITY OF DATA

IFRS!

VARIABLE PROFIT HISTORY

ASSESSED LOSS

VALUATION OF GROUP

(ie. ORDINARY SHARES IN HOLDING CO)

If holding and subsidiaries have similar risk profile -

operate in similar industries & similar financial

structure, use group results (consolidated).

If dissimilar risk profile or doubt value separately:

- value normal operations of each sub

separately, THEN

- H's share of S

ESTATE DUTY ACT: SECTIONS 5(1)(f)bis; 5(1)(g); 24

MEMORANDUM

* Restriction of transfer (1)

* Special procedures for valuation (2)

* Special rights in event of death (3)

* Special rights of current shareholder (4)

1 Disregard restrictions in Memo & Articles BUT

CAN adjust for limited marketability, especially

of minority holder

2 Ignore

3 Ignore

4 Take into account

DISREGARD KNOWLEDGE OF HINDSIGHT

VALUATION IN TERMS OF THE ESTATE DUTY

ACT, 1955

LISTED SHARES

Disposed of : gross proceeds

Not disposed of : middle market price on date of

death

Large parcel : price at which deal may be concluded

UNLISTED SHARES AT VALUATION SUBJECT TO

1 No regard to restrictions on transferability; shares shall be

assumed to be freely transferable

2 No regard to any specific directions whereunder the value of

the shares of the deceased or of any other member is to be

determined

3 Full value if it would have been greater on liquidation

4 No regard to any variation in the rights attaching to any shares

through or on account of the death of the deceased

5 No account of any power of deceased to gain greater benefit

for himself