Navigating business valuation after the EU referendum · 6 |Navigating business valuation after the EU referendum | PwC We note that the market had largely recovered by 30 June and

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Navigating business valuation after the EU referendum

Valuations

September 2016

In the two months since the UK’s vote to leave the European Union, the markets have experienced high volatility given the uncertainty over the impact for the overall economy and then for individual UK businesses.

We have seen the share price of listed companies shifting significantly since the referendum result, with movements in a particular sector over-riding individual company results. However, there are indications that those movements are beginning to stabilise.

In this article we share valuation themes from discussions with a variety of companies over the period since the ‘leave’ vote was announced, the key implications for value and our recommendations for valuing companies in the current market.

We explore whether there is any significant gap between current market value, in terms of what price might be obtained in the sale of a company or asset, and the intrinsic value of that company or asset (as derived from future cash flows).

We also highlight some key value considerations which are intended to help you think about how the value of your company or asset might have increased or decreased.

In doing so, we address the following:

Thank you to everyone who has contributed, including Attul Karir, Becky Clayton and Laura Hill.

I hope you enjoy this article.

Nick ReaUK Valuations Leader

Are you revising your company’s business plans to understand the impact of the ‘leave’ vote on its intrinsic value?

Do your internal and external communications do justice to your company’s value?

How will the results of the referendum vote impact UK M&A?

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Given current market volatility, are quoted companies still a useful valuation benchmark?

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Navigating business valuation after the EU referendum

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Key value considerations• Carry out additional valuation scenario analysis to understand the outcomes of the

UK trade arrangements and sensitivities to key macro-economic drivers.• Consider how the currency of transactions has been factored into the cash flows, and

whether any updates are needed.• In the current market, be prepared for even wider differing views on value. In a

transaction context, this could lead to additional negotiations on deal pricing.• Continue to review discount rates on a business by business basis.

Are you revising your company’s business plans to understand the impact on the intrinsic value of the company or asset?

‘Is the value of a UK company or asset likely to have increased or decreased since 23 June 2016?’

The answer depends on the specific way that each business’s future cash flows are likely to be impacted and perceptions of changes in the discount rate.For UK focused companies, which had not factored the ‘leave’ vote into their business plans before 23 June 2016, there may well be lower than expected cash flows and a similar or only marginally lower discount

rate. This may lead to a reduction in both the intrinsic value of businesses and the price that buyers may be willing to pay.This has been reflected to date in the relative under performance of the FTSE-250 compared to the FTSE-100.However, for other less domestically focused companies, this could well result in higher valuations, as discussed below.

Value drivers most impacted by the ‘leave’ result

Within cash flows

Do your business’s cash flows reflect the impact of updated UK economic growth forecasts, to the appropriate extent?Has the business’s exposure to foreign exchange been factored into the cash flows? Focus on:• Level of imports• Profits remitted overseas• Imported goodsDefined benefit pension schemes may demand additional cash to compensate for the higher deficit, arising from the lower government and corporate bond yields. Have you considered this in the cash flows?

Cost of capital

Have the following changes been captured in your cost of capital?• Movements in UK bond yields

(as a proxy for the risk free rate)• Equity market performance• Updates to the debt financing

costs

The discount rates for UK business valuations that we’ve carried out in the two months after the ‘leave’ vote have, on the most part, remained broadly unchanged.


• We recently completed the valuation update of one of our clients’ management incentive plans.

• As a niche provider of non-standard financing with a customer base 100% in the UK, it appeared as though the reduced outlook for the UK would lower future profitability and cash flows and therefore reduce value.

• However, analysis of how the company had performed in the previous UK recession demonstrated that lending had actually increased, despite higher levels

of bad debts. This had led to higher levels of repeat customers, thereby increasing overall profitability in the medium to long term.

• Understanding the company’s value drivers was vital in understanding the direction in which the value had changed following the ‘leave’ vote. By considering different scenarios for the business and not solely relying on the market approach, we avoided significantly understating the market value of the company.

A case to consider

In more detail: Potential cash flow updates to business’s forecasts

Impact of the lower short to medium growth outlook for the UK economy

The forecasts for the UK economy that were presented before and immediately after the ‘leave’ result have begun to be replaced by more promising signs that the UK economy is performing better than expected. Concerns do however remain around the potential for lower business investment and lower UK GDP growth in the medium to long term.

Our PwC Economics team has predicted UK growth to slow to around 1.6% in 2016 and 0.6% in 2017, largely due to the increased political and economic uncertainty following the ‘Brexit’ vote.

The extent to which this will impact your business valuation will obviously be specific to each business and depend on the extent of your exposure to the UK market, in terms of the customer base and where it is principally located.

Exposure to the changes in foreign exchange rates

Level of exports: This should benefit companies with a high proportion of sales to overseas customers if there is demand for such products in international markets. However some of these markets are also facing economic headwinds and so this may hold back some of this expected positive effect.

Remitted overseas profits: Companies with a high degree of overseas earnings in sterling will benefit from the translation into pounds due to foreign exchange movements.

Imported goods: This will likely reduce margins for those companies which are heavily reliant on imported goods for production, given the higher costs that will arise from a weaker pound.

There is also a lot of interest from UK companies looking to diversify, so that they get multi-currency earnings, thereby reducing their exposure to the pound.

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Yes, and now more than ever, we think you need to focus on selecting the most appropriate set of comparable quoted companies.

The value of an asset is a function of the intrinsic value described above but also driven by:1. market sentiment, which we have seen

can turn quickly; and2. specific buyer’s intentions and the level

of competitive tension for the asset. This can mean that the market value of an asset (i.e what it might realise in a transaction) does not always easily reconcile to its intrinsic value.

We saw this for example during the global financial crisis when the liquidity of some assets and the number of transactions reduced significantly, making it difficult to understand pricing due to the lack of benchmark data. Interestingly, we do not currently see a disconnect between market prices and intrinsic value resulting from the recent volatility in the market.

Share price movements have been diverse in the period since the ‘leave’ vote. Initially whole industry sectors were impacted until enough detail was understood around individual companies within that sector and how they might be impacted by the referendum outcome.

As a result, the impact on companies’ share prices has varied significantly by sector, as illustrated on the next pages. This is largely due to their differing exposure to factors such as business confidence, consumer spending, the proportion of earnings in foreign currencies, and export prices versus import costs.

Given current market volatility, are quoted companies still a useful valuation benchmark?2


We note that the market had largely recovered by 30 June and even more by 31 August 2016, such that the FTSE-100 was significantly above post-referendum levels and the FTSE-250 was also up, but by a lower percentage increase.

FTSE All-Share index

2015 2016

3,900

3,800

3,700

3,600

3,500

3,400

3,300

3,200

3,100

3,000 30 Jun 31 Jul 31 Aug 30 Sep 31 Oct 30 Nov 31 Dec 31 Jan 29 Feb 31 Mar 30 Apr 31 May 30 Jun

22 Jun 31 Aug

31 Jul 31 Aug

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In the medium term we may see further volatility in the stock markets given:• the terms of any future ‘Brexit’ agreement;• the ability of the UK to negotiate new

free trade agreements with the EU and the rest of the world;

• political instability and the impact of the downgrading of UK sovereign debt; and

• uncertainty on whether interest rates will rise to support the weakened pound and to counter the medium-term threat of higher inflation due to increases in import costs. While this is expected to happen in the medium to long term, interest rates are expected to fall further in the near term.

In summary, we note that share price movements initially reflected general uncertainty over the referendum result but are now capturing the revised expectations for growth and earnings expectations in the short to medium term. As such, they can continue to provide useful cross-checks to the intrinsic value described above.

This reflects the composition of the FTSE-100, comprising companies with moderate to low exposure to the UK economy, whereas the FTSE-250 contains more domestically focused companies, which remain more vulnerable to a more challenged UK economy and the decline in the sterling exchange rate.

+8%

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Largest loss

Largest gain

Significant sector movers in the two months since the ‘Leave’ vote

MiningUK listed mining companies are mainly global businesses which are expected to have little direct impact from the ‘leave’ vote, benefiting from a weaker pound and low exposure to the UK economy.

Healthcare, asset management, and consumer staple sectorsGenerally non-cyclical businesses and are expected to deliver stable earnings, and as a result are less impacted.

UtilitiesRegulated and non-regulated utilities underperformed the FTSE All-Share index, and benefited from higher inflation expectations and from no significant exposure to demand risk. Regulated utilities have historically demonstrated resilience to periods of previous financial uncertainty.

Oil and gasUnderperformed the 8% increase of the FTSE All-Share index, largely driven by the worsening outlook on oil prices in July 2016. This is partly offset by the strengthened dollar, as the income streams are largely dollar denominated.

Banks, real estate and consumer based companiesThese sectors are most heavily exposed to the UK domestic economy, with interest rates at record lows, the prospect of higher inflation, a reduction in consumer spending and an increase in unemployment. Potential knock-on effects may lead to problems with mortgage repayments and increasing levels of bad debt.

ITThe IT sector showed little immediate reaction, but has outperformed the FTSE All-Share index a month after the referendum.

20%

10%

3%

3%

7% to

9%

(3)% to

(6)%


Key value considerations

Operating in a certain sector does not necessarily guarantee a corresponding change in value as the entities in that sector.

When carrying out a valuation using the market approach, we would typically consider how much the comparable companies’ implied multiples have moved since the referendum vote and whether the factors behind the movement apply to the target company.

This may require you to challenge previous assumptions about how truly comparable your company is to the selected comparable listed companies. Questions to consider include: • Do the companies have the same

geographic spread of customers? • What level of imports/exports do they

have compared to your company?• Do they have the same strategic

intentions with regard to location of customers?

• We have seen some market participants making valuation adjustments without any meaningful support.

• In one recent project, external advisors were applying a discount of 20% to a consumer goods subsidiary company’s forecast earnings to reflect the ‘leave’ uncertainty impact.

• Upon delving into the business plan and discussions with management, nearly 100% of revenue was generated from the US markets, with costs incurred largely in continental Europe.

• As such, we considered the company to have almost no exposure to the UK, being shielded from the lower GDP outlook and revenue and costs, including financing costs which were not impacted by the weaker pound.

• Our valuation conclusion was therefore much more positive, which helped our client better understand the value of the company for their business planning needs.

A case to consider

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In the last quarter, we have had significantly more discussions with companies on how value is protected and communicated, both within and outside the organisation.


Protect the value of your workforceIn sectors such as technology, television and professional services, maintaining and developing your talented workforce is a key value driver. ‘Acqui-hire’ deals are very much a key strategic rationale in the technology sector – valuations are driven by a monetary multiple of the number of talented developers or PhD graduates employed by the target company. As such, maintaining the levels of engagement from the workforce during times of uncertainty remains a key challenge for management.

While no-one knows how Brexit will play out, investing time to listen to your team’s concerns and opinions with an open mind and appreciating diversity can make a positive impact and may even lead to innovation.

An opportunity to engage with your customers and strengthen your brand valueSome banks have been contacting existing and future mortgage customers about the recent change in interest rates. For example, first direct was quick to update customers and seek to provide reassurance announcing: ‘The Bank of England Base Rate has changed. No need to call us. We’ll be in touch soon to let you know if this affects you’.

Providing customers with relevant and interesting updates contributes to relationship and brand building and demonstrates commitment to maintaining a good relationship.

Have regular and clear investor communications As ever it is important to ensure regular communication of value to key stakeholders. We are seeing an increased demand for periodic updates of valuation and management incentive plans to assist shareholders in providing timely updates on value and to motivate senior management teams.

3 Do your internal and external communications do justice to your company’s value?


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On the day the ‘leave’ vote was announced, we saw a number of deals immediately put on hold. Some of these are now ‘live’ again, whilst others remain on hold.

Overall, the fundamental reasons for M&A remain valid and should lead to a return to activity levels of previous years in due course. In addition, some companies will see this as an opportunity to build scale to buy UK companies at a lower price or to sell parts of the business which are no longer core.

How will the results of the referendum vote impact UK M&A?


We may see buyers eager to exploit opportunities to acquire certain companies, especially given the following impacts:• Reduced prices due to a weaker pound,

making UK companies cheaper for overseas buyers, especially for buyers based in the US and Asia.

• Potential reductions in intrinsic value for some companies due to expected falls in profits and future cash flows owing to the factors discussed in this paper.

• Private equity investors still have lots of dry powder, and are keen to continue deal making.

• Currently we have not seen a significant change in the availability of debt funding. It appears to be largely unchanged for investment grade businesses and only slightly higher for sub investment grade businesses. There may potentially be less availability of debt finance for companies if banks are constrained in their lending capability.

These factors should help to reduce the bid/sell gap, which has prevented some deals from progressing in previous years, most notably during the global financial crisis.

This does, however, need buyers and sellers to come to an agreement at some level on key assumptions around future growth, risks and returns and to agree a price which works for both parties. This may not be that easy given the current levels of risk and uncertainty.

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Market valuations may well be lower for companies which have high levels of exposure to the UK market (and higher for those with overseas operations) but the implications will need careful consideration as the valuation outcome will not always be intuitive.Our key messages for valuing your business or asset in the months following the EU referendum are below.We’d really like to hear from you. If you have feedback on the topics raised in this article, or questions on your company’s value that you’d like to discuss with one of our independent, sector focused valuations advisors, please get in touch with me, Albertha, Attul, Carol, Kellie or Thomas. Our contact information is on the following page.Please also check out our Deal Blog for regular updates.

Our recommendations on how to approach current valuations

In summary:

It is important to consider in detail the impact on the level of exports, any increase in the cost of imported goods and how this might impact your profit margins. Then you can revise your business plans accordingly. Scenario analyses can also help you to consider the impact of different outcomes to assist with planning for the future.

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Given the different impacts which the ‘leave’ result will have on individual companies, it is also critical to consider how comparable companies have been affected and whether they still remain useful sources of benchmark data in terms of market value.

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Focus on your internal and external communications around the impact of the referendum on your business’ operations and financing, to ensure it is understood internally and externally. This should minimise the risk of lost value due to lack of clarity or information.

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The UK deals market remains active. Optimise the alignment between your view of value and the price you pay or receive for a company or asset by considering all of the above factors and take advantage of the opportunities arising from the current market situation.

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This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2016 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

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To get an understanding of the value of an asset or business and what is really driving that value, you need experienced and dedicated valuation specialists and industry experts. As the leading global valuation practice with 1,700 industry aligned, dedicated valuation professionals in 50 countries you’ll have the right people to support you. By approaching problems from both commercial and technical perspectives, you’ll get independent valuation advice that provides new insights alongside fulfilling an important corporate governance role.

Nick ReaPartner

T: +44 (0)20 7212 3711 E: [email protected]

Thomas RombergPartner


Kellie GreadPartner


Carol LeePartner


Albertha CharlesPartner


Attul KarirPartner


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Navigating business valuation after the EU referendum · 6 |Navigating business valuation after the EU referendum | PwC We note that the market had largely recovered by 30 June and