PRIVATE EQUITY: INDIA’S GROWTH CATALYST

BY J. MAITRA & ASSOCIATES

TOPICS

COVERED

VALUATION CONCEPTSVALUATION CONCEPTS

APPROACHES TO COMPANY & APPROACHES TO COMPANY & BUSINESS VALUATIONBUSINESS VALUATION

PRIVATE EQUITY IN INDIAPRIVATE EQUITY IN INDIA

VALUATION CONCEPTSVALUATION CONCEPTS

Valuations provide useful baseline to establish a value for a business as on today or a forecasted period

It serves as an alternate - to the role that major stock exchanges play for public companies - for small/unlisted companies

Assists in arriving at exit strategies for the Existing Owner & Prospective Financial/Strategic Investor to obtain value for their stake in the companies when they desire to sell

ABOUT

VALUATIONS

THE

ESSENCE

OF

VALUATION

Early Stage

Investing

• Simpler Valuation Process• Derived from Capital the

Company needs & % stake expected by VCs

Valuation of Large Public-Listed

Companies

• Actual Stock Price on Exchanges - function of supply-demand and investor preferences

• Analysts’ Estimates• They typically fall within a

reasonable band

• Companies are often privately-held

• Project rapid growth• Future performance subject to high degree of variability

In India, most investment

opportunities are in

companies that lie between these two extremes

VALUATION UNCOVERS WORTH OF MANAGEMENT

Is Derived Valuation >

Expected Value ?

Is Derived Valuation >

Expected Value ?

Might be an Opportune time to

sell

Might be an Opportune time to

sell

Opportunity for Business Owner to

work towards increasing Value of

the Company

Opportunity for Business Owner to

work towards increasing Value of

the Company

YES NO

THE

UNDERLYING

PRINCIPLE

APPROACHES TO APPROACHES TO COMPANY & BUSINESS COMPANY & BUSINESS

VALUATIONVALUATION

INCOME BASED APPROACH Discounted Cash Flows

Dividend Discount Model

ASSET BASED APPROACH Net Asset Valuation

MARKET APPROACH Relative Valuation using Multiples

APPROACHES

TO

VALUATION

INCOME

BASED

APPROACH

INPUTS• Free Cash Flows –

Forecasted Period• Cost of Capital – Cost

of Equity &/or Cost of Debt

INPUTS• Free Cash Flows –

Forecasted Period• Cost of Capital – Cost

of Equity &/or Cost of Debt

APPLICATIONS• Generally used for

firms likely to grow fast for few years & then

stable growth

APPLICATIONS• Generally used for

firms likely to grow fast for few years & then

stable growth

Free Cash Flows to Firm

discounted at Weighted

Average Cost of Capital i.e.WACC

ISSUES• Easily Manipulated

• Not Directly Linked to Market• Forecast Revenues & Costs – a

Challenge• Not Ideal Method for valuing

Firms with trouble, under-utilized assets

ISSUES• Easily Manipulated

• Not Directly Linked to Market• Forecast Revenues & Costs – a

Challenge• Not Ideal Method for valuing

Firms with trouble, under-utilized assets

* Ke is calculated using Capital Asset Pricing Model (CAPM) adjusted for Small Company Premium & Specific Company Risk Premium if any

Free Cash Flows to Equity

discounted at Cost of Equity i.e. Ke*

DISCOUNTED CASH FLOWSDISCOUNTED CASH FLOWS

INCOME

BASED

APPROACH

Contd….

INPUTS• Current Dividend Payout

• Growth in Dividends – High Growth, Tapering Phase & Stable Growth

• Duration of the Phase• Cost of Equity

INPUTS• Current Dividend Payout

• Growth in Dividends – High Growth, Tapering Phase & Stable Growth

• Duration of the Phase• Cost of Equity

APPLICATIONS• Companies that pays

out dividend without fail

• Companies where business model does not

envisage growth but make reasonable cash

APPLICATIONS• Companies that pays

out dividend without fail

• Companies where business model does not

envisage growth but make reasonable cash

DIVIDEND DISCOUNT MODEL

DIVIDEND DISCOUNT MODEL

ISSUES• Applicable to limited number of

companies• Undervalues Companies that pays

no or less dividends• Investors, besides dividend also

look for capital appreciation• For Academic Purposes Only

ISSUES• Applicable to limited number of

companies• Undervalues Companies that pays

no or less dividends• Investors, besides dividend also

look for capital appreciation• For Academic Purposes Only

ASSET

BASED

APPROACH

INPUTS• Current Value of Assets including Real Estate

• Current Value of External Liabilities • Normalized Profit forecast for remaining period of

Current FY• Adjustments w.r.t non-realizable/redundant

assets/liabilities

INPUTS• Current Value of Assets including Real Estate

• Current Value of External Liabilities • Normalized Profit forecast for remaining period of

Current FY• Adjustments w.r.t non-realizable/redundant

assets/liabilities

APPLICATIONS• For Strategic Investments• For holding Companies

• Applicable for companies with significant tangible assets &

Start Ups

APPLICATIONS• For Strategic Investments• For holding Companies

• Applicable for companies with significant tangible assets &

Start Ups

Generally, a Forward

Valuation for current FY is carried out

NET ASSET VALUATIONNET ASSET

VALUATION

ISSUES• Limited Applicability for

Operating Entities• Not used when investments are

financial in nature

ISSUES• Limited Applicability for

Operating Entities• Not used when investments are

financial in nature

RELATIVE

VALUATION

INPUTS• Identification of similar Transactions or Listed

Companies; the former is preferred• Deriving Various Multiples – P/E, P/BV,

EV/EBITDA, EV/Sales• Adjustments to Multiples – Illiquidity Discount, Size Premium, Execution Risk, Control Premium if

applicable• Applying the resultant multiple to get Enterprise

Value/ Equity Value of the company

INPUTS• Identification of similar Transactions or Listed

Companies; the former is preferred• Deriving Various Multiples – P/E, P/BV,

EV/EBITDA, EV/Sales• Adjustments to Multiples – Illiquidity Discount, Size Premium, Execution Risk, Control Premium if

applicable• Applying the resultant multiple to get Enterprise

Value/ Equity Value of the company

APPLICATIONS• The most widely practiced

approach as based on actual transactions

APPLICATIONS• The most widely practiced

approach as based on actual transactions

RELATIVE VALUATIONRELATIVE

VALUATION

ISSUES• Difficulty in finding similar Listed

Companies/ PE/ M&A transactions

ISSUES• Difficulty in finding similar Listed

Companies/ PE/ M&A transactions

Final Valuation is a Derivative of Mathematical Weights applied to various approaches & Professional Judgment

Both methods involve subjectivity

Final Valuation should prove the test of Common Sense & Reasonableness

Last but not the least, parties concerned Negotiate hard on arriving at a Value of the Company but the call is largely a gut feel valuation by the investor

REACHING

A

CONCLUSION

ON

VALUATION

EXIT OPTIONS IPOs

Mergers & Acquisitions Management Buy-out Sale to Another Fund

Buyback by Promoter/ Company Stock Market

EXIT

OPTIONS

AVAILABLE

TO

PRIVATE

EQUITY

FUNDS

Duration of Private Equity/ Venture Capital Investment normally ranges from 3-7 years

In case of Buyback by Promoter/Company , the value at which PE Fund would exit is IRR or market-based and is

pre decided at the time of investment on a certain valuation

PRIVATE EQUITY IN INDIAPRIVATE EQUITY IN INDIA

• Very rapid expansion in number of India-focused funds

– Risen from 8 in 1995, to 300+ in 2010

…Investor DilemmaCurrent PE Market…

• Large number of “first time” funds

– ~15 India-dedicated private equity funds

with at least one fund vintage

• Evaluating managers without track records

• Selecting funds from a broad universe

• Gaining access to the best funds

VALUATION

IS

TEMPORARY

BUT

CONTROL

IS

FOREVER