Corporate valuation

Ghassen Bouslama, Ph.D.

Associate Professor
Finance Departement
[email protected]

2019-2020 / PGE – Finance Specialisation

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Asset Bases Valuatiopn

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What is asset based valuation?
In intrinsic valuation, you value a business
based upon the cash flows you expect that
business to generate over time.
In relative valuation, you value a business
based upon how similar businesses are priced.
In asset based valuation, you value a business
by valuing its individual assets. These
individual assets can be tangible or intangible.

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Why would you do asset based
valuation?
Liquidation: If you are liquidating a business by selling its assets piece
meal, rather than as a composite business, you would like to estimate
what you will get from each asset or asset class individually.
Accounting mission: As both US and international accounting standards
have turned to “fair value” accounting, accountants have been called
upon to redo balance sheet to reflect the assets at their fair rather than
book value.
Sum of the parts: If a business is made up of individual divisions or
assets, you may want to value these parts individually for one of two
groups:
Potential acquirers may want to do this, as a precursor to
restructuring the business.
Investors may be interested because a business that is selling for
less than the sum of its parts may be “cheap”.

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How do you do asset based
valuation?
Intrinsic value: Estimate the expected cash flows on
each asset or asset class, discount back at a risk
adjusted discount rate and arrive at an intrinsic
value for each asset.
Relative value: Look for similar assets that have sold
in the recent past and estimate a value for each
asset in the business.
Accounting value: You could use the book value of
the asset as a proxy for the estimated value of the
asset.

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When is asset-based valuation
easiest to do?
Separable assets: If a company is a collection of separable assets (a
set of real estate holdings, a holding company of different independent
businesses), asset-based valuation is easier to do. If the assets are
interrelated or difficult to separate, asset-based valuation becomes
problematic. Thus, while real estate or a long term
licensing/franchising contract may be easily valued, brand name
(which cuts across assets) is more difficult to value separately.
Stand alone earnings/ cash flows: An asset is much simpler to value if
you can trace its earnings/cash flows to it. It is much more difficult to
value when the business generates earnings, but the role of individual
assets in generating these earnings cannot be isolated.
Active market for similar assets: If you plan to do a relative valuation,
it is easier if you can find an active market for “similar” assets which
you can draw on for transactions prices.

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I. Liquidation Valuation
In liquidation valuation, you are trying to assess how
much you would get from selling the assets of the
business today, rather than the business as a going
concern.
Consequently, it makes more sense to price those assets
(i.e., do relative valuation) than it is to value them (do
intrinsic valuation). For assets that are separable and
traded (example: real estate), pricing is easy to do. For
assets that are not, you often see book value used either
as a proxy for liquidation value or as a basis for
estimating liquidation value.
To the extent that the liquidation is urgent, you may
attach a discount to the estimated value.

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II. Accounting Valuation
The ubiquitous “market participant”:, accountants are asked to attach
values to assets/liabilities that market participants would have been
willing to pay/ receive.
Tilt towards relative value: “The definition focuses on the price that
would be received to sell the asset or paid to transfer the liability (an
exit price), not the price that would be paid to acquire the asset or
received to assume the liability (an entry price).” The hierarchy puts
“market prices”, if available for an asset, at the top with intrinsic value
being accepted only if market prices are not accessible.
Split mission: While accounting fair value is titled towards relative
valuation, accountants are also required to back their relative
valuations with intrinsic valuations. Often, this leads to reverse
engineering, where accountants arrive at values first and develop
valuations later.

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III. Sum of the parts valuation
You can value a company in pieces, using either relative or
intrinsic valuation. Which one you use will depend on who you
are and your motives for doing the sum of the parts valuation.
If you are long term, passive investor in the company, your
intent may be to find market mistakes that you hope will get
corrected over time. If that is the case, you should do an
intrinsic valuation of the individual assets.
If you are an activist investor that plans to acquire the company
or push for change, you should be more focused on relative
valuation, since your intent is to get the company to split up and
gain the increase in value.

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SUM OF THE PARTS
VALUATION
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Introduction
The sum-of-the-parts method consists in valuing and
summing up the company's different assets, divisions or
subsidiaries and deducting Liabilities.
It is a method well suited for diversified groups or
conglomerates, for which consolidated accounts
projections give too global a view.
The sum—of-the-parts method is simple. It consists in
systematically studying the value of each asset and each
liability on the company’s balance sheet.

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Introduction
For a variety of reasons — accounting. Tax, historical
book values are often far from reality.
They must therefore be restated and revalued before
they can be assumed to reflect a true net asset value.
The sum-of—the parts method is an additive method.
Revalued assets are summed and the total of revalued
liabilities is subtracted.
For diversified groups, the SOTP or NAV method implies
valuing subsidiaries or activities pro rata the ownership
level using either the DCF or the multiples of comparable
companies method.
Then, the debt of the mother company is deducted as
well as the present value of central costs.
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Example
Exane BNP Paribas issued the following
valuation in early 2016 for the French
construction and concession group Vinci:

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Introduction
Value Valuation method

Vinci construction 3 074 Listed peers, M&A, DCF

Vinci Eurovia (roads) 1 994 Listed peers
Vinci Energies 5 943 Listed peers, M&A
Vinci Real Estate 553 Listed peers
ASF/Escota (concession) 24 144 DCF, DDM
Cofiroute (concession) 8945 DCF, DDM
A19 700 DCF, DDM
Airports 8171 Listed peers, DDM
Other consolidated concessions 212 BV multiple, M&A
Equity consolidated concessions 512 BV multiple
Holding -492
Tax losses carried forward 825
Total enterprise value 54 536
Adjusted net debt 12 277
Minorities 333
Minority stakes 1 713
Equity value 43 644

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Introduction
To apply this method properly, therefore, we must value each
asset and each liability Estimates must be consistent, even
though the methods applied might be different.
Several basic types of value are used in the STOP method
market value: this is the value we could obtain by selling the
asset. This value might seem indisputable from a theoretical point
of view, but it virtually assumes that the buyer’s goal is
liquidation. This is rarely the case. Acquisitions are usually
motivated by the promise of industrial or commercial synergies;
value in use: this is the value of an asset that is used in the
company’s operations. It is a kind of market value at replacement
cost;
liquidation value: this is the value of an asset during a fire sale to
get cash as soon as possible to avoid bankruptcy. It is market
value minus a discount.

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Introduction
The sum-of-the-parts method is the easiest to use and the values it
generates are the least questionable when the assets have a value on
a market that is independent of the company’s operations, such as the
property market, the market for aeroplanes, etc.
It is hard to put a figure on a new factory in a new industrial estate.
The value of the inventories and vineyards of a wine company is easy
to determine and relatively undisputed, since a secondary market
exists for these assets.
A wide variety of values is available when we apply the sum-of-the-
parts method.
Possible approaches are numerous. We can assume discontinuation of
the business — either sudden or gradual — or that it will continue as a
going concern, for example.
The important thing is to be consistent and stick to the same approach
throughout the valuation process.

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Tangible Assets
Can be evaluated on the basis of replacement value,
liquidation value, going-concern value or yet other
values.
It is important to determine an overall value for
productive and commercial assets.
Rather than trying to decompose assets into small units,
you should reason on a general basis and consider
sufficiently large groups of assets that have a standalone
value (i.e. for which a market exists or that can operate
on a standalone basis).

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Tangible Assets
Example
It makes no sense to value the land on which a
warehouse has been built.
It makes more sense to value the combination of the
land and the buildings on it.
An appraiser will value the combination based on its
potential productive capacity, not on the basis of its
individual components.
Of course, this is not the case if the objective is to
reuse the land for something else, in which case you
will want to deduct the cost of knocking down the
warehouse.

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Inventories
For industrial companies, valuing inventories usually
does not pose a major problem, unless they contain
products that are obsolete or in poor condition.
In this case, we have to apply a discount to their book
value, based on a routine inventory of the products.
In some situations, you will have to revalue the
inventories of companies with long production cycles;
the revaluation can lead to gains on inventories. This is
often the case with champagne, cognac, whisky and
spirits in general.
Here again, revaluation will have an impact on income
taxes. Remember that when you revalue inventories,
you are decreasing future profits.

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Intangible assets
It might seem paradoxical to value intangible assets,
since their liquidation value has, for a long time, been
considered to be low.
It is now widely acknowledged, however, that the value
of a company is partly determined by the real value of
its intangible assets, be they brand names, a
geographical location or other advantages.
The sum-of-the-parts approach makes no sense
unless it takes into account the company’s
intangible assets.

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Intangible assets
Some noteworthy examples:
1. Brands: particularly hard to value but the importance
of brands in valuation is growing.
In general, there are three methods for valuing
brands:
Method 1:
It asks how much would have to be spent in
advertising expense, after tax, to rebuild the
brand.
This method leads to undervaluation of new and
successful brands and overvaluation of older and
failing brands.

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Intangible assets
Method 2:
The second method calculates the present value of all
royalty payments that will or could be received from
the use of the brand by a third party.
It is very sensitive to the chosen royalty rate.

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Intangible assets
Method 3:
It consists in analysing the brand’s fundamental utility. After all,
the brand’s raison d’être is to enable the company to sell more and
at higher prices than would otherwise be possible without the
brand name (costs of enhanced quality and services, of
communication).
Discounting this “excess profit” over a certain period of time
should, after subtracting the related higher costs, yield an
estimate of the value of the brand.
Users of this method discount the incremental future operating
income expected from the use of the brand and subtract the
additional operating expense, working capital and investments,
thereby isolating the value of the brand.
We will not hide the fact that this approach, while intellectually
appealing, is very difficult to apply in practice, because often there
is no generic “control” product to use as a benchmark.

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Intangible assets
2. Patents and technical know-how:
They are valued as brands, but with the same
difficulties.

3. Lease rights:
The present value of the difference between market
rental rates and the rent paid by the company.

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Tax implications
The acquirer’s objectives will influence the way taxes are
included (or not) in the sum-of-the-parts approach.
If the objective is to liquidate or break up the target company into
component parts, then the acquirer will buy the assets directly,
giving rise to capital gains or losses. The taxes (or tax credits)
theoretically generated will then decrease (increase) the ultimate
value of the asset.
If the objective is to acquire some assets (and liabilities), and to
run them as a going concern, then the assets will be revalued
through the transaction. Increased depreciation will then lower
income tax compared to liquidation or the breakup case above.

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Tax implications
If the objective is to acquire a company and maintain
it as a going concem (i.e. not discontinue its
activities) and as a separate entity, then the
acquiring company buys the shares of the target
company rather than the underlying assets.
It cannot revalue the assets on its books and will
depreciate them from a lower base than if it had
acquired the assets directly. As a result, depreciation
expense will be lower and taxes higher.

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Usefulness of Sum-Of-The-
Parts Values
Sum—of—the—parts values can be deceptive, as many people
think they imply safe or reliable values.
In fact, when we say that a company has a high net asset
value, it means that from a free cash flow point of view, the
company’s terminal value is high compared with the value of
intermediate cash flows.
Consequently, the more “net asset value" a company has and
the fewer cash flows it has, the more speculative and volatile
its value is. Granted, its industrial risk may be lower, but most
of the value derives from speculation about resale price.
For this reason, the sum—of—the—parts method is useful for
valuing small companies with no particular strategic value, or
companies whose assets can be sold readily on a secondary
market (aeroplanes, cinemas, etc.)

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