Читать книгу Performance of Valuation Methods in Financial Transactions - Группа авторов - Страница 5

Introduction

In France, public tender offers, public exchange offers and combined offers are all processes of acquisition. The governing regulations of the Autorité des marchés financiers (AMF) guide how these public offers are carried out. Before they are launched, the initiator, with the help of their advisory bank, undertakes a process of analysis, with the main objective of determining the financial capacity of the business, in order to reach an offer price that will be proposed to the security holders of the company under evaluation. As underlined by Bellalah (1998), the shareholder will only divest their shares to the initiator of the offer if they consider the price proposed to be satisfactory. Therefore, the market capitalization of the target company is not enough to constitute the benchmark for the offer price; the evaluation must always follow an approach informed by multiple criteria.

The direct link between the profit reaped from a company’s investments and the profit demanded by the company’s investors will determine the quality of the investment policy pursued. By generating cash flows such that they maximize the amount of value created by the economic asset, a well-conducted investment policy will result in a higher return on investment than that demanded by investors. The economic value of shareholder equity will then increase. However, if the investment policy fails, the shareholder may sanction the company in question by selling its securities. They will then face financial difficulties, insofar as their economic assets have been devalued. And so, the shareholder has the power to grant funds to the company, and must, in this scenario, understand how to properly evaluate the company’s assets from an economic perspective, as well as their shareholder equity.

Beyond a sufficiently profitable investment policy, maximizing the value of economic assets comes from an optimal financial structure. Indeed, in order to determine the value of the economic asset, the cash flows that result from the investment policy are brought in line with the cost of capital. In this instance, it would be possible to have the ability to maximize this rate by using an appropriate financial policy. Evaluation regarding the structure of liabilities must include considerations that go well beyond the simple cost of different sources of financial gain. There are three major elements to take into account when looking to evaluate the feasibility of an optimal financial policy: these are taxation, both at the level of the company and of the individual, consideration of the costs of dysfunction and bankruptcy that an additional amount of debt would incur, and the behavioral phenomena in theories created by organizations. Indeed, beyond the framework of the theory of market equilibrium which considers the company to be a single player, conflicts between the various stakeholders, who do not always share the same interests nor make the same choices when it comes to the correct financial policy to be adopted, inevitably impact the nature and distribution of the funds that are granted to the company.

The traditional valuation of equity can be undertaken indirectly by first estimating the economic asset, and then subtracting the value of net debt after adjustment, or directly by adopting an average industry multiple. Within the acquisition market and in view of the sums involved, the valuation of the target company is essential to be able to come to a target buyback price for which a control premium is calculated, and before embarking on any negotiations with potential buyers. In short, valuation helps to make decisions about an opportunity for merger or partnership. More generally, this exercise is designed to help position the company within its particular market in terms of performance, as well as to improve the way it is managed and run, with a view to generate value by working on the areas that have been identified as weaknesses. In addition to this, valuation constitutes a tool that facilitates the development of a company that is seeking out opportunities for new financial support and entering new markets, for example. Finally, valuing the securities of the company allows us to comply with tax legislation and potentially reap the rewards that it offers.

The target price of a company can be fixed according to its assets, its competitors or even how it is predicted to progress into the future. A business plan will encompass all of these aspects. In practice, business valuation is carried out by at least three types of professionals: Financial analysts, who determine target prices for listed companies and provide recommendations on whether to buy, sell or hold stock. Corporate and investment banks assess companies for mergers and acquisitions. In France, if the target company is listed, its valuation must be submitted to the AMF in order to justify that the offer price is satisfactory for all of the stakeholders involved. The evaluation is therefore incorporated into a specific document that is sent to the organization with the aim of obtaining a visa. Here, several valuation methods may come into play. The offer price is the result of an analysis informed by multiple criteria. If the company is not listed, a public offer for tender is usually initiated by the banks. In this case, the seller’s advisory bank sends a document that briefly describes the characteristics of the company to be sold to potential buyers. Questioned at the start about their possible interest in the company, the potential buyers formulate an indicative offer based on their own valuation of the target company and an informative note which contains past accounts and the business plan. Then, potential acquirers may put forward a binding offer, which may be significantly different from that conceived at the beginning, on the basis of receiving additional data from due diligence services following meetings with management. Corporate and investment banks also perform equity capital market valuations during initial public offerings, and more traditional issuances. Finally, the transactions, for which the private equity analysts are responsible, are carried out with leverage buy out (LBO). Their approach is different, as the value of the target company is a result of the resources (equity and debts) that can be raised by a holding company that is created ad hoc. Capital investors demand an internal rate of return of 20% over 3–5 years. The debt raised from banks has its own constraints: 80% of senior debt is absorbed on a linear basis over 7 years, and 20% is reimbursed in the end.

Professionals and academics believe that there are three main categories of methods that must be combined to carry out an evaluation of a company and its equity. The comparables method is based on evaluation via sector multiples from listed companies or via transaction multiples. The discounted cash flows approach deems the value of a company to be the sum of its future cash flows, discounted using the weighted average cost of capital. Cash flows are calculated using the operating income, and the discount rate includes, on the one hand, the cost of equity derived from the capital asset pricing model and, on the other hand, the cost of debt. Finally, asset-based methods are based on the sum of the parts that represent the sum of assets. This method is used in particular by value holding companies and conglomerates for integrating unrealized capital gains and losses restated for hypothetical elements. For listed companies, market capitalization provides a fourth value, which cannot be ignored, regardless of the size of the floating business. When the valuation is undertaken in order to merge a target company with the company at the origin of the offer, the process is able to be undertaken, provided that funds can be raised to carry out the process and that the benefit of the initiator’s action is fully assessed in relation to the synergies that are envisaged from the merger.

In this context, it seems interesting to ponder over traditional valuation methods. In what circumstances are they relevant and reliable and, according to specific situations, to what extent is it more appropriate to favor certain methods over others? The term “relevant” justifies why various methods must be evaluated, as they aim to demonstrate equality when coming to the final value of a company.

Chapter 1 aims to bring to light a theoretical framework regarding the possibility of optimizing the financial structure, the various methods of traditional valuations and the possibilities of applying them within the acquisition market, such as the structuring of financial arrangements with the leverage effect. Chapter 2 is dedicated to a study of the financial literature that highlights the theoretical adjustments that can be made to improve the performance of these methods, how they are used according to specific empirical contexts and how value is created as a result of company mergers.