Assets Based Share Valuations, Hybrid Valuation methods, Procedure for public, private takeover

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Corporate Finance FIN 622

Lesson 35

SHARE VALUATIONS

We shall take up following topics in this hand out:

Assets Based Share Valuations

Hybrid Valuation methods

Procedure for public takeover

Procedure for private takeover

Anti-takeover tools

o Poison pill

o Pac man

o White knight

o Counter offer

o Disposal of key assets

o Acquisition by the target

o Shark repellent

o Political pressure

Assets Based Share Valuations

Asset-based methods typically involve restating both assets and liabilities to their current values to arrive at

a net asset value. The restatement can be done on an individual component level (discrete valuation) or

collectively (collective valuation). Given the relative difficulty of individually valuing a variety of assets, such

as real estate, machinery and equipment, and inventory, it is often necessary to employ valuation specialists.

Collective valuation requires a single analysis, which identifies the collective value of the assets and liabilities

over and above their recorded value (i.e., a price-to-book multiple). Even with asset-based models, value

remains a function of expected benefits to the owners. The value of assets is generally derived from either

future income-generating potential or liquidation value, depending on the circumstances at a given time.

Some add a fourth approach to valuation to the three that we describe in this handout. They argue that you

can argue the individual assets owned by a firm and use that to estimate its value asset based valuation

models. In fact, there are several variants on asset based valuation models. The first is liquidation value,

which is obtained by aggregating the estimated sale proceeds of the assets owned by a firm. The second is

replacement cost, where you evaluate what it would cost you to replace all of the assets that a firm has

today.

While analysts may use asset-based valuation approaches to estimate value, we do not consider them

alternatives to discounted cash flow, relative or option pricing models since both replacement and

liquidation values have to be obtained using one or more of these approaches. Ultimately, all valuation

models attempt to value assets the differences arise in how we identify the assets and how we attach value

to each asset. In liquidation valuation, we look only at assets in place and estimate their value based upon

what similar assets are priced at in the market. In traditional discounted cash flow valuation, we consider all

assets including expected growth potential to arrive at value.

The two approaches may, in fact, yield the same values if you have a firm that has no growth assets and the

market assessments of value reflect expected cash flows.

Asset based methods are generally considered suitable when shareholdings > 50% are being valued. Such

shareholdings give the holder the right to control the acquisition and disposal of the underlying assets.

Therefore, if there are assets not needed for generation of income, the controlling shareholders may cause

these to be realized to generate cash.

Book Values: these figures are bases on past or historical costs and are meaningless and useless to be used

for merger transaction valuations.

Replacement Cost: this should provide a measure of the maximum amount that any buyer should pay for

the whole business, since it represents the total cost of forming the business from scratch. However, a

major element of any business as a going concern is likely to be the goodwill. Since this can only be defined

as income based value of business tangible assets it may be seen that there is no real way of applying a

pure asset based value to a business. It is always necessary to consider an income-based value as well.

Break up value: is the assets in the business will often be less than any other computed value. It represents

the minimum price, which should be accepted for the sale of a business as a going concern, since if the

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Corporate Finance FIN 622

income based valuations give figures lower than the break up value it is apparent that the owner would be

better off by ceasing to trade and selling off all the assets piecemeal.

However, when a break up is considered in this way it must be remembered to include such items as

redundancy costs, liquidator's which may have substantial effect on the final outcome.

Hybrid Methods Mix Of Asset Based & Income Method:

The income and asset-based approaches to valuation have relative strengths as well as obvious limitations.

For example, the income approach allows for specific and direct estimation of future benefits to the owners,

which is consistent with the theory of value. On the other hand, if the estimation of future benefits is

directly based on historical income, the precision of the estimate will depend heavily on the persistence

embodied in the historical income measure and on the growth assumptions incorporated into the model. If,

for example, current or historical income contains large transitory components, the relationship between

historical and future income may be distorted. In addition, to the extent an inappropriate discount rate is

utilized, value estimates will be adversely affected.

Asset-based valuation approaches can be effective in that the accurate identification of individual asset and

liability values will yield a reliable value estimate. In addition, unlike the income approach, an equity

discount rate, the estimation of which can have a significant impact on the valuation conclusion, is not

required for an asset-based approach. On the other hand, it is often difficult to accurately restate book value

to current value for an array of assets, especially when a significant amount of unrecorded intangible assets

exists.

This method includes the characteristics of both income and asset based valuation methods. For example,

the income approach allows for specific and direct estimation of future benefits to the owners, which is

consistent with the theory of value.

The estimation of future benefits is directly based on historical income; the precision of the estimate will

depend heavily on the persistence embodied in the historical income measure and on the growth

assumptions incorporated into the model asset-based valuation approaches can be effective in that the

accurate identification of individual asset and liability values will yield a reliable value estimate. in addition,

unlike the income approach, an equity discount rate, the estimation of which can have a significant impact

on the valuation conclusion, is not required for an asset-based approach.

Taken collectively, however, income and asset-based valuations generally yield better valuation accuracy and

more-effective analysis, which is the real benefit of a hybrid approach.

Acquisition Procedures:

Procedure for public take over:

Growth / expansion is decided

Predator company appoints experts legal consultants, banks, accountants and stock brokers

Decision regarding contact with target firm approach before the bid or hostile takeover

Purchase of certain % age of shares of target

Establish an offer and communicate target

Includes offer document, offer validity, predator may revise offer if declined by target

Acquisition of private company:

Limited consultancy services from expert are required. internal evaluation is normally enough.

Detailed investigation is conducted before the transaction.

Offer price is negotiated by both parties

Finalization of deal by entering into a contract

Payment of price finishes the deal.

Anti-takeover tools:

Takeovers are not easy there is always some opposition to takeovers by some or all of the stakeholders of

target company. In this section, you will learn how to thwart a takeover attempt successfully. The following

methods have been used in practical life to stop a takeover:

Poison pill:

Poison pill originally meant a literal poison pill (often a glass vial of cyanide salts) carried by various spies

throughout history, and by Nazi leaders in WWII Spies could take such pills when discovered, eliminating

any possibility that they could be interrogated for the enemy's gain. It has since become a term referring to

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any strategy, generally in business or politics, to increase the likelihood of negative results over positive ones

for anyone who attempts any kind of takeover.

Pac-Man:

The Pac-Man defense is a defensive option to stave off a hostile takeover. It is when a company that is

under a hostile takeover acquires its would-be buyer.

The most quoted example in U.S. corporate history is the attempted hostile takeover of Martin Marietta by

Bendix Corporation in 1982. In response, Martin Marietta started buying Bendix stock with the aim of

assuming control over the company. Bendix persuaded Allied Corporation to act as a "white knight," and

the company was sold to Allied the same year. The incident was labeled a "Pac-Man defense" in retrospect.

The name refers to when Pac-Man, the star of the videogame of the same name, turns around and devours

the ghost that was previously pursuing him (after eating a Power Pill that allows him to do so). The term

(though not the technique) was coined by buyout guru Bruce Wasserstein.

White knight (business)

In business, a white knight may be a corporation, a private company, or a person that intends to help

another firm. There are many types of white knights.

The first type refers to the friendly acquirer of a target firm in a hostile takeover attempt by another firm.

The intention of the acquisition is to circumvent the takeover of the object of interest by a third, unfriendly

entity, which is perceived to be less favorable. The knight might defeat the undesirable entity by offering a

higher and more enticing bid, or strike a favorable deal with the management of the object of acquisition.

In short, if Company T (target) is going to be acquired by Company H (hostile firm), but Company A

(acquirer) can acquire ownership of Company T, and then Company A would be acting as the white knight.

The second type refers to the acquirer of a struggling firm that may not necessarily be under threat by a

hostile firm. The financial standing of the struggling firm could prevent any other entity being interested in

an acquisition. The firm may already have huge debts to pay to its creditors, or worse, may already be

bankrupt. In such a case, the knight, under huge risk, acquires the firm that is in crisis. After acquisition, the

knight then rebuilds the firm, or integrates it into itself

Disposal of Key Assets:

Disposal of key assets is also very important tools which go in anti, because some times vital assets when go

to liquidate or companies go to amalgamate then, too many hurdles come in order to process the disclosure

of the assets, because investment made by the investor.

Acquisition by the Target:

A targeted repurchase is a technique used to thwart a hostile takeover in which the target firm purchases

back its own stock from an unfriendly bidder, usually at a price well above market value.

Politics

Political pressure is an effective anti-take over tool. Two good examples will make you understand better

how a government can stop takeover bid.

DWP Middle East based port company acquired the management of some US ports after successful

bidding. Later, as the congress raised concern about the security of its ports, US president had to interfere

to stop this bid. On the same lines, an Indian business tycoon had a successful bidding of a French steel

manufacturer but later French government intervened and cancelled the bid.

A poison pill may also be used in politics such as attaching an amendment so distasteful to a bill that even

the bill's supporters are forced to vote against it. This manipulative tactic may be intended to simply kill the

bill, or to create a no-win situation for the bill's supporters, so that the bill's opponents can accuse them of

voting for something bad no matter what. This is sometimes known as a "wrecking amendment".

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