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Valuation in M&A Transactions Importance and Issues N S Kumar & Co Chartered Accountants Valuation in M&A Transactions Importance and Issues N S Kumar & Co Chartered Accountants

Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Issues in Valuation in M&A transactions Conclusion N S Kumar & Co Chartered Accountants

Indian Laws governing valuation Companies Act Insolvency and Bankruptcy Code Takeover Regulations SEBI and Indian Laws governing valuation Companies Act Insolvency and Bankruptcy Code Takeover Regulations SEBI and Stock Exchanges Income Tax Indirect Tax FEMA Stamp Duty N S Kumar & Co Chartered Accountants

Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Issues in Valuation in M&A transactions Conclusion N S Kumar & Co Chartered Accountants

Process flow: M&A Mergers Court Process Acquisition (Section 230 -236 of Companies Act, 2013) Process flow: M&A Mergers Court Process Acquisition (Section 230 -236 of Companies Act, 2013) Share Purchase Listed Company Unlisted Company Asset Purchase Slump Sale Itemized Sale N S Kumar & Co Chartered Accountants

Motive behind acquisition also affect valuation Diversification Synergies Reduce competition Increased market share and Motive behind acquisition also affect valuation Diversification Synergies Reduce competition Increased market share and broader market access Strategic re-alignment and technological change Managerial self-interest Poorly managed firms Under valuation of target companies N S Kumar & Co Chartered Accountants

Valuation methodologies Book value Asset based approach Liquidation Replacement value Capitalization of Earnings Valuation Valuation methodologies Book value Asset based approach Liquidation Replacement value Capitalization of Earnings Valuation Approaches Income based approach DCFF Comparable companies market multiple Market based approach The First Chicago Method is another method used to value start-ups and high growth firms Comparable transactions multiples Market value (in case of quoted securities) N S Kumar & Co Chartered Accountants

Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Issues in Valuation in M&A transactions Conclusion N S Kumar & Co Chartered Accountants

Valuation – Inherent conflict Buyer always wants to buy at the lowest pricepossible while Valuation – Inherent conflict Buyer always wants to buy at the lowest pricepossible while the seller wants to sell at the highest pricepossible. How does one decide what is the best price for a transaction, hence the fair value valuation…. . “win-win situationfor both the parties buyer and seller” N S Kumar & Co Chartered Accountants

Fair value “…the price at which the property will change hands between a willing Fair value “…the price at which the property will change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having a reasonable knowledge or relevant facts. ” q There are established precedence for valuation methodologies Ø Valuer’s role is to incorporate case specific factors and use appropriate methodologies so as to determine a fair value Ø Give weightagesto value arrived at under different methods Ø Market price method and Earnings methods dominate the valuation methodologies q In case of a merger, the emphasis is on arriving at the relativevalues of the shares of the merging companies to facilitate determination of the swap ratio q The key issue to be addressed is that of fairness to all shareholders N S Kumar & Co Chartered Accountants

Importance – Fair value Acquisition value = FMV + Premium/(Discount) Why is it wise Importance – Fair value Acquisition value = FMV + Premium/(Discount) Why is it wise to obtain a fair market valuation? Ø A diligent buyer should know the spread between FMV and the price they are willing to pay Ø Without a fair market valuation, a buyer has no meaningful benchmark of value other than what they are willing to pay Ø The spread between the seller's asking price and the fair market valuatio serves as a useful reference point for "reality testing" and determining how deep the buyer is going to have to dig to find synergies Ø It enables buyer to decide the structure of the purchase (100%/deferred buy-out, earn-out clauses, etc. ) Ø It helps buyer to allocate purchases price various assets to Ø Gives the seller an idea of minimum price that they could expect N S Kumar & Co Chartered Accountants

Control premium “Beauty lies in the eyes of the beholder; valuation in that of Control premium “Beauty lies in the eyes of the beholder; valuation in that of the buyer” Ø An investor seeking to acquire control of a company is typically willing to pay more than the current market price of the company. Control premium is an amount that a buyer is usually willing to pay over the fair market value of a company to acquire controlling stake in a company Ø A premium paid, if any, will be specific to the acquirer and the target; actual premiums paid have varied widely Ø Research has shown that the control premium in India has widely ranged from 30 -50% The value of control is the difference between the firm run as is (status quo) and the value of the firm run optimally Recent transactions Control premium Microsoft acquired Linked. In ~50% Verizon acquired Fleetmatics ~40% Oracle acquired Netsuite ~19% N S Kumar & Co Chartered Accountants

Synergies Financial synergies: Ø Diversification Ø Cash Slack Ø Tax Benefits Ø Debt Capacity Synergies Financial synergies: Ø Diversification Ø Cash Slack Ø Tax Benefits Ø Debt Capacity Operating synergies: Ø Economies of scale Ø Higher levels of growth Value of synergy Value of combined firm - Sum of the values of the = independent firms N S Kumar & Co Chartered Accountants

Case study: Adidas – Reebok Ø Adidas acquired Reebok in 2005 Ø Deal value Case study: Adidas – Reebok Ø Adidas acquired Reebok in 2005 Ø Deal value $ 3. 78 billion Ø Adidas offered ~34% premiumover last closing price for Reebok Ø The footwear market in North America was mainly dominated by Nike Ø Increased market share and cost cutting through synergies were clearcut strategies for both Adidas and Reebok N S Kumar & Co Chartered Accountants

Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Issues in Valuation in M&A transactions Conclusion N S Kumar & Co Chartered Accountants

Reasons for M&A failures Poor strategic fit: Wide difference in objectives and strategies of Reasons for M&A failures Poor strategic fit: Wide difference in objectives and strategies of the company Poorly managed Integration: Integration is often poorly managed without planning and design. This leads to failure of implementation Incompletedue diligence: Inadequate due diligence can lead to failure of M&A as it is the crux of the entire strategy Overlyoptimistic: Too optimistic projections about the target company leads to bad decisions and failure of the transaction N S Kumar & Co Chartered Accountants

Beware of thumb rules, Synergy etc. Ø It is common practice to add arbitrary Beware of thumb rules, Synergy etc. Ø It is common practice to add arbitrary premiums for brand name, quality of management, control etc. Ø These premiums will often be backed up by data, studies and services. However, there is enormous sampling bias in the studies and the standard errors in the estimates Ø If you have done your valuation right, those premiums should already be incorporated in your estimated value. Paying a premium will be double counting Ø Synergy is created when two firms are combined. Combined firm will be less risky than two individual firms and that you would have lower cost and higher value – which will vary from case to case Ø Assume that there are potential growth and cost saving synergiesin the acquisitions, that would increase the value of the firm Ø Since synergy requires both the acquiring firm and the target firm’s strengths to be pooled, the acquirer should demand his fair share of that synergy. N S Kumar & Co Chartered Accountants

Biased comparable and exit multiples Ø Analysis of other acquisitions reveals that buyers are Biased comparable and exit multiples Ø Analysis of other acquisitions reveals that buyers are willing to pay 5 x, 10 x may be even 20 x of EBITDA…. . Should you also as an acquirer pay the same? Ø Biased samples yield biased results. Basing what you pay on what other acquirers have paid is a recipe for disaster. Ø When we use the pricing metrics of other firms in the sector, one may be basing the price he is willing to pay on firms that are not truly comparable. Ø Investment banker will tell you that acquisitions are accretive. If your PE is 20 and whereas target company’s PE is just 10… you will get jump in earnings per share post acquisition Ø When we use exit multiples we are assuming that , what the market is paying for comparable companies today is what it will continue to pay in the future. N S Kumar & Co Chartered Accountants

Typical issues while valuing Indian companies Ø Non-availability of comparable companies/transactions especially for , Typical issues while valuing Indian companies Ø Non-availability of comparable companies/transactions especially for , foreign owned subsidiaries Ø Limited availability of deal related informationfor historical transactions Ø Different interpretationof terminologies. Term “earnings” could refer to net income, net operating cash flow, pre-tax earnings, EBITDA or net free cash flow Ø Rules of thumb fail to take into account the specific company’s financial performance which could be above or , below industry averages Ø Personal attachmenttowards businesses and other factors result in setting of high value expectations by Indian promoters N S Kumar & Co Chartered Accountants

External factors which affect valuation FMV Sole bidder Public target Pay with cash Small External factors which affect valuation FMV Sole bidder Public target Pay with cash Small target Cost synergies FMV + Premium Bidding war Private target Pay with stock Large target Growth synergies N S Kumar & Co Chartered Accountants

Impact of swap ratio Ø If the exchangeratio is set too high, there will Impact of swap ratio Ø If the exchangeratio is set too high, there will be a transfer of wealth from the bidding firm’s stockholders to the target firm’s stockholders. Ø If the exchange ratio is set too low, there will be transfer of wealth from the target firm to the bidding firm’s stockholders. N S Kumar & Co Chartered Accountants

Change in valuations/price N S Kumar & Co Chartered Accountants Change in valuations/price N S Kumar & Co Chartered Accountants

Don’t pay for buzz words Ø Through time, acquirers have always found ways of Don’t pay for buzz words Ø Through time, acquirers have always found ways of justifying paying for premiums over estimated value by using buzz words - synergyin the 1980 s, strategic considerations the 1990 s and GMV’s/users in current in decade Ø While all of these can have value, the onus to demonstrate the value should be on those pushing for the acquisition Principal behind M&A is “ 2 + 2 = 5” “Render unto the target firm that which is the target firm’s but not a penny more…” N S Kumar & Co Chartered Accountants

GMV/User based valuations Ø Facebook bought Whats. App in October 2014 for $19 billion. GMV/User based valuations Ø Facebook bought Whats. App in October 2014 for $19 billion. Ø Last valuation at time of Facebook acquisition: $1. 6 billion Ø Valuation increase: 1, 118% N S Kumar & Co Chartered Accountants

Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Area Indian laws governing valuation Typical process flow Importance of Valuation in M&A transactions Issues in Valuation in M&A transactions Conclusion N S Kumar & Co Chartered Accountants

Conclusion “Valuation is an art, not a science” Take away: Ø Be clear on Conclusion “Valuation is an art, not a science” Take away: Ø Be clear on the objective of transaction Ø Be reasonable on projection Ø Deal structure Ø Consider all factors N S Kumar & Co Chartered Accountants