C
OMMUNICATING THE
V
ALUATION
R
EPORT
Dave Diehl, CFA Chieoke Moore, CPA Prairie Capital Advisors, Inc. Prairie Capital Advisors, Inc. [email protected] [email protected]
2
O
UTLINE OF
T
ODAY
’
S
P
RESENTATION
Introduction
Hiring an Independent Financial Advisor
Valuation Report Basics
Basic Valuation Concepts
Common ESOP-Related Valuation Issues
Synthetic Equity
Communication Tips
I
NTRODUCTION
- D
ETERMINING
V
ALUE OF
S
TOCK IN THE
ESOP W
ORLD
Valuation is at the core of all succession planning decisions…including
ESOPs
•
Value and value “trajectory” are both relevant
ESOPs exist in a regulated world
An ESOPs fiduciaries may engage in purchase and sale transactions
and/or set the value at least annually
4
H
IRING AN
I
NDEPENDENT
F
INANCIAL
A
DVISOR
What should you be looking for when hiring an independent financial
advisor?
Qualifications and Education
•
Some professional credentials include:
•
Chartered Financial Analyst (CFA)
•
Accredited Senior Appraiser (ASA)
•
Certified Valuation Analyst (CVA)
•
Accredited in Business Valuation (ABV) for Certified Public Accountants (CPA)
•
Certified Business Appraiser (CBA)
5
H
IRING AN
I
NDEPENDENT
F
INANCIAL
A
DVISOR
(C
ONT
’
D
)
What should you be looking for when hiring an independent financial
advisor?
Qualifications and Education (Cont’d)
•
At least a college degree or equivalent experience in a subject related to
valuation, such as finance, accounting, economics or business
•
Industry specific experience
•
ESOP specific valuation experience
•
Standing and reputation of the appraiser’s firm
V
ALUATION
R
EPORT
B
ASICS
Valuation opinions can be communicated to a fiduciary in the form of a
business valuation report
What information should be included in a business valuation report?
•
Description of the assignment
•
Definition of value
•
Fair Market Value
•
Revenue Ruling 59-60
7
V
ALUATION
R
EPORT
B
ASICS
(C
ONT
'
D
)
What information should be included in a valuation report? (Cont’d)
•
Name of company
•
Form of ownership (C-corp, S-corp, etc.)
•
Name and standing of the party hiring the appraiser
•
Is the appraiser working for the fiduciary, or the company, or some other party?
•
Is there a conflict?
•
Valuation date
•
Report preparation date
8
V
ALUATION
R
EPORT
B
ASICS
(C
ONT
'
D
)
What information should be included in a valuation report? (Cont’d)
•
Description of the company and its position
•
History
•
Description of products/services
•
Competition
•
Strengths, weaknesses, opportunities, threats
•
Management depth / capabilities (any weaknesses?)
•
Employees
•
Capital structure
•
Board structure
V
ALUATION
R
EPORT
B
ASICS
(C
ONT
'
D
)
What information should be included in a valuation report? (Cont’d)
•
General economic background
•
Industry specific information
•
Sources of information used
•
Due diligence procedures used (did the appraiser perform a site visit?)
•
Financial statement analysis
•
Analysis of financial projections
•
Valuation methodologies
•
Discounts / Premiums
•
Synthesis and Conclusion
10
B
ASIC
V
ALUATION
C
ONCEPTS
-
S
OME
V
ALUATION
L
ANGUAGE
Assets = Liabilities + Equity
Invested Capital = Interest Bearing Debt + Equity + Preferred Equity + Minority
Interest
All Other
Fixed and
Intangible
Assets
Net
Working
Capital
Long Term
Liabilities
Equity
Invested
Capital
Value
Stockholders’
Equity Value
11B
ASIC
V
ALUATION
C
ONCEPTS
(C
ONT
’
D
)
•
Valuation comes down to
expectations of cash
–
Profits provide a return on your
investment
–
The more return, the more
valuable the investment
•
Profit streams can be risky…that is,
they may not happen
•
Value is also impacted by external
market factors
•
The Income Approach
–
Discounted Cash Flow Method
(DCF)
–
Capitalized Cash Flow Method
–
Potential weakness: Are the
projections reasonable and/or
reliable?
–
The discount or cap rate used
•
The Market Approach
–
Guideline Publicly-Traded
Company Method
–
Guideline Merged and Acquired
Company Method
–
Potential weakness: Are the
comparables truly comparable?
•
The Asset-Based Approach
Valuation is a carefully scrutinized component of many ESOPs
B
ASIC
V
ALUATION
C
ONCEPTS
(C
ONT
'
D
)
We want to reflect the economics of…
•
The Company itself
•
Its competitive marketplace
•
The general economy and capital markets
•
Our goal is to think like investors
As such, we must look inside and outside of the Company
13
B
ASIC
V
ALUATION
C
ONCEPTS
(C
ONT
'
D
)
This is how the market prices stock
•
Research analysts developing recommendations
•
Investment bankers considering mergers and acquisitions
•
Corporate development professionals evaluating acquisitions
•
Sub-debt/mezzanine lenders pricing warrants on their facilities
We want to “MIMIC” the marketplace
What do we look for…
14
B
ASIC
V
ALUATION
C
ONCEPTS
(C
ONT
'
D
)
What drives value?
B
ASIC
V
ALUATION
C
ONCEPTS
- L
EVEL OR
B
ASIS OF
V
ALUE
Change of control Control premium applied Synergistic premium possible Value “as if” Publicly Traded
PCA Starting Point No discounts or premiums Illiquid Minority Interest
Gift and estate valuation Internal stock transfers
Non-Marketable
Minority
Marketable
Minority
Controlling
Interest
Factors Affecting Marketability
Likelihood of achieving liquidity Provisions of ESOP (put right) Financial strength and solvency
Company risk
Factors Affecting Premium Size
Degree of control Empirical evidence of premiums Value enhancements of control Future prospects of the Company
Premise of Value in Valuation
16
B
ASIC
V
ALUATION
C
ONCEPTS
- I
NCOME
A
PPROACH
DCF method is most common
Modeling can vary in duration
•
Single or multiple-year models are used
•
All future years are valued
•
Typically, a “discrete” period (usually 5 years) and a “terminal value” are used
Revenue, expenses, reinvestment and other assumptions are reflected
in the DCF
What causes value change?
•
Value changes directly as revenue and profitability expectations rise and fall
•
Value also changes as risks and costs of capital fluctuate
17
B
ASIC
V
ALUATION
C
ONCEPTS
- I
NCOME
A
PPROACH
(C
ONT
’
D
)
The discount rate is used to discount future cash flow streams back to
present value
•
Time value of money
•
Risk
It is common to project the cash flow of the Company on a debt-free
basis
•
In doing so, use the weighted average cost of capital (WACC) to calculate the
discount rate
•
Projected rate of return that debt and equity holders would require to invest in
this particular business
B
ASIC
V
ALUATION
C
ONCEPTS
- I
NCOME
A
PPROACH
(C
ONT
’
D
)
The WACC involves:
•
The cost of equity
•
The cost of debt capital
•
Calculating the WACC by multiplying the returns required for each component
of capital by its contribution to total capital
Determination of an appropriate discount rate cannot be reduced to a
simple mathematical formula
19
B
ASIC
V
ALUATION
C
ONCEPTS
- M
ARKET
A
PPROACH
Guideline Publicly Traded Company Method is most common
Guideline Merged and Acquired Company Method also can be useful
•
Comparative public companies (or comparative private transactions) are
selected as a representative group of alternate investments
•
Issue in today’s market: Is our company on the same path?
•
Value may be a significant function of the company ’s economics
Valuation multiples may include:
•
Net Income, Cash Flow, EBIT, EBITDA, Revenue, Book Value, etc.
EBIT = Earnings Before Interest and Taxes
EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization
20
B
ASIC
V
ALUATION
C
ONCEPTS
- E
ARNINGS
A
DJUSTMENTS
In order to reflect an accurate representation of the Company’s true
earnings, certain items may be adjusted
Income/expenses deemed to be one-time in nature
Expenses that are in excess of “normal” market levels
Expenses that will no longer occur in the future
B
ASIC
V
ALUATION
C
ONCEPTS
- E
ARNINGS
A
DJUSTMENTS
(C
ONT
’
D
)
Examples of Adjustments/Add-backs to Earnings
Excess compensation
Non-continuing compensation
Personal (entertainment) expenses (cars, plane, etc.)
Extraordinary legal or professional fees
Income / expense from discontinued operations
Environmental litigation/ remediation
Gain on sale of assets
22
C
OMMON
ESOP-R
ELATED
V
ALUATION
I
SSUES
- ESOP V
ALUATION
S
UBTLETIES
Whole companies are worth
more than “parts”…and many
ESOPs own “parts”
•
Entire enterprises
•
Fractional controlling blocks of
ownership
•
Fractional minority interests
Small companies are worth less
than big companies
M
ul
tip
le
o
f P
re
ta
x
Ea
rn
in
gs
Size, public market, high growth,
high visibility, etc.
23
C
OMMON
ESOP-R
ELATED
V
ALUATION
I
SSUES
- R
EPURCHASE
O
BLIGATION
I
SSUES
Greater ESOP % + Value द = Greater Repurchase Obligation (RO)
Many ESOP companies have seen this occur
There are choices…
•
Redemption vs. recycle or both
•
Pay out of corporate cash
•
Use borrowed funds
•
Deferred payouts
Has a formal analysis been completed or been considered?
C
OMMON
ESOP-R
ELATED
V
ALUATION
I
SSUES
– RO G
UIDING QUESTIONS
How does repurchase obligation affect valuation?
•
As an employee benefit expense
•
As something that increases risk to the Company
•
As something that can “crowd out” other important expenditures
Will the Company have the operating cash flow to fund expected
repurchase obligations?
•
Will funds be saved or borrowed?
If the Company “saves for the future” where will that money be
“housed?”
25
S
YNTHETIC
E
QUITY
Common types of synthetic equity
•
Options
•
Warrants
•
As financing incentive or equity participation?
•
Stock Appreciation Rights (SARs)
•
Phantom Stock
Valuation impacts
•
The details matter
Common rules of thumb
26
C
OMMUNICATION
T
IPS
Guessing Game
Contests
ESOP Committee
Education (e.g., Appraiser Valuation Visit and Presentation)
Employee Impact Discussion
Others?
28
D
AVE
D
IEHL
’
S
B
IO
As Chief Operating Officer, Mr. Diehl oversees the day to day operations of Prairie Capital Advisors and the Company’s Fairness Opinion Committee. On a project basis, Mr. Diehl provides closely held businesses a complete understanding of the best available options for their ownership transition needs. He expertly executes projects for mergers and acquisitions (M&A), management buyouts (MBO), Employee Stock Ownership Plans (ESOPs), estate planning and other corporate finance purposes. Mr. Diehl serves as a trusted advisor to a diverse range of clients nationwide delivering highly strategic consultation. With extensive end-to-end management experience and a focus on his clients’ success, Mr. Diehl helps ensure an exceptional ownership transition experience. Mr. Diehl is a CFA Charterholder and is on the board of directors of two companies – a manufacturer of plastic parts and a financial consulting firm. He is also a frequent speaker in forums around the country on topics including ownership transition, valuation, capital management and business sale.
Before joining Prairie Capital Advisors, Mr. Diehl was Relationship Manager/Senior Administrator in the Northern Trust Company’s Wealth Management Group, specializing in advising and administering individual family relationships for families with liquid net worth in excess of one hundred million dollars. Services provided included structured equity, financial reporting, investment management, asset allocation, lending, family partnership administration, performance analysis and tax-related work. Prior to that, Mr. Diehl worked for Harris Trust and Savings Bank, providing financial reporting and performance analysis for the bank’s largest relationship, a twelve billion dollar pension trust.
Mr. Diehl holds a Master of Business Administration Degree in Finance from Northwestern University’s J.L. Kellogg Graduate School of Management and a Bachelor of Science Degree in Marketing from Indiana University. He is a member of the ESOP Association, Business Valuation Association, National Center for Employee Ownership. In addition, he is a candidate member for the American Society of Appraisers.
29
C
HIEOKE
M
OORE
’
S
B
IO
Mr. Moore operates out of Prairie Capital Advisors Atlanta office. As an Analyst, Mr. Moore performs financial analysis and modeling services, as well as analyzes the business dynamics and trends of publicly traded companies. In addition, he performs merger and acquisition (M&A) research and prepares narrative reports in support of a wide variety of valuation projects, including Employee Stock Ownership Plans (ESOP), leveraged buyouts (LBO), management buyouts (MBO) and other capital structuring projects for clients nationwide.
Prior to joining Prairie, Mr. Moore was an associate in the Private Company Services (PCS) Tax group at PricewaterhouseCoopers LLP.