Chapter 1 : Why Value ?

When your values are clear to you, making decisions becomes easier

Roy E Disney
In Investments and Corporate Finance, success is usually judged by wealth created or value augmented. Intrinsic or Business Valuation is about forecasting cash flows from today to infinity and discounting back with the cost of capital one may expect, to obtain the present value. While the price determines the cost at which you buy, the value defines a company's true worth! Investment Managers, CEOs and CFOs thus take keen interest to measure and create wealth. More specifically, there are several reasons why you need to undertake 'Business Valuation'.

The Gap in Price and Value

Legendary American Investor, philanthropist and business tycoon Warren Buffett said "Price is what you pay, value is what you get". He stressed on how one can make extraordinary returns only if there is a gap in Price and Value. Markets are always young and give you an opportunity to identify companies that you can invest into make excessive returns. Thus, understanding "Value" is of prime importance in any investment decision.

"Business Valuation" in this book means the Discounted Cash Flow and also may be called Intrinsic Value, Economic Value, or Shareholder Value.

Analyzing Expectations

Intrinsic Valuation helps us in understanding what value drivers are built in the current market price of the stock, for example, growth rate, margins, investment rate, risk levels etc. This helps us understand the probability of the company delivering the numbers and will also help us analyze what the market may be ignoring.

Valuation exercise elucidates factors influencing the Value of a Company

Valuation exercise helps you understand what value drivers are driving value up or down in the company concerning sales growth, margins, cost of capital or investment rate. The value impact of each driver on the Intrinsic Value of a business highlights which value driver one needs to work on and how to improve.

Identify Opportunities that are available to Create Wealth

  • Divestitures : These could be divisions or brands that would require corporate actions such as Divestitures, Spinoffs etc. Zee Entertainment divested from its Sports Business to Sony for $385 million as it was losing money for years (Accumulated Losses of about $100 million) and was, in no way, going to get an Indian Premier League contract.

  • Valuing Synergies in Merger and Acquisitions : Hindustan Unilever Limited (HUL) acquired GSK Consumer for INR 37,100 crores in a Cash and Stock Deal. The transaction was aligned with Unilever's stated strategy of increasing its presence in health food categories and high-growth emerging markets. GSK HFD is the undisputed leader in the Health Food Drinks category in India, with iconic brands like Horlicks and Boost. With Horlicks being originally introduced in the 1930s as a popular nutritional supplement, and a portfolio of strong products with nutritional claims, GSK HFD was a strong support to HUL's product strategy. Synergies in terms of top-line and cost are anticipated to grow the business in double digits in the near medium term. The strong distribution network of HUL is expected to be used as a strength to improve the Sales Growth Rate.

  • Share Buyback : Concerning the under-priced market worth and a motive to return surplus cash to shareholders tax-efficiently, the IT services companies like Tata Consultancy Services, Infosys, etc undertook Share Repurchase programs. The idea of returning excess cash to its shareholders tax-efficiently, particularly when the management believes its intrinsic value is more than the market price, unfolded opportunities to increase business valuation.

  • Business Model Changes : Sometimes, a change in the Business Model can change the entire dynamics of a company. For instance - Ray Kroc, the founder of McDonald's changed his brand's business model from merely a fast-food chain to real estate business. It was this vision that elevated his aim of creating wealth.

  • Change in Capital Structure Mix : The way a company raises its funds can change its valuation metrics significantly. In 2017, Apple having huge Cash Overseas still raised a Debt. If Apple had chosen to repatriate its cash and liquid assets held overseas using the earlier applicable tax rate, it might have had to shell out taxes at a 35-percent rate. With Apple enjoying a low-risk credit rating, raising funds through bonds could have been a relatively cheaper option. The economics of the debt work out better for Apple when the earlier 35-percent repatriation tax is taken into consideration. Change in Capital Structure Mix can alter the debt ratio making the shareholder value rise significantly.

Going Public, Successions or Family Realignment

One needs to know the Intrinsic Value of the business to understand what they are leaving on the table and what their strategic priorities are. Know your worth even before you step out for a meeting with an Investment Banker. With your homework done, you can be clear with your expectations and finances.

Capital Raising

The Shortest Route to Success is to

Know Your Worth

Entrepreneurship is all about Capital, Capital and Capital. Capital Raising is probably one of the most important aspects of a start-up or a growth company. Here, it is very important to analyze how much capital is required during the journey of a company, how long it is required for and what will the existing Founders/Shareholders will be left with, at the end of each stage of the journey and thus the dilution today. Valuation also assists in the changes required in the business model of the company.

Valuation is the decision maker !

When intending to understand the business model, strategic business options, analysis and decision making for maximizing expected value, valuation is an important aspect.