The Financial Times Guide to Corporate Valuation

16 The Financial Times Guide to Corporate Valuation

incentive programme is to be treated as salaried income for the employees.

The consequence is that an employee is obliged to pay income tax and

the company to pay social security expenses on the entire programme.

A common stipulation from tax authorities is that the price of the share,

convertible or option, which employees are entitled to acquire, must

reflect a market-based value.

When dealing with tax authorities, and this is likely to be universal,

it is better to be safe than sorry and have an independent party, often an

accountancy firm or an investment bank, to do the valuation in order to be

able to argue effectively for the objectivity of the valuation used.

Figure 3.2 shows a generic theoretical development of a company’s value and

cash flow.

Executing a merger, acquisition or divestiture

When Mobitronics had been in business for ten years the company was

contacted by representatives from PayMobile, a small niche player with a

strong competence in internet-based, mobile applications. The represent-

atives for PayMobile expressed an interest in selling the company. After

thoroughly analyzing the acquisition opportunity, Mobitronics’ manage-

ment believed there was a clear strategic fit between the companies and

that an acquisition of PayMobile would strengthen Mobitronics’ service

Value

Time

Capital need 1

Capital need 2

Phases: Seed Start Development Expansion Exit LBO/MBO

FIGURE 3.2 The ‘expected’ evolution of a company

3



When do you need to value a company? 17

offering and R&D competence. However, as cash reserves were limited,

Mobitronics would carry out the acquisition only if PayMobile would

accept Mobitronics’ stocks as payment.

In a share-for-share transaction both the acquisition target and the

acquirer need to be valued. In this situation both sides will want to maxi-

mize the value of their respective asset and minimize the value of the

other – all in order to achieve the maximum relative value. Normally, a

mixture of valuation models is used to get a number of reference points

for the valuation discussion. Typically, some type of standalone DCF val-

uation is used for a fundamental discussion of the two companies, their

operations and their future earnings potential. In addition, financial and

operative ratios are used to allow for effective comparisons in the discus-

sions and negotiations.

The idea behind this kind of transaction in valuation terms is that the

value of the combined entity will be more than that of the separate enti-

ties. In industrial transactions, the price that the acquirer is willing to pay

usually exceeds (and, in theory, should always

exceed) the value a financial buyer would ascribe

to the company. This is because the industrial

party can pay not only for the pure financial

value, but also for synergies and other operating

and strategic values. These are values the financial

buyer or the capital market simply cannot real-

ize. Since an industrial acquirer normally can pay

a higher price than the financial markets, price

is normally not the only critical concern. Instead, the loss of independ-

ence and management issues are often of equal importance (sometimes to

shareholders’ despair). However, as has been seen in transactions in the

past decade, it is not uncommon that financial buyers, typically private

equity firms, have a much more aggressive view of how much debt the

acquisition target can bear. In other words, private equity firms have been

using a much higher leverage than industrial acquirers and therefore have

been able to pay higher prices. (We will go through the mechanism of

why higher leverage results in higher valuations in Chapter 6.)

When valuation is conducted in an industrial deal the valuation technique

differs slightly from earlier situations discussed in this chapter. This is

because the synergies, economies of scale and other strategic assets have

a value that needs to be added to the value of the target company (see

Figure 3.3).

Private equity firms

have been using a much

higher leverage than

industrial acquirers

and therefore have

been able to pay higher

prices