#IRL Valuation Methods

For your exam, they will ideally give you the EBITDA. Now, let's say the comparable multiple for a particular company is 10. So, you will take the EBITDA, multiply it by 10 and you will get the enterprise value. When you minus the debt from the enterprise value, you will get the equity value. But while doing this for an actual company, you will have the EBITDA of the unlisted company that you are valuing. But you will have to calculate everything else. So, you will have to go through a big process to arrive at the comparable multiple. The first difficulty or challenge number one is finding out the comparable company. If your company is in a standard industry or a defined industry, there may be a lot of listed companies in that industry and that will make it easy for you. You can take a look at the listed companies, find out the multiples and then apply them to your company. However, there is a catch there. But we'll come back to that later. But if you don't have any comparable companies, or if there is no listed company that is similar to your company, what do you do then? You will have to go through a huge research process. In such a case, you might have to look at the global companies. Now, let me tell you that there was a recent deal involving INI Farms, a horticulture company. It got investments from Unilazer Ventures. It was a recent deal announced in the newspapers. It's not some secret deal that I'm talking about. They recently announced it. Now, you need to find out a listed company in India that is in the farming sector. It would be better to find a company that's into horticulture because the farming sector is a much broader term. So, you need to find a company that's into horticulture. Now, there is no such company over here. Even if there is, it is either not performing consistently or there are multiple challenges in the company itself. So, how do you apply the multiple to those companies? You might have to find a company in other economies or other countries. You need to find companies that are into the farming sector and especially into horticulture. Then you will have to find out the multiples. After that, you will have to find out the difference between that company and the company that you are valuing. You also need to establish the differences in the economies to which those two companies belong. Because share prices are mainly dependent on mainly how the economy is functioning, how the farming sector is functioning and how the horticulture sector is functioning. So, you have to keep in mind all those sectoral and the macro level challenges to understand how that company is functioning in that economy and then arrive at a multiple. You will then have to do some sort of adjustments to apply that multiple to your company.

Let's take the example of Reliance Jio, a fairly new company from a large sector. Since Jio is housed under Reliance Industries, it is a part of a listed company. But if it was an independent company, how do you value Reliance Jio which is a new company? It is a company that has negative profits. It is a company that didn't have any subscriber base until August 2016. It simply had an elaborate plan and some groundwork which was related to the networking and the fibre-optic cable. So, they had already invested Rs 1-1.5 lakh crores into developing the back-end infrastructure. But how do you value a company that has no customers, no profits and no revenue? How do you value that company?

Now DCF is a wonder of Excel. Basically, you put in numbers, 5-6 years worth of numbers to determine cashflow.Cashflow is like, any standard cashflow you learn in accounting as per accounting standard 3. Where for EBITDA or PBT of the company you add back the non cash items. You reduce operating assets. In actual cashflow, operating and non-operating - all cashflow is reduced.But to value a company only operating expenditure and operating assets are reduced. Assets like uh...capital expenditure of the company and operating working capital of the company. You reduce all those and the final, whatever is there is the operating cashflow out of the business.  Discounted by some WACC (Weighted Average Cost of Capital) and you come to the enterprise value of the company. There's another approach which is called FCFE. What I spoke about is FCFF (Free Cashflow To The Firm). Firm is the company where equity and debt both are equal.  FCFE (Free Cashflow To equity) will be cashflow only to equity. There's just one more step where you just have to go ahead and reduce the debt. Any repayment you're going to show through that company.  So if debt is removed then obviously whatever is remaining is for equity share total.  So that is FCFE. So it's all a wonder of Excel.  You change one WACC or one parameter and your value can shoot from 0-100 in less than 10 seconds. *laughs*  So the challenge here is not the Excel. Projections will be provided by the client or the company that you're valuing because obviously you need the numbers are coming out of the company.  How's the company going to be like in 5 years? What the management is expecting?  This is all expectations and sleight of hand...to arrive at the value. But again, the challenge here is not how the Excel is looking.  The challenge here is; what is the discount rate? You have to really analyse from where the company is coming. Like say, again...if people going to the US from India in a year is 10 million and lets say the company is targeting only 500 people.  Then obviously it's achievable. Then the projections are not aggressive. The projections are infact, pessimistic projections. Where you're targeting only 500 people where your universe is 10 million. Right? So you have to really understand where the company is in relation to the market. And based on that uh...you have...obviously it comes with practice but you have some kind of a feeling that ok...the projections are aggressive/not aggresive/realistic.  Based on that again you'll see what comparable companies' beta is and then see what kind of risk you want to apply to that company. So there are multiple factors that go into DCF. There's no right answer to it. There's just a gut feeling that a valuer has about the VACC and the kind of discount you want to give to that company. Based on that you value the company. So your biggest challenge is to decide the WACC discount rate and not the cashflow's benefit Cashflow is easily done on Excel. The discount is the difficult part. It needs practice to understand and develop. A lot of research in the market and how the projection is done. There is another regulatory risk. Again, we spoke about that.  Saying RBI coming up with various regulations. So that is a regulatory risk which affects even DCF and the projections. Uh...management. Again, how the management is going to be. Whether the management serious about taking the company to the next level or achieving the projections. To understand the management and their insights. Another major factor to be considered is competition. Something which is right there in front of us is how Reliance Jio broke each and every telecom operator in the country along with his own brother's company. Right, since a year ago the revenues of other telecom companies have almost halved. The profits have almost gone down by 75%. So imagine the kind of impact competition has on your company.So you also have to understand what kind of competition is there in the market to understand what kind of challenges the company will face while growing.  Uh...if it's a saturated market, there's not much space to grow.  If it's a new market...probably you're the only player in the market, you have tremendous potential to grow.  So you have to judge all those patterns and data points avilable in the market to undestand how to value the company.