In this interview, Christophe Vandendorpe and Adrian Padurariu, who are valuation practitioners at EY Luxembourg's Strategy and Transactions team, address the topic of valuation nuances in uncertain times.
Is it a good time to perform a business valuation, considering the uncertain prevailing economic conditions?
The COVID-19 pandemic has created uncertainty and volatility in the global economy. Many businesses face unexpected financial, legal, and regulatory hurdles. Investment decisions are made even in volatile markets, so it is crucial to develop an appropriate view of a business’s value.
A valuation can provide a general perspective of how a business performs today, where it is headed, and the main areas needing to change or improve for long-term success.
If a business is in either the first years of growth or has already reached a mature level, the need for a business valuation can be determined by objectives such as: raising capital, transactions between companies (merger or acquisition), contribution in kind, or just managing the financial reporting requirements (e.g. the need to assess the impairment of your assets).
Now more than ever, it is vital to assess how the actual economic developments have impacted and will influence a business value from the perspective of investors, negotiating parties, auditors, and regulators.
What are the main causes of uncertainty in a valuation process?
The valuation process always entails a degree of uncertainty. Still, it has been felt during the last year as a more prevalent factor.
The markets have been disrupted. We have seen examples of panic buying and selling of assets leading to rapid changes in prices. This can prove challenging because you rely on market evolution data to derive key valuation parameters, such as components of the cost of capital and market multiples.
Company and industry-specific inputs used in valuation models are no longer predictive. Most businesses had to change their operating model. This, along with the speed and shape of the economic recovery, impacts the financial forecasts.
Considering the above, what valuation methodology should I consider for my business?
There is no one size fits all answer. The selection of a valuation methodology depends on the asset class and the asset’s specifics. It is also important to provide an appropriate definition for the value used (market, investment, or liquidation value) and respect recognized standards, such as the International Valuation Standards.
As with any valuation process, we can always consider the main three widely accepted approaches:
- Income (relies on the future income generated by the business);
- Market (comparing the value of the subject to selling prices of similar companies);
- Asset-based (consists of subtracting the market value of a business liabilities from the one of its assets).
However, this enumeration is not exhaustive.
While each of the approaches has its own pros and cons in terms of applicability, we should always consider that a valuation needs to be assessed in the context of the economic fundamentals and financial market conditions available at the valuation date.
My business and operational model has evolved. How should this be reflected in a valuation?
Many businesses have been affected from various directions and will experience a change in shareholder value creation and the free cash flow patterns.
It may be the case that information used for the financial forecasts in the past has become static or imprecise. Third-party data on pandemic hot spots, consumer sentiment, and other indicators can act as inputs in statistical models. Data analysis techniques and social media should be leveraged to improve future estimates.
It is recommended to consider alternative scenarios in the forecasting process, each one reflecting a probability-weighted expected free cash flows.
Where should we go from here?
Uncertainty regarding the current economic conditions does not obstruct a valuation from being undertaken. However, a greater level of caution and attention to details must be used when performing one. Given the growing complexity, it may be useful to consider the advice of a professional valuer.
To learn more and connect with the EY Strategy and Transactions team, visit https://www.ey.com/en_lu/strategy-transactions.