value vs. price; add-ons to, deductions from business value · controversy d. assessment. 2....

Wolfgang Ballwieser

Value vs. price; add-ons to, deductions from business valueIACVA‘s

5th Annual

Valuation

Conference

Neuss –

11 November 2011

111 November 2011Wolfgang Ballwieser 1

Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature

311 November 2011Wolfgang Ballwieser

1. Value vs. price

a. Basic economic insights 1

Prices result

from

market

transactions

of goods

or

services

Markets

are

large or

small

(liquid or

illiquid): cf. shares

of a Euro

STOXX company

vs. the

painting

of Mona Lisa

Prices depend

on

The

nature of the

good or

service: take

bottles

of Coke

vs. shares

of

BMW

The

transaction

unit: usually

there

is

no price

additivity

The

point of time: usually

there

is

no price

stability

The

location: usually

there

is

no unique

price

for

material goods

at all

places


1. Value vs. price


Transactions

normally

only

arise

if

values

and price

differ

A good is

bought

if

value

is

not

lower

than

price

A good is

sold

if

price

is

not

lower

than

value

Price might

equal

value

if

A transaction

partner

did

not

negotiate

or

act

well

An authority

(e.g. a judge) set

price

equal

to value

Unrealistic

models

(like

CAPM) are

taken

for

granted


1. Value vs. price


Why

is

the

CAPM far away

from

being

realistic?

Important

assumptions:

A finite number

of market

participants

Decisions

are

taken

on basis

of probability

distributions

of one-

period

rate of returns

of shares

and a risk-free

bond

Identical probability distributions for all market participants

What drives transactions?


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


1. Value vs. price

b. Value definitions 1

Subjective

business

value

= subjektiver Unternehmenswert

Objectified

business

value

= objektivierter Unternehmenswert

(IDW S 1)

Fair market

value

= gemeiner Wert or

Verkehrswert

Fair value

= beizulegender Zeitwert


1. Value vs. price

b. Value definitions 2

Subjective

business

value

is

the

basis

of individual

decisions

Value

results

from

a subject-object

relationship

Valuation

needs

an individual

preference

function

The

price

of a particular

BMW 5 does

not

tell

us

anything

about

individual

value

Objectified

business

value

(IDW S 1) is

a misname

A better

name

would

be

standardised

(or

normalised) business

value

What

are

the

rules

of standardising?


1. Value vs. priceb. Value definitions 3

Standardisation

rules

for

objectified

business

value

(IDW S 1)

In general, DCF model

with

forecasts

of two

or

more

phases

Stand-alone

value

Measures

considered

must

be

sufficiently

concrete

Direct

or

indirect

standardisation

of personal taxes

Share portfolio

is

alternative to company

No positive NPV of non-distributed

earnings

in second phase

Equity

costs

based

on CAPM or

Tax-CAPM

Risk-free

rate of return

based

on term

structure

of spot

rates



IDW S 1 (Business Valuation) paras 142-4:“7.5.

Considerations

for

plausibility

assessments

7.5.1. Market priceIf

market

prices

are

available

for

shares

in the

entity, they

are

to be

used

to assess

the

plausibility

of the

value

of the

entity

or

of a share

in the

entity

calculated

in accordance

with

the

above

principles

(…).

7.5.2. Simplified

pricingSimplified

pricing

(e.g. earnings

multiples, sales

multiples or

multiples based

on

product

quantities) can

serve

in specific

cases

as a basis

for

assessing

the plausibility

of the

results

of the

valuation

determined

using

the

dividend

discount

method

or

the

DCF methods.In practice, use

is

often

made

of simplified

pricing

methods

for

small

and medium-

sized

entities

(…). Such methods

cannot

substitute

a business

valuation.“ (Emphasis

added.)



IDW S 8 (Fairness Opinions) para 26“The

assessment

especially

follows

present

value-techniques

(DCF or

dividend

discount

methods) as well as market

price oriented

approaches

(analyses

of share

prices

of the

trans-

action

object

and multiples).“

„Die Beurteilung erfolgt insb. über kapitalwertorientierte Bewertungsverfahren (Discounted-Cash-Flow-

oder Ertrags-

wertverfahren) sowie über marktpreisorientierte Verfahren (Analysen von Börsenkursen des Transaktionsobjektes und Multiplikatoren).“



Fair market value (gemeiner Wert)“The

fair market

value

is

determined

by

the

price

which

would

be

gained

according

to the

nature of the

object

in a normal business transaction

when

selling

the

asset. All circumstances

that

influence

the

price

have

to be

considered. Exceptional

or

personal circumstances

must

not

be

considered.“

(§

9 para

2 Bewertungsgesetz; also

compare

§

738 BGB; §

194 BauGB)

„Der gemeine Wert wird durch den Preis bestimmt, der im gewöhn-

lichen

Geschäftsverkehr nach der Beschaffenheit des Wirtschafts- gutes bei einer Veräußerung zu erzielen wäre. Dabei sind alle Um- stände, die den Preis beeinflussen, zu berücksichtigen. Ungewöhn- liche

oder persönliche Verhältnisse sind nicht zu berücksichtigen.“



Fair value (beizulegender Zeitwert)

IFRS 13: Fair value

is

the

price

that

would

be

received

to sell

an

asset

or

paid

to transfer

a liability

in an orderly

transaction between

market

participants

at the

measurement

date (an exit

price).

That

was the

definition

of fair value

in US GAAP.


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


1. Value vs. pricec. Controversy

Assertion: “objectified business value equals fair market value“

Pros: objectified business value Cons: objectified business value

… is used by courts which decide on

indemnity

payments

according

to

German and Austrian

law

… differs

from

valuation

by

transaction

or

trading

multiples though

those

valuations

are

also used

by

market participants

… has a selling

perspective, neglecting, e.g. synergies, just like

fair value

… is

conservative

when

forecasting future

cash flows

… uses

capital

market

information

in determining

the

discount

rate

… depends

on many

assumptions which

cannot

be

easily

made

plausible


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


1. Value vs. priced. Assessment 1

I do not

see

advantages

of trading

or

transaction

multiples. WHY?

First, we

need

trading

of shares

of the

same

company

or

of

comparable

companies, since

we

need

homogeneous

goods.

A look

on companies

of the

same

sector

with

comparable

size

and

leverage

does

not

really

lead

to comparable

companies.

Let‘s

take

three

companies

from

the

automotive

sector: BMW,

Daimler, and Volkswagen.


1. Value vs. price

d. Assessment 2

Percentage

of sales 2010

BMW Daimler Volkswagen

Motor cars 73 % 61 % 83 %Trucks 22 % 7 %Buses 5 %

Motorcycles 2 %Financial services 25 % 12 % 10 %Sales (bn. €) 60.5 97.8 126.9


1. Value vs. price

d. Assessment 3

Second, many

companies

are

(almost) unique. Which

company is

like

Skype, Google, General Electric, Deutsche Bahn?

Companies

may

change

the

business

model

in a radical

way

Nokia: from

paper

products, gumboots, tyres

for

bicycles

and

wheelchairs

to mobile communications

and car

supplier

Mannesmann: from

steel

pipes

to mining

and

telecommunications

Deutsche Bank: from

retail

bank

to investment

bank


1. Value vs. price

d. Assessment 4

Third, valuation

based

on share

prices

is

too

short-sighted

Share prices

reflect

average

expectations

of market

participants

without

inside

information

Share prices

reflect

prices

for

shares, not

for

investments

Transaction

prices

usually

differ

from

market

capitalisation


1. Value vs. price

d. Assessment 5 (Source: Gaughan 2007, p. 556)


1. Value vs. price

d. Assessment 6

Fourth, combination of multiples with DCF valuation does not help!

1

0 1 EBITDA 0 0(FCF )EV (EBITDA ) m = E + D

wacc risk premium g

wacc + risk premium > g

How is EBITDA1 determined?

E0 is usually measured by market capitalisation which is

not equal to equity value


1. Value vs. price

d. Assessment 7

I do not say

that

the

objectified

business

value

is

a good value for

preparing

decisions; many

of its

standardisation

rules

are

criticised

by

good reasons

I only

detect

no advantages

in transaction

or

trading

multiples


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


2. Add-ons to, deductions from business value

a. Starting point

Modifications

of business

value

need

a reference

point

My reference

valuation

is

one

by

DCF having

integrated

Expected

synergies

Operating

(= investment

or

cash flow) risk

Leverage

risk, but

no liquidation

risk

In a technical

sense

it

does

not

matter whether

there

is

A deduction

from

reference

value

or

an increase

of discount

rate

An add-on

to reference

value

or

a decrease

of discount

rate


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


2. Add-ons to, deductions from business valueb. Add-ons

Add-ons

became

popular

in the

80s and 90s of last century

They

should

reflect

“strategic

value“

or

“options

value“

To my

conviction, they

were

nothing

more

than

an excuse

for

an overpayment

Strategic

value

must

be

able

to be

calculated

in cash flows; that was Rappaport‘s

message

Real options

(like

companies) cannot

be

valued

like

financial options. The

binomial

model

and the

Black-Scholes

model

require

market

prices

of the

underlying

in order to estimate

the model‘s

parameters. We

have

market

prices

for

shares, but

not

for

whole

companies.


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature



c. Deductions 1

Deductions

seem

to be

the

most

popular

game

today

They

shall

reflect

all kinds

of risks

A deduction

from

reference

value

can

be

substituted

by

an increase

of discount

rate

What are the relevant risks?


2. Add-ons to, deductions from business valuec. Deductions 2

Risk

components

(models

or

authors)

Operating

risk

= investment

risk

= cash flow

risk

(CAPM, Tax-CAPM)

Financial risk

= leverage

risk

(Modigliani-Miller; Miles-Ezzell)

Size risk (Fama-French; Ibbotson; Duff & Phelps)

Non-diversification risk = “cluster

risk“

(Total Beta; Damodaran)

Immobility risk = Illiquidity risk

Country risk (Damodaran)

Insolvency risk (Damodaran; Gleißner)

Political

risk

…


2. Add-ons to, deductions from business valuec. Deductions for small size 1

Size risk

Prominent discussion

by

Fama-French, Grabowski-King, Ibbotson,

Duff & Phelps

Controversial

debate

inside

and outside

the

U.S.A.



Source: Duff & Phelps Risk Premium Report 2011, p. 30


2. Add-ons to, deductions from business valuec. Deductions for small size 3 (Source: Duff & Phelps Risk Premium Report 2011, p. 16)



CAPM cannot

be

connected

with

SSRP on a theoretical

level

Fama-French

model

is

no theoretical

model

Size

effect

is

empirically

controversial

with

respect

to direction, stability

over

time and country

dependency

Schulz 2009 mostly

gets

no statistically

significant

effect

for Germany

Is

size

effect

the

result

of data

mining

or

even

data

snooping?



c. Deductions for small size 5

Schulz uses

the

Grabowski-King 1995 method

(more

recently

Pratt-

Grabowski 2008) for

monthly

returns

between

April 1995 and March 2008; no banks, insurance

companies

and companies

with

less

than

1

mio

Euro sales

or

less

than

5 employees; listed

for

at least 5 years

Schulz finds

a positive (!) relationship

of size

and return, being

robust

against

model

or

parameter

variation

Size

premiums

of small

companies

are

almost

completely

insignificant,

size

premiums

for

large companies

–

if

at all –

have

mostly

a 10 per cent

level

significance

and depend

on the

market

portfolio

surrogate


2. Add-ons to, deductions from business valuec. Deductions for non-diversification 1

Unsystematic risk

Prominent discussion

by

Damodaran, Gleißner-Wolfrum, etc.

Controversial

debate

inside

Germany



Pros

CAPM requires

market

participants

using

the

portfolio

model

of

Markowitz

Owners

of SMEs

are

not

diversified

Total beta: addition

of a second risk

premium

according

to

j

jM

( ß ) MRP , e. g. (2.5 1.5) 5% 5%



Cons

Damodaran

2002, p. 668 (earlier

Camp-Eubank

1981, p. 54) has no

theory: “To measure

exposure

to total risk

(σj

), we

could

divide

the market

beta

by

ρjM

. “

(Emphasis

added.) One also could

have

taken ρjM

= 1.

If

one

does

not

believe

in CAPM, one

cannot

take

the

structure

of

CAPM (ß) for

help: contradiction

It

is

not

necessary

to be

diversified

for

valuing

a SME: The

question

is,

what

amount

is

necessary

to reconstruct

the

cash flows

of the

firm that has to be

valuated? The

reconstruction

price

can

be

gained

by

using

CAPM.



c. Deductions for illiquidity 1

Pros

Selling

businesses

is

highly

uncertain

with

respect

to time and

price; selling

shares

only

need

a phone

call

and has low

time- price

uncertainty

Analytical

models

(Liquidity-CAPM), empirical

studies

(restricted

stocks, IPOs), court

decisions

and practical

experience

support deductions

for

illiquidity




Cons 1

Risk

premium

for

illiquidity

makes

sense, when

selling

is

expected;

the

regular

assumption

is

not

to sell; if

selling

is

expected, a

scenario

approach

could

count

for

this

expectation

The

selling

problem

is

one

of forecasting

cash flows, not

one

of

adding

a risk

premium

to discount

rate or

deducting

an amount

from reference

value




Cons 2

The

mere

possibility

of selling

necessity

is

not

sufficient: a nuclear

war or

a war of the

U.S. with

Saudi Arabia or

Mexico

might

also be possible

I do not

know

how

the

Liquidity

CAPM can

be

used

practically

The

empirical

studies

have

many

drawbacks

which

are

well-known

in the

valuation

community

(misspecification, omitted-variable

bias,

etc.)



c. Deductions for country risk 1

Pros

Investment in Ukraine, Belarus or

Greece

is

more

risky

than

one

in UK

CAPM does

not

reflect

this

kind

of risk

Damodaran‘s

proposal

Default spread

for

country

x volatility

factor

(1.5 for

emerging

countries)

Volatility

factor: stand. dev. of rates

of return

of shares

divided

by

stand. dev. of rate of return

of government

bonds

of the

country

Example: Belarus Jan. 2011 (Damodaran‘s

website)

CRP = 4.0 % x 1.5 = 6.0 %

Risk

Premium = Beta x (5.0 % + 6.0%) = Beta x 11 %



c. Deductions for country risk 2

Cons

Country

risk

again

is

a problem

of forecasting

cash flows

Damodaran‘s

proposal

combines

CRP with

CAPM, even

though

CAPM was blamed

for

neglecting

country

risk: contradiction

There

is

no theoretical

basis

for

multiplying

beta

and the

sum

of

MRP and CRP

There

is

no theoretical

basis

for

adding

CAPM risk

premium

and

CRP (cf. Kruschwitz-Löffler-Mandl

2010 and 2011)



c. Deductions for insolvency risk 1

Pros

Investment with

expected

insolvency

is

less

worth

than

investment

without

this

expectation; CAPM does

not

reflect

this

kind

of risk

If

one

takes

the

insolvency

as identical

and stochastically

independent distributed, then

the

result

looks

like

a negative growth

rate model

(Gleißner

2011, p. 247)

01

0E E

D (1 p)(D )Er p r p



c. Deductions for insolvency risk 2

Cons

It

is

not

clear, why

the

probability

of insolvency

is

not

integrated

in

the

calculation

of µ(D1

)

Constant

and stochastically

independent probabilities

of insolvency

seem

to be

unrealistic

rE

cannot

be

determined

without

reflection

of getting

insolvent

A global sample

of more

than

50,000 listed

companies

in 1986-

2008 shows

an average

rate of insolvency

per year

as of 0.18%

(Lobe/Hölzl

2011, p. 255)


Agenda1.

Value

vs. price

a.

Basic economic

insights

b.

Value

definitions

c.

Controversy

d.

Assessment2.

Add-ons

to, deductions

from

business

value

a.

Starting

point

b.

Add-ons

c.

Deductions3.

Implications

4.

Literature


3. Implications

Example: Assume a dividend discount model with

MRP = 5.0 %

Risk-free

rate of return

= 3.0 %

Beta (levered) = 1.5

µ(D1

) = 100

g = 2.0 %

Then equity value is

0

100 100E 1,1760.03 1.5 0.05 0.02 0.085


3. Implications

Example: Assume

Size

premium

over

CAPM = 6.0 % (p. 32)

Non-diversification

premium

over

CAPM = 5.0 % (p. 37)

Illiquidity

premium

over

CAPM = 3.0 %

Country risk premium (Belarus) = 6.0 % (p. 42)

Insolvency

risk

premium

= p x (1 + g) = 0.04 x 1.02 = 4.08 %

Then the equity value is

0

100 100E 3070.03 1.5 0.05 0.02 0.06 0.05 0.03 0.06 0.0408 0.3258


3. Implications

Reference

value

has been

diminished

by

(roughly

speaking) 74%

The

result

is

neither

based

on theory

nor

on empirical

evidence

But

I will not

exclude

that

such valuations

can

be

seen

in practice


4. LiteratureBallwieser, Wolfgang (2011), Unternehmensbewertung –

Prozeß, Methoden und Probleme, 3. Aufl., Stuttgart.Damodaran, Aswath

(2002), Investment Valuation

–

Tools and Techniques

for

Determining

the

Value

of Any

Asset, 2. Aufl., New York.

Dörschell, Andreas/Franken, Lars/Schulte, Jörn (2009), Der Kapitalisierungszinssatz in der Unternehmensbewertung –

Praxisgerechte Ableitung unter Verwendung von Kapitalmarktdaten, Düsseldorf. Duff & Phelps

(2011), Risk

Premium Report 2011, Selected

Pages

and Examples, http://www.duffandphelps.com/sitecollectiondocuments/2011_Duff_Phelps_Risk_Premium_Report_EXCERPT.

pdf.

Camo, Robert C./Eubank, Arthur A., Jr. (1981), The

Beta Quotient: A new

measure

of portfolio

risk, in: Journal of Portfolio Management 7, Nr. 4, S. 53-57.

Gaughan, Patrick A. (2007), Mergers, Acquisitions, and Corporate Restructurings, 4. Aufl., New York u.a.Gleißner, Werner (2011), Der Einfluss der Insolvenzwahrscheinlichkeit (Rating) auf den Unternehmenswert und die

Eigenkapitalkosten, in: CFB 2, S. 243-251.Knoll, Leonhard/Tartler, Thomas (2011), Alles hat ein Ende …

–

Anmerkungen zu einer mehrstufigen Diskussion in FB und CF biz, in: CFB 2, S. 409-413.

Kruschwitz, Lutz/Löffler, Andreas/Mandl, Gerwald (2011), Damodarans

Country

Risk

Premium –

und was davon zu halten ist, in: WPg

64, S. 167-176.Kruschwitz, Lutz/Löffler, Andreas/Mandl, Gerwald (2010): Damodaran’s

Country

Risk

Premium: A Serious

Critique. SSRN Working

Paper (as of 31 July

2010): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1651466.Lobe, Sebastian/Hölzl, Alexander (2011), Ewigkeit, Insolvenz und Unternehmensbewertung: Globale Evidenz, in:

CFB 2, S. 252-257.Schulz, Roland (2009): Größenabhängige Risikoanpassungen in der Unternehmensbewertung, Düsseldorf.

http://www.duffandphelps.com/sitecollectiondocuments/2011_Duff_Phelps_Risk_Premium_Report_EXCERPT.pdf

http://www.duffandphelps.com/sitecollectiondocuments/2011_Duff_Phelps_Risk_Premium_Report_EXCERPT.pdf

value vs. price; add-ons to, deductions from business value · controversy d. assessment. 2....

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