Vol 6 (2009) - Issue 1

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Distressed Valuation

Introduction

The analysis which has served as a general guideline for the valuation of closely held securities for many years may be applied to a broad spectrum of valuation assignments, including those related to share ownership plans, stockholder buy/sell agreements, mergers and acquisitions, corporate reorganisations, marital dissolution, and bankruptcies, among others. The approaches to valuation should not be viewed as formulaic or written in stone, but rather as tools to be used by the valuation professional in the proper context of the specifics of the company being valued. In some situations, certain valuation methodologies might be weighted or eliminated completely as inappropriate for a particular company or a particular purpose.

An appraiser is often called to assess the goingconcern value of a company experiencing distress or undergoing a restructuring. Indeed, in restructuring proceedings, the courts look to the valuation analysis to test the going-concern versus liquidation presumptions and decisions often hinge on which party can present the most supportable valuation analysis.

But what differences are there when it comes to valuing distressed companies? In essence the methodologies are similar to valuing healthy companies, although the approach and methodologies do require some modification and the weighing that is applied to different valuation techniques may vary

General valuation principles

The fundamental premise on which all investment decisions are based is that the value to a potential investor is equal to the present worth of future benefits. This basic concept can be applied to the valuation of an entire company, as well as to the individual securities that comprise the capital structure of the company. In each instance, valuation is a matter of identifying the future returns that the company can be reasonably expected to generate and determining their present value in the context of the uncertainty associated with realising those returns.

There are three widely accepted approaches available to the valuation professional when determining the value of a business enterprise:
1. the market approach;
2. the income approach;
3. the liquidation approach.

The choice of which approach to use in a particular situation, and the relative weightings to be applied to the different valuation methods, depend on the specific facts and circumstances associated with the company, as well as the purpose for which the valuation analysis is being conducted.

When considering the valuation of distressed companies, a combination of subjective and analytical modifications to traditional valuation methodologies is required. In many cases, a company may be unprofitable in the period leading to the distress, making a simple capitalisation of operating earnings or cash flow not useful.

Market multiples approach

The market multiples approach entails determining financial results considered to be representative of the future performance of the subject company, and capitalising those amounts by appropriate riskadjusted rates. This approach provides an indication of value that corresponds with the particular figure being capitalised (e.g., capitalising net earnings available to common stockholders yields an indication of value for the common stock).

The capitalisation rate is an expression of what investors believe to be a fair and reasonable rate of return for the particular security given the inherent risks of ownership. It incorporates expectations of growth and rests on the implicit assumption that some level of earnings will be generated by the enterprise into perpetuity. The most common means of obtaining capitalisation rates is through the market multiple method, whereby companies having their stock traded in the public market are selected for comparison purposes and used as a basis for choosing reasonable capitalisation rates for the subject company. Capitalisation rates obtained in this manner are generally expressed as ratios of the various financial results, and are referred to as 'market multiples.'