What factors could impact value?
Businesses are facing uncertainty on many fronts as the world adjusts to the impacts of the COVID-19 outbreak. Supply chains and production have been disrupted, businesses have been closed, while events and travel are being cancelled. Combined with “physical distancing” and other measures imposed by various levels of government, businesses are experiencing and will continue to experience significant financial and operational disruption.
Stock markets are experiencing tremendous volatility and valuation is becoming even more of a challenge. Oil prices have dropped to levels not seen in decades, which is also impacting foreign exchange rates. Business owners and their finance teams are facing uncertainty in terms of their goodwill impairment and fair value testing for financial reporting purposes, the pricing or re-pricing of estate transactions, as well as acquisitions, divestitures and shareholder buyouts.
Exactly how much value has been impacted in the current environment? Financial markets have experienced a precipitous decline in recent weeks, along with heightened volatility, but what does that mean for the valuation of privately-held businesses or your fund investments?
Performing valuations during this period of unprecedented social and economic disruption can be extremely daunting.
Given the limited time available to assess the impact of the current environment on the cash flows and inherent risks of companies, an initial reaction may be to apply an ad-hoc adjustment to address every potential value impact. We firmly believe that valuation considerations should be made on an individual case-by-case basis, accounting for a number of factors.
While every business is being impacted differently, here are some factors that will likely impact value:
Global economic pressures have resulted in a temporary shock to economies and expectations of a global recession to follow. This has impacted interest rates, exchange rates, and growth outlooks. Most sectors will be impacted, but to varying degrees, with significant financial deterioration in some sectors and opportunities in others.
Stock markets are experiencing unprecedented volatility, causing wide swings in implied valuation multiples and making relative valuations more difficult.
How and when the market recovers will be a larger determinant of value impact than the movement in equity markets day-to-day.
Subject asset characteristics
Each asset will have a different exposure to risk. For example, demand-based assets will have the potential to recover quicker and may also be the beneficiaries of government stimulus measures. The value impact may be greater for shorter life assets.
Management of cash flows
A company’s ability to manage working capital and discretionary capital expenditures may mitigate adverse short-term value impacts, although, such measures may adversely affect growth in the medium to long-term.
The leverage position of a business can impact risk. Other factors like refinancing events, credit spread assumptions, and covenant headroom will impact financing availability, pricing and risk. Higher debt levels and changes to capital structure will impact equity values.
The broad economic downturn will increase counterparty risk and the potential for default on existing obligations.
A patchwork of government financial support programs have, and will continue to be, announced over the coming weeks. The impact of these programs may soften the economic impact on certain sectors and businesses. The adequacy of this government support may need to be assessed relative to the support provided to a company’s competitors in other countries.
Discount rates have increased for most sectors and multiples have decreased to reflect changes in market inputs and the increases in risk premiums.
Forecasts have likely changed dramatically from those prepared only a few months ago. Revenue, margins, foreign exchange rates, working capital requirements, capital expenditures, and other cash flow assumptions need to be revisited for the short-term and thereafter. Short-term business decisions may have lasting impacts in future years.
Valuation conclusions are typically presented as a range. Consideration should be given to where in the valuation range the point estimate is selected. Sensitivity testing can be used to determine the impact of alternate assumptions.
March 31, 2020 is the first quarter impacted by COVID-19. More information will continually become available, so a more frequent valuation cycle should be considered during this period of uncertainty.
What was known at the valuation date
Government policy decisions with respect to social distancing measures and economic aid continue to develop in real time. So too does our understanding of the nature of the virus itself. As valuation is specific to a point in time, careful consideration should be made as to what facts were known at the valuation date.
Financial reporting and impairment considerations Auditors will require impairment assessments prepared on a reasonable and supportable basis, and consideration of an appropriate balance of risk assessment between the discount rate and cash flows of the subject asset. Frequent impairment assessments could result due to triggering events. Individual asset values may be impacted, which could directly impact value for some businesses.
Review macro-economic assumptions
Market uncertainty is also impacting the sources typically used to support macro-economic assumptions, such as base lending rates, exchange rates, and inflation rates. Changes in these underlying assumptions are likely to be more dynamic as governments and central banks enact aggressive fiscal and monetary policies to support domestic economies.
Long-term growth assumptions
It is likely that a greater percentage of value will come from the terminal value, so increased focus on assumptions driving terminal value and supporting evidence is expected.
KPMG’s valuation professionals can advise on all aspects of valuation, including:
Be it planning an acquisition or divestiture, raising funds, preparing fair value assessments, meeting financial reporting requirements or resolving a dispute, you will need to understand value drivers and assumptions better so you can make optimal decisions for your business. This value, however, is not only about the numbers.
With over 100 dedicated valuation professionals across Canada, KPMG’s Valuation Services team can quickly mobilize to help meet an organization’s needs, whether local or international. Employing a rigorous valuation approach, our team invests the time required to understand an organization’s business and applies a robust process and sophisticated, tailored valuation techniques to every engagement.
As a result, our conclusions are well supported and our reports clear and concise.
For more information or to discuss how we can help you, please contact us firstname.lastname@example.org.
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