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Measuring fair values of assets and liabilities

The unparalleled and fast-evolving nature of the COVID-19 pandemic has posed several challenges for financial markets across the world. A number of economies have been pushed to a standstill while there are growing risks of a global recession. In fact, early estimates indicate that most major economies may lose over 2% of their GDP this year. Adding to this, measures taken by countries to curb the virus outbreak, such as social distancing, partial or complete lockdown and restriction on local and international travel have affected business supply chains, revenue and demand significantly.

The GCC countries too have been hit hard, with oil prices witnessing a 60% slump in the first quarter of 2020, due to the combination of falling demand and higher supply. On 22 April, the OPEC Basket crude oil recorded its lowest daily closing price for this year at USD 12.22 per barrel. The level of impact on the oil price can be gauged by reflecting on the annual average price of the OPEC Basket crude oil in 2019, which stood at USD 64.05 per barrel.

While the Kuwaiti government has taken a slew of relief measures to contain the economic slowdown, such as a moratorium of up to 6 months on bank loans and a cut in the discount rate to a historic low of 1.50%, companies too need to take preemptive measures to overcome upcoming economic challenges.

In measuring fair values of assets and liabilities, investors need to be extra careful, given the current market volatility. Here, Ankul Aggarwal, Partner Deal Advisory at KPMG Kuwait, emphasizes the need for quality data and assessing range of possible outcomes to perform valuations. 

In these unprecedented times there are more unknowns and judgements to be made, accordingly access to quality information, specific facts and circumstances will progressively enable more informed assessments. Further, businesses need to have processes and systems in place to monitor and capture quality data (i.e. reliable, relevant and up to date) including use of a range of sources before finalizing the data set or reaching final outcomes

As we look to measure the fair value during these volatile times, KPMG has come up with market insights and some key valuation considerations to support your business. .

  1. Evaluate the business subject: Companies should assess the pandemic’s impact on their businesses, by evaluating business model, nature of revenue, products and services, cash flows, creditworthiness of customers, inventory levels and supply chain risks, liquidity and solvency.
  2. Update the forecast cash flows: While adjusting cash flows, businesses need to consider the possibility of permanent growth loss and/or potential shape and tenor of recovery. As forecasting in these unprecedented times can be challenging as compared to a stable market, it is recommended to carry out scenario analysis and model adjustments to cash flows to understand the magnitude of impact. 
  3. Adjust the discount rate: Companies should appropriately adjust their discount rates for clients according to their ability to achieve updated forecasts. This means that organizations should try not to get influenced by the social, economic or financial factors and be mindful of adjusting the discount rates so that they do not end up incurring losses. In addition, the uncertain economic environment has already resulted in the increase of credit and liquidity risks for many companies, and may further result in intensified or altogether new risks.
  4. Consider investment time horizon:  Private equity investments are typically characterized by time horizons and return expectation. Investors need to assess how current markets could change the investment horizon, return requirements, exit valuation and assumptions. It is important to ensure that such an assessment is performed over a consistent time period, as a relative assessment of equity market performance may be flawed.
  5. Use multiples with caution: Adjusting equity values for unlisted stocks based on the market performance of listed comparable companies may understate the values of these companies. One should be prudent not to ‘double dip’ with respect to valuation inputs — if performance metrics have been adjusted to take into account lower expected performance, an appropriate multiple should be applied rather than a multiple derived from comparable public companies whose results have not yet included lower expected performance.

While companies continue to develop their plan of action and identify ways to address the current economic unrest, it is crucial they choose an advisor, if required, that has the necessary technical skills and practical experience to provide sound and objective advice. Experts from KPMG Kuwait have come up with three key takeaways to help companies ensure robust valuation practices, from their understanding of the current market scenario and way forward.

The first learning point pertains to frequency of valuations. In this regard, Ankul Aggarwal advises

In current times of increased volatility, it will be important for investors to undertake a more frequent approach to valuations, i.e. quarterly assessments (rather than just annual) until markets stabilize.

It is also advised that investors initiate reforecasting and valuation processes earlier than usual.

Secondly, as valuation is usually presented as a range rather than a point estimate, companies should consider where the point estimate should sit in the range, with the lower end perhaps better reflecting market participants’ increased risk aversion. 

The third takeaway concerns financial reporting and impairment assessment. In forthcoming audit/process reviews, impairment assessments will come under scrutiny, and evidence that the underlying financial information is prepared on a reasonable basis will be critical. In addition, auditors will expect investors to demonstrate an appropriate balance of risk assessment between the discount rate and cash flows.

At KPMG, we believe any adjustment to value should be assessed on an individual investment basis, having regard to a number of factors. We have set out above our considerations when thinking about the key issues that will shape the extent of the value impact on an asset/investment, as well as the implications. To conclude, it is critical that companies understand the implications of the ongoing crisis to be better prepared for any future uncertainties that may impact their businesses.

Ankul Aggarwal - Partner Deal Advisory

Ankul Aggarwal

Partner - Deal Advisory

Ankul has over 20 years of experience in both Corporate Finance and Corporate Planning. Prior to joining KPMG, he as he worked with one of the leading banks in Kuwait and one of the largest business houses in the Middle East.

Nitin Bahl, Associate Director, Deal Advisory - KPMG in Kuwait

Nitin Bahl

Associate Director - Deal Advisory

Nitin is the M&A lead at Deal Advisory in KPMG Kuwait and has over 14 years of professional experience including 11+ years in M&A, debt advisory and valuations across United Kingdom, India and Kuwait. 

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