In 1985 after 95 years of success, and when nobody was asking for it Coca-Cola  decided to change the formula for Coke.  The new drink was imaginatively called "New Coke".  But reaction to it was overwhelmingly negative and it was withdrawn in just 79 days. 

Surely the world record for the shortest time for announcement to withdrawal of a high profile commercial venture.  Until now.  The recent attempt by 20 of the top football clubs to create a European Super League went from initial fanfare to abandonment in just 3 days.

It highlights the huge value of football and of the clubs.  The top 10 clubs are collectively worth c£26Bn and enjoy more than c£4.4Bn of revenues. The UK contingent in the top 10 in declining order by value are Manchester United, Liverpool, Manchester City, Chelsea, Arsenal, and Tottenham.  Together they're worth c£16Bn.

 So how do you value a football club?

Conventional valuation methods don't work terribly well when compared to the prices paid for clubs. The market method which seeks to compare with publicly traded entities is hard to use effectively given the small number of public listed football clubs. The discounted cash flow method relies on a clear quality forecast of profitability which is never going to happen in this sector.  And using revenue multiples is a bit simplistic and takes no account of things such as the clubs stadium, assets and cost base.

So how do you value a football club?

Well it turns out that there is a model to do so. Dr Tom Markham is a graduate of Liverpool University's MBA in Football Industries.  His dissertation on valuation, in which he came up with the model, won the Premier League Best Dissertation award.  And is it seems to be quite widely used.

The Markham model is basically an enhanced revenue multiple valuation.  But it factors in the state of the balance sheet, profitability, stadium utilisation and the wages ratio.  These are all KPIs that are tracked for clubs.

Value = (Revenue + Net Assets) * ((Net profit + revenue))/revenue) * (%stadium filled/% wage ratio)

Put simply the bigger the turnover, the greater the asset value, profitability ratio, and how close to stadium capacity attendances are the higher the valuation. And a higher the wage ratio (wages/revenue) lowers the valuation. 

Interestingly for the 6 UK clubs their revenue multiples are remarkably consistent with the top five ranging between 6.2x and 6.6x with only Tottenham at 4.7x much adrift from the average of 6.2x. 

It would be interesting to see statistics for the lower leagues which of course will have smaller stadia, and revenues but lower wage bills.   There’s not enough information in the public domain to do the same calculation with Cambridge United – but I’d hazard a guess that the revenue multiple could be a low as half the above.

EBITDA

At PEM Corporate Finance we live and breathe EBITDA – it’s the performance metric of choice for M&A advisers and valuers alike as, at least in simplistic terms, it’s a good proxy for cash flow. And ultimately it’s cash flow that a corporate purchaser, investor or valuer ought to be focused on.  That’s what they’re buying or valuing.

EBITDAC

Of course EBITDA needs to be cleaned up before use, often adjusting for the true economic costs of the directors, and adding back any one offs costs. One might think it would be enough to consider the effects of Corona Virus on business, be it in reduced sales, margins, disrupted supply lines, or increased debt, as an add back. But in fact a new acronym has been coined: EBITDAC or earnings before interest tax depreciation and corona.

You can even get it on a mug!

How might it help in practice. Well it will depend on how readily you can quantify and clearly identify the effects of Corona. That might not be altogether straightforward. It might hit the business in many ways, some of which won’t become apparent until later. It is also likely that the Corona effect will vary over time, and by sector. So for example we’ve found that some businesses are picking up slowly after an initial hit, and some sectors particularly in tech weren’t much impacted.
I do think it’s worth trying to isolate EBITDAC. It’s going to be an ongoing difficulty for business valuers. But in M&A there are some immediate impacts:-

Price expectations

Coming out of the recession that followed the financial crash in 2008/9 one of the issues was a big gap that had opened between vendors and purchasers expectations as to price. This could be an issue in the short term now. Vendors will want to sell on the back of the EBITDAC profit metric and on pre-Corona multiples. Buyers will want to back off some of the risk that the current reported EBITDA is the new normal through a reduced price. In practice we’re already seeing the use of earnouts, convertible instruments and ratcheted deals to bridge this gap. Creative deal structuring is going to be needed.

Locked box v Completion accounts

The locked box has become quite common and is especially popular with private equity buyers as it gives them certainly as to price/structure and their funding requirements to allow them to draw down funds if needed. However in a fast moving situation where there’s ongoing uncertainty as to how Corona Virus will impact it may now suit both buyer and seller to move to Completion Accounts where the final deal structure is established on completion. It’s quite likely that deals will progress slowly over the summer as buyers and funders are cautious with their diligence – that further emphasises the need to see what the world looks like on completion if that’s going to take to the autumn.

Normalised working capital

Upon closing an M&A transaction there is always a debate around the normal level of working capital, and what are the debt like items are in the target. And from that just how much surplus cash can be taken off the table by the Sellers. Of course short term there’s a good chance that working capital will not be normal, with a build up of creditors on stretched terms quite likely – and so that needs to be dealt with.

Just how much use is EBITDAC anyway?

Short term I’d say it’s interesting, we must use it, but as a proxy for cash flow it’s useless and that will ultimately limit its applicability in M&A without consideration of other factors such as the fundamental value drivers of the business, it’s forecasts and scenario planning for 2021. As far as valuation opinions are concerned 2020 EBITDAC can only really be used alongside consideration of 2019 results, and a detailed scrutiny of the business fundamentals and prospects for 2021.  It really underscores the need to start planning now for the recovery, as it will be all about having a credible view of 2021 and beyond.   

For more on business valuations and corona have a look at our valuations site or this article on the PEM Corporate Finance site 

Valuation is art not science

A recent finance editorial in The Guardian on the 21^st Century Fox v Comcast battle for Sky was critical of the Sky independent directors.  It felt they should be embarrassed at recent events and should realise that valuation is art not science.

Too good to miss?

Paraphrasing the argument - in 2016 the independent directors felt a £10.75 per share cash offer was too good to miss.  Surely offers 40% above the previous weeks share price don’t come a long too often.    In fairness at that time the share price had fallen from £11 in April 2016 to 769p as the market fretted about Netflix and BT.  And you can be sure that Brexit fears didn’t help either.  But at the same time based on the fundamentals including the benefits to be derived from getting Sky Italia and Sky Deutschland motoring properly UBS analysts reckoned a fair price for Sky was £13.70.   So they’d not have been sellers at that price.

Today in 2018, with the political and regulatory issues behind them the real bidding has begun and the action is around the £14.00 to £14.75 range - so far.

Price v Valuation

This is all about price v valuation.  So what are the lessons?  Well the discussions at the board are of course mostly about price.  First time around in a jittery market, amidst fears about market trends (the threat from streaming), and with a one horse race the independent directors view on price wasn’t too bullish.  They obviously weren’t feeling too confident.  Either that the value was light, nor were they sufficiently robust to turn it down and take and flak from further share price decline afterwards.  So that was all about what price to accept. 

But back in 2016 UBS valuation opinion based on fundamentals was clearly suggesting something much higher – I’d be surprised if that wasn’t also the view in the Murdoch’s camp.

Now it looks so different.  Better performance, better market sentiment, and true competitive bidding is driving a value c£7Bn higher than before!  No wonder Sky shareholders were angry in 2016.

The above is all about how it felt for the sellers, for some insight into how it might have felt on for the purchasers have a look at this blog post on the PEM Corporate Finance website on how to pitch an acquisition offer.

The need for competition to get the best price

Taking the lesson a step further this really underscores the need to sell your business at a time of your choosing and to get a competitive process going.  It also demonstrates graphically how much higher a price you might get as a result of real competitive tension between strategic buyers.

Motivation

Like Hercule Poirot you should be on the lookout for ulterior motivation.  Was the forecast prepared with one eye to selling the business (usually inflated) or getting a valuation for a matrimonial dispute (this often produces a low valuation if the business owner is the defendant).  Or perhaps it was prepared for bank funding – in which case be sure the bank will scrutinise and sensitise the forecast.

Poor track record of forecasting

If the business has historically been poor at predicting its results which should it be different now?

The pattern of growth or margins look odd

It’s always possible to benchmark the figures against public companies or other data.  If the business producing the forecasts has wildly different growth rates, or margins one needs a good explanation as to why that should be.

Forecasts prepared in isolation by the finance director

The CFO or FD in the business needs to canvas inputs from the key mangers in the business before he or she can produce anything meaningful.

The forecast is based on a huge assumption

If there’s one or two huge assumptions that drive the forecast, such as being able to raise millions of pounds of equity finance, or winning a significant new contract then you should consider what happens if those assumptions don’t prove realistic.

Forecasts conjured out of thin air

Of course if there are no, or few, supporting assumptions to check out then the forecast will lack credibility.  I recently valued an early stage technology company where it quickly became clear that the forecasts beyond the first twelve months were just round figure guesses – so I had to discount them altogether in my appraisal.

No balance sheet

I do sometimes see forecasts based on a profit and loss account and some cash flow assumptions.     Without a balance sheet a vital logic check is missing.

This 2012 High Court case is interesting for the comments made by Justice Eder about Expert valuations.

Stabilus was a leading German manufacturer of gas springs and hydraulic vibration dampers used in the automotive industry which was the subject of a number of transactions. In 2008 it was bought by Paine & Partners LLC for €519M. Shortly afterwards got into financial difficulty and underwent a major restructuring in 2009 which carved up all the value to the Senior Lenders leaving nothing for the Mezzanine lenders.

Unsurprisingly – with €83M at stake in the Mezz layer – the Mezzanine lenders challenged the validity of the restructuring. Three different valuation firms gave opinions and three of the “big four” accounting firms were involved one way or another.

The judgement 100 pages long judgement had some key lessons for business valuation.

Use of previous valuations

If they’ve been prepared for internal reporting purposes rather than “fair market value” then they’re not suitable support

Business plans

Adjusting forecasts without considering the reasons for variations is not acceptable, and past variations from plan are not an automatic indication that there will be future variations.

Other Experts Reports

The Expert must request to see other Witness reports to check assumptions and any deviations from their viewpoint. Any deviations must be fully supported.

Discount to EBITDA multiples relative to guideline companies

The judge was happy that EBITDA multiples should be discounted. He commented that applying a discount is qualitative rather than quantitative.

The Expert needs to compare the risk, size, growth pattern of the business being valued to the guideline company when estimating a suitable discount. Stabilius had a lower growth rate than the rest of the industry which justified a lower multiple.

Hindsight

The valuer must focus on the facts and business outlook as at the valuation date. Hindsight is not a sense check for assumptions at the valuation date.

Ultimately the Judge agreed for the most part with the American Appraisal valuation – that the mezzanine debt had no economic value at the date of valuation.

That's the title of a recent PEMCF article in Acquisition International.  We covered the need for valuations, saleability, valuing early stage technology companies, and the need to get beneath the numbers.  Have a read here.  For more information have a look at the valuation section of our website here.

It’s a cliché that business valuation is both and art and a science.   Or as it’s been more aptly put it is a craft.   Either way it needs to be done thoughtfully.   You don’t need to look hard online to find sites that invite you to put your data in and I’ll value your company for a low fixed fee.  Trouble is that “under the bonnet” this is just some maths – this is a problem because you have no idea if the site is asking the right questions, and more importantly its only as good as the data input.   As they say garbage in garbage out.

But if you do treat valuation as a craft, to be conducted thoughtfully, making insightful and supportable judgements about the business at each step you need to guard against bias – and this can arise accidentally.

Anchoring is a well documented phenomenon.   There have been psychology experiments that have demonstrated this.   Business students are asked if they’d pay the last two digits of their national insurance number for each of several items.   Then they’re asked the maximum they’d be prepared to pay item by item.   Despite it being random students with higher NI numbers consistently indicated higher maximum bids.    The anchoring phenomenon can work to ones advantage – it’s a reason why it’s often helpful to go first in a negotiation – to try to anchor the debate at your end of the value range.    But it has no place in valuation as the valuer should form an independent judgement.     

So as a corporate finance adviser I’m keen to understand what my clients objectives are as input to negotiations. Conversely as a business valuer I need to be deaf to the client’s desired valuation.  This might be a business valuation for divorce purposes, or to do with shareholder exit, or tax.  But I need to avoid anchoring bias to make sure I arrive independently at my best judgement of valuation which is supported by the evidence and by my understanding of the business. 

For more information on our Business Valuations service have a look at our website - based in Cambridge we provide valuation services to business owners around East Anglia, in London, nationally and internationally. 

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Asman Damodaran of the New York University Business School had a go at valuing the Star Wars franchise.  Disney paid $4Bn for it – so did that turn out to be a good deal?

Damodaran reviews the franchise to see where the revenues have come from.  Interestingly the original film is still the biggest grosser to date at nearly $4Bn.  But the other revenue streams are even more important; VHS/DVD/Rentals, Toys, Gaming, Books, and TV series.  These other revenues dilute Movie income to 20% of the whole alongside 23% for rentals, 15% for gaming and books, and a whopping 36% for toys and merchandise.

So how do you value it?  Like any other business, one needs to take a stab at future earnings potential.  In the absence of Disney’s,  no doubt closely guarded, forecasts Damodaran makes educated guesses.  Starting with Disney’s intent to make another two films he then assumes they’ll each gross something similar to “the Force Awakens”.  I’d have assumed some slight decline each time around (as the history suggests) but you have to start somewhere.  He judges that add-on revenues will continue be more important - streaming replaces rentals and he assumes $1.20/dollar v $1.14/dollar thus far, Toys continue to generate $1.80 for every dollar of movie income, Books drop 25% to $0.20/dollar, Gaming stays at $0.5/dollar, and he assumes that with the distribution power of Disney and Netflix (rumoured to be planning 3 live action series) TV rights will increase to $0.5/dollar. 

One needs to keep making assumptions, when the films will be released, inflation, and of course the margin levels on the income streams – he uses sector averages here, for example toys/merchandise at 15%.  Put it all together and you get an overall net income projection which he discounts at 7.61% being the average cost of capital for the entertainment sector.   Net result a valuation of $10M.   So Disney did a good deal.   If you want the full calculation Google “Galactic Finance: Valuing the Star Wars Franchise” which will take you to his blog.

It shows you can build up a cogent case to value almost anything, although I’d  have factored in some kind of discount just because of the existence of Jar Jar Binks. 

May the force be with you.

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Planning for exit and succession can be difficult in any business, but in family businesses there are additional factors to consider.   One of the problems with family succession planning is that the two key objectives – liquidity and preservation of the business legacy appear to be in conflict – how can you get cash without selling up?   A sale to a trade buyer may be unattractive if the plan is to keep things in the family, and this is where the idea of a sale to family comes in.  

This is a form of management buyout – the family members buying the business are very often the team running the company.    Often it goes beyond that to key managers – hence the occasionally used abbreviation the FAMBO. This is meant to mean Family and Management Buyout, or Family Buyout, although just to confuse things I’ve recently seen it used in East Anglia to refer to a Franchisee and Management Buyout.   It can also be called a VIMBO or Vendor Initiated Management Buyout – because the its usually (though not always) the older generation which initiates the sale to the younger family members.  At PEM we prefer to refer to such deals as Succession Buyouts – because that neatly encapsulates the overarching strategic intent of the deal.

Because family relationships are involved things can go wrong so as to delay the transaction or even kill it completely.  So here are some key thoughts on how to preserve family harmony whilst successfully completing a buyout.

Plan ahead and don’t rush each other. It is really important that harmony and trust is maintained. Nothing breeds suspicion more than the idea that one family member wants to take advantage of another, either by being pushy or appearing to scheme behind the scenes. This is true whether a family member is a buying or selling. An aggressive buyer almost ensures that the seller will react negatively; an aggressive seller communicates desperation and may undermine his or her own negotiating position.   Actually this is also true of Succession Buyouts amongst long standing colleagues who are not related.

Take account of peoples personalities Families ought to know one another pretty well. They know about personality traits or past circumstances giving rise to unusual levels of loyalty, or even resentment, or jealousy.   This might all come out in the run up to a transaction, sometimes they are deep-seated psychological feelings, and can be almost childlike—“Dad always preferred you.”   Being alert to such attitudes and steering the transaction in a sensitive way that respects feelings will help ensure success. Often the most important thing is to make sure everyone is listened to.

Get the business professionally valued If your shareholder agreement doesn’t prescribe a valuation methodology, it will be helpful to everyone involved in negotiating a transaction that there should be an independent assessment of valuation. Fairness is the key to completing the transaction and maintaining positive family relationships, and possibly sanity.  Neither buyer nor seller wants to looking back on the transaction with regret or suspicion.

Find some trusted advisors. Truly independent advisors who have the best interests of the family in mind can be hugely helpful in communications and facilitating agreement amongst the family. Each family member can get some independent advice, but its much better to select an adviser with a track record of brokering/facilitating such deals amongst close knit family or business groups to work for the company/family as a whole with the objective of reaching an agreement that works for all.  A skilled adviser will listen to all the agenda’s and try to manage any emotional pressures that arise during negotiations.

Tax and estate planning My tax colleagues would point out that it’s really important to consider the tax and financial affairs of the whole family, up and down the generations. And a deal like this is an opportunity to consider these things holistically.   Has the family provided for everyone as they intend and have they done inheritance tax planning?  Again these are things that need to be done early. One of the consequences of some buyout structures is that IHT planning becomes more important – don’t leave it to the last.

Family businesses are important to us all – according to INSEAD they account for 57% of US GDP.   There’s a general perception that many don’t make it beyond one or two generations. I’m not sure that’s true, INSEAD reckon there are 5,500 bicentenary family businesses around the world, and we’ve certainly worked with some family businesses which are now at fourth or fifth generation stage.  Visit our website to read about some of the family buyouts we've worked on.

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Bloopers are the mistakes made by cast or crew on a film that end on the DVD extras. Sometimes they can be better then the film.   Business Valuation bloopers on the other hand are no laughing matter.   You might need a business valuation for divorce purposes, a shareholder exit, or as part of some kind of tax planning. Whatever the reason, whether you’re valuing an early stage technology company in Cambridge, or a mature SME in London there are some common business valuation bloopers to avoid.

As valuation experts we are often get to look at and comment upon other advisers valuation reports.  Often basic flaws in valuation methods, logic, or lack of decent data lead to challengeable advice being given. 

Here are some valuation out-takes, make sure you avoid them.

"I believe you"

Believing everything you’re told isn’t a good idea.  But I see lots of report where advisers have based all of their calculations on profit figures supplied by directors without having challenged them, or having reviewed the business.   Sometimes its pretty clear that most of the text is templated and applied to any and every business.

Lies, d*mn lies and statistics

You can find statistics to prove anything – just ask any politician. When valuing a business there a range of indices available from which to source an earnings multiple.   The lazy adviser might just reach to for one of these without either questioning it, or corroborating it with other data.   This is a problem because these indices by their very nature are averages – and so they say nothing in particular about any one sector or company.  It doesn’t matter whether they use, the BDO Private Company Price Index, FT All Share PE ratio, the Leading Edge Alliance’s PERDA, the Argos Soditic Mid Market Index, or the UK200 Group SME Valuation Index, a generic multiple will rarely give you the right answer in a business valuation.

Out of code information

As in any field business valuers need to keep up to date, and to use current data.  I recently saw a valuation based solely on the Private Companies Price Index.  Just relying on that would be bad enough, but the valuer then applied it to the wrong profit figure in the companies accounts.  My guess is he has been using PCPI for years and has never noticed that it changed a few years ago from an EBIT multiple to an EBITDA multiple.  

Apples and Pears

Don't mix apples and pears or you'll get a curious byproduct.  Likewise there are a range of profit measures, EBITDA, EBIT, PBT, PAT, Operating Profit.  And a range of multiples  including EV:EBITDA and the price earnings ratio or  PE ratio.   If you apply a price earnings ratio to EBITDA you will significantly overstate the result.

Rules of Thumb

As a business valuer I wouldn’t disregard rules of thumb in a particular industry, so transactions involving shops, cleaning companies, and professional service firms are amongst those where one comes across them. But I’d only ever use them as corroboration of more rigorous methods.   So shops are often sold for a number of weeks turnover plus the value of the stock – ultimately this must also equate to an earnings multiple, but where data might be patchy it’s probably a useful ready reckoner of valuation. The trouble is one often see’s quite inappropriate, and unquestioning, extension of these rules to other sectors. So for example I recently saw a service firm valued by a valuer who I suspect must specialise in valuing corner shops for after arriving at a (not entirely supportable) earnings valuation he then added the balance sheet value.  

I could go on. There are lots of ways to go wrong, indeed a quick Google produces an academic paper entitled “110 Common Errors in Company Valuations”

The answer, and you’d expect me to say this, is to find a business valuation expert who knows what they’re doing, and produces a well reasoned valuation that would stand up in court if you ever found yourself there.

Have a look at our http://www.pem.co.uk/corporate-finance/business-valuation

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