Restructuring

Business Valuation in Debt Restructurings

Market values for banks, creditors, security trustees, mezzanine providers, equity sponsors

Independent valuation of a business is a central component to debt restructurings, where a creditor (or Security Trustee seeking to discharge their duty and exercise their rights under the inter-creditor agreement) seeks to enforce on its security. 

Best practice for insolvency practitioners (restructuring and recovery professionals) who pursue a pre-packaged administration in order to preserve maximum value for creditors requires an independent view of value.

Company directors may also want to satisfy themselves that any valuation carried out is accurate and that proper and due process has been followed, in order to minimise their personal liability exposure.

There are usually multiple parties with differing interests in a debt restructuring:

• Senior debt holders
• Subordinated debt holders
• Mezzanine debt holders
• Preference share holders
• Equity holders
• Pension scheme trustees
• Hedge counterparties
• Company management

The market value of a business enterprise (the enterprise value) is integral to determining which of these parties retains an economic interest in the business. The market value of the business is therefore a central pillar to negotiating, among other things, which parties should retain an interest following a debt restructuring, the size of the interest retained and the level of debt or equity to write off. 

Applying a repayment ‘waterfall’ across the enterprise value determines where the value break lies.  It may be the case that the value break is comfortably in the senior debt, in which case the senior debt holders are in a strong negotiating position.  However, the higher the value break, the stronger the negotiating position of other players in the debt stack and other capital holders.

Case History: IMO Car Wash
In 2009, the English High Court delivered judgement in the IMO Car Wash case (in the matter of Bluebrook Ltd and others [2009] EWHC 2114 (CH)), in which the High Court considered whether to sanction three related schemes of arrangement for restructuring indebtedness proposed by the IMO Car Wash group to the senior lenders of the relevant group companies.
In creating the schemes, the IMO Car Wash group and the senior lenders engaged an external consultant to undertake a valuation exercise which involved valuing the group on a going-concern basis, and not on a liquidation or fire-sale basis, by adopting the following methodologies:
- an income approach, which valued the business on a DCF basis.  In this approach, an “alpha factor” was added to the cost of capital to reflect uncertainty in
  the market and the impact of the credit crunch on the availability and cost of financing;
- a Market Multiples approach, which analysed comparable publicly traded companies; and
- a LBO analysis, which looked at the debt capacity to assess the level of equity investment a potential private equity purchaser would be prepared to make.
The judgement in the IMO Car Wash case supported the “going concern” basis of valuation and, in general, the valuation approach and assumptions of the valuation consultants acting for the senior lenders.

American Appraisal’s valuation approach to business valuation in debt restructurings is consistent with the judgement in the IMO Car Wash case (in the matter of Bluebrook Ltd and others [2009] EWHC 2114 (CH)).

Valuation Approaches

Valuation techniques applicable for determining the value of a business for use in debt restructurings, include:

• Discounted cash flow
• Comparable Transaction Multiples
• Comparable Publicly Traded Company Multiples
• LBO Method

Depending on the size of the equity interest being valued and the type of company to which the equity interest relates, together with the valuation methodology employed and the nature of the data used to arrive at a preliminary valuation conclusion, it may be necessary to apply premia or discounts, as follows:

• Premium for Control
• Discount for Lack of Control (Minority Discount)
• Discount for Lack of Marketability (Liquidity)

Discounted Cash Flow Valuation Approach

The DCF Approach measures economic value through the analysis of cash flows, rather than accounting-based indicators which are subject to distortion by accounting conventions that may not adequately reflect the realities of investment markets. Since sophisticated investors define “value” in terms of cash flows, this approach is widely utilised in the financial community.

After establishing the cash flows to be used, the DCF Approach typically involves:

• estimating the terminal value of the business at the end of the explicit forecast period;
• determining an appropriate discount rate to reflect the present day value of money and risk; and
• discounting the free cash flows and the terminal value to arrive at their NPV.

The discount rate applicable to the free cash flows and terminal value is usually the WACC.  The WACC is an estimate of the overall after-tax rate of return required for equity and debt holders of a business.  The WACC is computed by calculating a company’s cost of equity and after-tax cost of debt.  These two calculations are then weighted based on the company’s target capital structure to arrive at the WACC.

Market Multiples Valuation Approach

The Market Multiples Approach involves capitalising the earnings, or cash flows, of a business at a multiple that reflects the risks of the business and the stream of income that it generates.  These multiples can be applied to a number of different earnings and cash flow measures, including EBITDA, EBIT or net profit after tax.  These are referred to respectively as, EBITDA multiples, EBIT multiples and price earnings multiples. 

Application of the market multiples valuation methodology involves:

• estimation of earnings or cash flow levels that a purchaser would utilise for valuation purposes having regard to historical and forecast operating results, non-recurring items of income and expenditure and known factors likely to impact on operating performance; and
• consideration of an appropriate capitalisation multiple having regard to the market rating of comparable businesses, the extent and nature of competition, the time period of earnings used, the quality of earnings, growth prospects and relative business risk.

Selection of an appropriate earnings multiple is usually the most judgemental element.  Historic transactions, or even indicative offers, for a particular asset or business can provide reliable support for selection of an appropriate multiple.  In the absence of such data, it is necessary to infer the appropriate multiple from other evidence.

The analysis of comparable transactions and equity market prices for comparable companies will not always lead to an obvious conclusion as to which multiple, or range of multiples, will apply.  There will often be a wide range of multiples and the application of judgement becomes critical.  Moreover, it is necessary to consider the particular attributes of the business being valued and decide whether it warrants a higher or lower multiple than the comparable companies.

LBO Valuation Approach

A LBO valuation approach is often used by private equity and investment banks to determine what a company might be worth in a leveraged transaction. A LBO model can be utilised to determine how much debt financing a company can support given its assets and cash flow potential.   Under a LBO, the investor generally obtains returns through a “cashing out” event.  Such an event can occur in one of three ways: (i) an IPO; (ii) via a private sale of the company; or (iii) via a recapitalisation, or creation of a new LBO.

In order to calculate the terminal value of the subject company on cashing out, it is common to apply a Market Multiples or DCF Approach at a projected cashing out horizon.

In general, there are two ways to convert estimated terminal values into comparable present values:

• Impose a target IRR; and
• Calculate the year-by-year cost of equity using the CAPM, taking into account the changing capital structure of the enterprise and the changing risk of the equity.

The key elements of an LBO model are the three major financial statements (balance sheet, income statement and cash flow statement), as well as assumptions regarding debt levels, repayment periods and interest rates.

Our work

American Appraisal performs 100s of commercially-focused business valuations annually. 

American Appraisal consultants, both in the UK and across our network of global offices, have skills across all industries and extensive experience of business valuation and applying business valuation and share valuation techniques including.

• Discounted Cash Flow
• Market Multiples
• LBO Method

Within these models we use our extensive databases and experience to select the most appropriate valuation inputs such as:

• discount rate
• long-term growth rate
• sustainable working capital and CapEx requirements
• maintainable earnings
• capitalisation multiple (EBITDA multiple, PE multiple etc)
• Leverage
• Interest rates and payments

We have played a key role in both complex and more straightforward valuations of businesses for debt restructurings in recent years, including:

• Valuation for Security Trustee acting on behalf of Senior Lenders to a global automotive business
• Valuation for a Senior Lender to a global music business
• Valuation of a ferry operator to assist Senior Lenders consider their options 
• Valuation of a publishing business to justify a pre pack administration

lease feel free to get in touch with us if you are involved in a restructuring and require an independent opinion of value.