Deloitte | A Middle East Point of View - Spring 2017 | Asset-based approach

Reading
between
the lines
The merits of an asset-based
approach to valuing businesses

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Deloitte | A Middle East Point of View - Spring 2017 | Asset-based approach

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Deloitte | A Middle East Point of View - Spring 2017 | Asset-based approach

T
angible assets form the core of Illustrative example Company A Net book Adjusted
many companies’ balance sheets. (US$’ 000) value NAV
These include real property (such Tangible assets 12,500 20,000
as land, building, improvements) and Intangibles (software) 500 500
Intangibles (customer relationship) 1,000 1,000
personal property (including machinery,
Goodwill 2,500
equipment, motor vehicles, furniture, Other assets 1,000 1,000
computer equipment, etc.) Total assets 17,500
Bank debt (loan for assets) 7,000 7,000
Other liabilities 3,000 3,000
The 2008 financial crisis and the recent
Net book value of equity 7,500
economic sentiment from the relatively Adjusted net asset value 12,500
low oil price has reminded investors of Going concern value (income-based) 17,500 17,500
the instability of earnings and the Implied price/book multiple 2.3 1.4

associated unpredictability of the future

performance of businesses. This When valuing income-generating under a liquidation scenario. In
increased risk from cash-flow uncertainty businesses, the usefulness of this determining the value using this
is encouraging equity and debt investors approach may be limited as it does not approach, the intangible assets that
to understand the worth of a business capture the future income-generating cannot be sold separately from the
based on the value of its underlying potential of the business or the value of business are excluded and the value is
tangible assets. its goodwill and other intangible assets. adjusted for estimated costs of disposal;
It does, however, present a reality check implying a value of US$9m to Company A.
The asset-based valuation approach to the overall business valuation in
is less complex and easier to apply providing an estimate of the potential In instances where the business is a
The asset-based approach to valuation lower end of the valuation range of the going concern, an assessment of the
focuses on a company's net asset value business. liquidation value acts as a useful
(NAV), or the fair market value of its total measurement aid of the downside risk
assets minus its total liabilities, to The asset-based valuation provides for an investor by providing an
determine what it would cost to recreate an indication of the downside risk approximation of the net realizable value
the business. While there is some room In order to correctly apply the asset- in the event the business is wound up
for interpretation in terms of deciding based valuation approach, a fundamental shortly after investment.
which of the company's assets and decision needs to be made upfront as to
liabilities to include in the valuation, whether the net tangible assets of the A value of the underlying tangible
an asset-based valuation approach is business comprise part of a going assets impacts the overall business
generally the easiest to apply relative to concern entity or, alternatively, they do value
the traditional income-based and market not and must be liquidated. A potential debt or equity investor will
approaches. take into consideration the value of the
Taking our example further, if say, due underlying tangible asset when deciding
As an illustrative example, if we consider to certain new industry regulations, the on the appropriate pricing for equity or
Company A, a pipe manufacturing prospective viability of Company A as a a loan rate for providing debt to a
business that has been operating for going concern is uncertain, it would be businesses with limited historical
10 years and has a net book value of appropriate to understand its value information.
US$7.5m, its tangible assets are
Illustrative example Company A Adjusted NAV
estimated to have a fair market value in
excess of their book value if applying the (US$’ 000) Net book Value in use Liquidation
value value
adjusted net asset approach. One of the
reasons for this is that some equipment Tangible assets 12,500 20,000 17,500
Intangibles (software) 500 500 500
that was fully depreciated for accounting
Intangibles (customer relationship) 1,000 1,000
purposes is expected to have an Goodwill 2,500
economic useful life for years to come. In Other assets 1,000 1,000 1,000
applying the adjustments, the value of Total assets 17,500
Bank debt (loan for assets) 7,000 7,000 7,000
the equity of Company A becomes Other liabilities 3,000 3,000 3,000
US$12.5m. Net book value of equity 7,500
Adjusted net asset value 12,500 9,000

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 Deloitte | A Middle East Point of View - Spring 2017 | Asset-based approach

A business with a greater portion of Company A Company B

tangible assets on its balance sheets is (US$’ 000) Net book Net book Liquidation
Liquidation
considered safer for an equity investor as value value value value
it may mitigate the loss potential. The Tangible assets 12,500 17,500 12,500 13,500
higher the value of the tangible assets, Intangibles (software) 500 500 500 500
the lower the potential risk and the Intangibles (customer relationship) 1,000 1,000
Goodwill 2,500 1,500
higher the potential business value, and
Other assets 1,000 1,000 1,000 1,000
vice versa. Total assets 17,500 16,500
Bank debt (loan for assets) 7,000 7,000 6,000 6,000
The asset lever for an equity investor Other liabilities 3,000 3,000 3,000 3,000
Net book value of equity 7,500 7,500
Adjusted net asset value 9,000 6,000
Tangible Asset Backing (TAB) 2,500 7,500 3,500 4,500
Loan to net assets % 78% 100%

Assets Risk Value/price

It is important to note that while making
It is important to note
an assessment of the underlying tangible
The asset lever for a debt investor
asset backing and the liquidity value is a that while making an
useful tool when deciding on the value assessment of the
of a business, these do not necessarily
represent the true value of a going
underlying tangible asset
Assets Risk Loan rate concern. The asset-based valuation backing and the liquidity
methods are more suited to valuation
of going concern operations of asset-
value is a useful tool
Debt investors often seek assets pledged intensive businesses with little value when deciding on the
to them by the borrower as collateral. from goodwill or intangibles, not-for- value of a business, these
These are viewed by the debt investor as profit organizations or businesses to be
a secondary source of loan repayment purchased from a competitor in a similar do not necessarily
should the borrower be unable to repay industry. represent the true value
the full amount. As such, all things being
equal, the higher the value of the Concluding remarks
of a going concern
collateralized assets, the less risky the The need to know the worth of a
borrower, and the lower loan rates business is one of the most common In emerging economies there generally
obtainable. questions that transacting parties look is a high level of information asymmetry
to address upfront. While different and the investor has a significant
An asset-based valuation may not valuation methods may be considered information disadvantage due to opaque
always represent the true value of in undertaking a potential valuation, the financial statements or undisclosed
a going concern choice of the appropriate methodology is information. This has led debt and equity
Back to our illustrative example, dependent on the characteristics of the investors to look more closely at their
Company A and Company B are identical subject asset being valued, the purpose downside risk, and seek asset-based
in all material aspects and have the same of the valuation and the availability of valuations as a supplemental, if not an
net book values. However, Company B reliable data. alternate approach, to the traditional
has a significantly lower liquidation value income and market-based valuations.
as its tangible assets are not as valuable While an asset-based valuation approach Considering the challenging market
in the used equipment market. provides a comprehensive analysis of the sentiments and the tightening liquidity
Considering its higher tangible asset asset position of a business, its benefits conditions, the relevance and demand
backing, Company A will be perceived as vary across industries. Medical device for asset-based valuations is expected
a less risky investment to a potential manufacturers, for example, have high to increase across the region.
equity investor or a debt provider. While levels of valuable intangible assets that
US$9m may indicate a downside value may be difficult to value. In valuing a by Munish Mohendroo, Partner,
for Company A given the operating risk going concern the assessment of the Valuations, Financial Advisory, Deloitte,
from the new industry regulations, it is asset-based liquidation value provides Middle East
not necessarily representative of the an investor the potential downside value
actual value of Company A under a of the business. It may, however, not
going concern scenario. necessarily represent the true value of
a company.

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