Comparability can be a difficult standard when valuing businesses with significant real estate assets used as part of their operating company assets. Some business valuers are concerned that IFRS 16 changes around lease accounting may have made the problem worse.
Another great model—this time for valuation experts with real property-intensive business clients—was released last week from The Footnotes Analyst. The authors are more positive about IFRS 16 than other commentators, even during this calendar year when conversion to the new lease accounting standards remains inconsistent.
‘Similar operating businesses may have very different exposures to the risks and rewards of real-estate investment,’ say the authors in their introduction to their Opco-PropCo analysis. ‘Because real-estate performance and valuation metrics, such as return on capital and valuation multiples, are likely to differ from those for operating businesses, combining the operating business with differing real-estate exposures makes comparing metrics for the combination of operating and real-estate activities very difficult.’
‘Sectors with other “big-ticket” fixed assets, such as airlines or energy companies, where different leasing or ownership strategies are pursued for non-property assets, are also affected,’ they state.
Value nearly doubles depending on real property strategy: A brilliant comparison of four similar operating companies shows that ownership, midterm, and short-term (noncapitalised) lease strategies can increase enterprise value by nearly 80%. Four similar businesses with the same EBITDA plus rental expense (EBITDAR) varied from a low enterprise value of 800 to a high of 1,400. ‘The lower valuation multiples arising from a leasing (and particularly short-term leasing), rather than ownership strategy may lead to the incorrect conclusion’ that companies with owned real property are automatically worth more, The Footnotes Analyst concludes.
They warn business valuers to use caution with the following standard valuation metrics that can be altered because of real property investment strategies within an operating business:
- Return on invested capital (ROIC). Companies that have higher real-estate exposure generally have a lower aggregate return on capital;
- Enterprise value to invested capital (EV/IC). The contribution to enterprise value should reflect the fair value of the real-estate investment; and
- Enterprise value profit multiples. ‘Valuation multiples based on profit measures are also impacted by real-estate strategy. This applies to all of the commonly used multiples such as EBIT, EBITDA and EBITDAR. In each case, a higher level of real-estate exposure is likely to increase the reported multiple,’ they say.
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