Quarterly economic indicators are barely sufficient for business valuers now. ‘Normally, we get data that’s four weeks out of date from economics sources, but COVID has created the need for higher frequency. If you can capture weekly data you’re more likely to see current changes,’ says Simon Rubinsohn, chief economist of RICS.

He points to the Jeffries Activity Index as an example, which currently shows that global economies have flatlined for the last few months in the US and the UK. So, instead, RICS are looking at new inputs, such as restaurant traffic and public transport ridership, both of which show numbers at about 38% of normal.

Rubinsohn was speaking at the Impact of COVID-19 on Global Business Valuation and Appraisal webinar July 22, co-sponsored by RICS, and also NACVA, the ASA, GACVA, and CBVI. Panelists included William (Bill) A. Johnston (managing director, Empire Valuation Consultants Group); the Chartered Business Valuation Institute’s Stephen Cole; Wolfgang Kniest from the Global Association of Certified Valuators and Analysts; and NACVA’s Lari B. Masten (Masten Valuation). RICS representatives included Leigh Miller, EY global valuation, modeling and economics leader, along with and Rubinsohn.

Since RICS primarily represents the interests of real property appraisers, it’s no surprise that Rubinsohn tends to start his economics analyses by looking at real estate trends, but he finds many worthwhile proxies for business value in these indicators. For instance, end-of-July indicators of office tenancy, unsurprisingly, ‘which are currently a good lead indicator included in monthly purchasing managers’ reports,’ show ‘not much expectation of a recovery.’

These same indicators suggest that recovery will be ultimately at a lower level. For instance, current forecasts suggest that office tenancy has undergone a structural (rather than cyclical) change and will only come back to 85% or so of previous maximums globally.

How long will this be going on? A poll during Rubinsohn’s webinar comments showed that 67% of the attendees believe the economy will have recovered within three years. However, 17% think we won’t return to previous levels until five years—or never.

Central bankers are saying, ‘We expect interest rates to stay near zero for the next two years,’ Rubinsohn said. ‘So we know that these leading regulators and economists expect this situation to persist for an extensive period.’

This is despite the promises of fiscal support, which ‘are really big numbers in the range of 10% of GDP in the UK, EU, and US.’

‘The economy will still be smaller at the end of 2021 than it was at the start of 2020,’ Rubinsohn concludes.

Does this pessimism impact fair market value? Stephen Cole says yes, with caveats. ‘The public markets will be volatile, and likely more “irrational” than private assets. You need to be very specific about the industry and the company before selecting equity risk premia.’ Cole agrees that ‘probability adjusted cashflow models are now even more important because the equity risk premiums are not capturing all the risk.’

How does this change business valuation practice compared to 2019? Bill Johnston noted several items:

• ‘Compared to the great recession, the bounceback in the markets has been much more rapid. We’re now at the point where there are a fair number of public companies that have recouped most of their value, so each industry is radically different from the next.’
• What you assume about a long-term RfR and ERP is influenced by the willingness to accept negative interest rates, and then potentially impacts on equity risk.

Wolfgang Kniest agrees that business valuers need to spend even more time deriving the future value of expected cash flows. He’s concerned about the cash conversion characteristics of working capital during a period when sales are shrinking. Even if the sales recover in the next months or years, ‘all businesses will have a huge cash need,’ Kniest says. Not all businesses will have the cash available to recover even if growth returns.

Kniest says, ‘I don’t have a solution to this upcoming cash crisis but I’m very worried.’

Because public-market and private-transaction data now could lead to unsound benchmarks, the panel seemed in agreement that it would be hard to do a valuation now where DCF was weighted less than 50% (perhaps even for HMRC or other users that have traditionally refused to acknowledge income approaches).

If you do start relying on DCF in your valuations, Kniest advises that the scenarios need to be ‘left-skewed’ toward the pessimistic, given all the variables, up to and including insolvency, if that seems plausible. ‘You have to develop these probabilities jointly with the client,’ he said.

Kniest believes that Monte Carlo tools can assist business valuation experts because they show the entire range of outcomes ‘over 10,000 scenarios.’ So he’s using this tool increasingly with care, and mostly to help educate users. ‘It’s just not “put in your assumptions and push the button,”’ he joked.

Taking the long view of the business valuation profession: Leigh Miller reminds business valuation experts that ‘the question of whether our valuation methodologies are broken comes up about every 10 years. Market multiples or earnings or revenue are always just a proxy for what might happen in the future, or for legit cashflow forecasts. If we have sellers who are prepared to offer robust forecasts (with a real premium for liquidity so they can survive), then we can support high values, rather than a proxy from the markets that tries to make that assumption for us.’

Similarly to disrupted periods in the past, Miller, the ex-auditor, says, ‘Users will be looking for more robust forecasts and better support for assumptions about risk.’