As the coronavirus pandemic continues its relentless march across the globe, we have reached out to members of the Business Valuation Update Editorial Advisory Board to begin to gather their thoughts on the impact of the crisis on valuations. We will assemble the full comments of the board into a free document and make that available soon. In the meantime, here are a few observations and pieces of advice we have received so far from experts the world over.
From the U.S.: Gary Trugman, Trugman Valuation (Plantation, Fla.): “Developing cost of capital in troubled times should be nothing new. We saw this in 2008 after the financial crisis and it should be dealt with in a similar fashion. What is critical to remember is that we value businesses based on what is known or knowable at the valuation date and we must consider what the investing public is thinking at the date of the valuation. While many tried to deal with risk-free rates and the ‘flight to safety’ back in 2008, that almost became the new normal. Thought must be given to the fact that the risks associated with the cash flow of the particular business that you are valuing is what the discount rate must be based on. If all you do is a mechanical computation to build up a discount rate, you are most likely going to be wrong. You need to use common sense and think about how the risk of receiving the cash flows is impacted at the date of the valuation.”
Ron Seigneur, managing partner, Seigneur Gustafson LLP (Lakewood, Colo.): “My sense in all of this is the ‘risk-free’ rate is not really risk free and we will see more emphasis on how to get our arms around the unsystematic risk associated with investments as this is where I think the extra risk we now have ahead of us should be captured. All that said, ask me again tomorrow and next week on all of this as it sure seems like we are in that sort of environment just now.”
Gilbert E. Matthews, chairman of the board and a senior managing director of Sutter Securities Inc. (San Francisco): “Since volatility is a factor in discounts for lack of marketability (DLOM), the extreme volatility of the market in recent weeks will materially increase DLOMs. In addition, I would argue that DLOMs should be adjusted upward because:
- “The abnormal conditions in the market will necessarily cause buyers to be reluctant to invest in illiquid securities; and
- “The restrictions being put in place to limit the spread of COVID-19 are limiting the ability of prospective buyers of restricted securities from conducting due diligence and even to meet with financial and legal advisors.
“There is no data to quantify these factors, but they should be considered, and valuators should use their professional judgment.”
Harold Martin, partner-in-charge of valuation and forensic services for Keiter (Richmond, Va.): In terms of what was known or knowable, “the issue actually goes back to late February and early March when the virus started to spread, and the stock market began to reflect the expected economic impact. For purposes of assessing the impact on a valuation completed on or after those dates, an appraiser would essentially do what they always should do for any valuation:
- “Perform an analysis of the current and expected economic and industry conditions based on what was known or knowable as of the effective valuation date;
- “Assess the impact of these factors, as well as the financial and operational characteristics of the subject company, on the subject company’s expected growth rate; and
- “Assess the risk resulting from these factors on the company’s ability to achieve projected future cash flows and reflect this in the company-specific risk component of the discount rate.
“Further, to the extent that there is a lapse of time between the valuation date and the report date, the appraiser should consider reporting material developments as a subsequent event.”
From the UK: Andrew Strickland, former corporate partner at Scrutton Bland Chartered Accountants (UK), now a consultant to the firm: “In the UK, the short-term risk-free rate was reduced from 0.75% to 0.1% in short order. The impact on the cost of equity must be far more than that movement of 0.65%, and in the opposite direction from that indicated by CAPM. Times like these lead us to challenge the very fundamentals of our training. But challenge and enquiry are always positive attributes, making us into better valuers.”
From Australia: John-Henry Eversgerd, senior managing director of the valuation and litigation consulting practice in the Sydney office of FTI Consulting: “I’m expecting some significant asset impairments in a number of industries, particularly in Australia, since we have some every strict ‘continuous disclosure’ rules. Those rules require public company boards to announce almost immediately any impairments or other factors that would impact the share price significantly. It is a very low bar, which means boards have little choice but to impair.”
From Hong Kong: Edwina Tam, partner at Deloitte in Hong Kong: “For the development of cost of capital, given the market uncertainty, one needs to critically consider the impact of the current market uncertainties (COVID-19, U.S.-China trade war, etc.) on the business operations in developing the forecast. In determining the nature and extent of the impact on the business and valuation assumptions, the following potential issues may need to be considered:
- “Store or facility closures;
- “Loss of customers or customer traffic;
- “The impact on distributors;
- “Supply chain interruptions;
- “Production delays or limitations;
- “The impact on human capital;
- “Regulatory changes; and
- “The risk of loss on significant contracts.
“Implicitly, these uncertainties need to be reflected in the cash flows; however, a risk-appropriate discount rate also needs to be considered. There is no set approach to account for market uncertainties as the impact will be different for different businesses in different regions.”
We will bring you more thoughts and advice in future issues of BVWire and Business Valuation Update. For now, we leave you with these words from Andrew Strickland: “We are in a privileged position. We are members of a profession which has developed the techniques to value that which cannot readily be valued: fractional holdings in private companies are assets for which there is no ready market, yet we are prepared to ascribe values to them using our professional judgement and training within a discipline developed over many years. We all see further by standing on the shoulders of giants. We therefore have the skills to value businesses when the lubrication in the market runs dry.”
Extra: BVR will present a free webinar on April 7 with a panel of thought leaders to discuss how valuation experts should respond to today’s volatility and risk—and to answer your questions.