To keep DCF analyses trustworthy, are multiple scenarios now required? What growth rates are supportable? How do business valuers help clients sort out the uncertainty? Tune in Thursday at 18:00 to hear what adjustments Gary Trugman and Harold Martin are making for their reports with current valuation dates. Discounted Cash Flow: Speculative or Convincing will cover the major challenges to forecasts of turnover and operating expenses. The special session also includes a case study so analysts can work through the impact of their forecasting decisions on subsequent discount rates.

Most valuers sense that small and medium-sized enterprises are less marketable, and less valuable, than they were at the beginning of the year. Multiple new studies appeared since the last issue of BVWire—UK to help quantify current M&A conditions.

• The May 2020 issue of the FactSet Mergerstat Monthly Review shows a dramatic 36.4% decline in M&A activity in the U.S. market, with similar declines suggested in the UK. Industry sectors that have seen the biggest declines include tech services, manufacturing, and finance.

• The quarterly Argos Index, prepared by Epsilon Research, measures midmarket valuations in the eurozone. The latest study finds a 10% decrease compared to CYE2019, but Epsilon CEO Grégoire Buisson cautions users of the study to recognise that the index is prepared on a six-month rolling basis, so the impact of COVID-19 only began to be felt mid-March. Until then, eurozone midmarket deal volume was actually up 15%, driven largely by deals in Germany. The new Argos Index includes two interviews on values and the market, from Professor Reiner Braun (Technical University of Munich) and Éric de Montgolfier, CEO of Invest Europe. They note that private companies retained value better than small listed stocks, since the EURO STOXX TMI Small Indexfell 26.1% between 1 January 2020 and 31 March 2020 (though, of course, like all the major indices, it’s enjoyed a record April and May). The Argos Index is calculated based on the information contained in the Epsilon Multiple Analysis Tool.

• Meanwhile, the DealStats Value Index confirms that small-company values outperformed the public markets in the first quarter. DVI reflects values for smaller transactions and generally reports lower multiples since most of the transactions reflected in the index do not involve financial buyers. DVI found an increased EBITDA multiple of 4.8x, up from 4.0x in the preceding quarter, and the trailing average leveled out after nine months of decline, as shown in the table.

• Other leading sources of private equity and small-company M&A, such as PERDa and M&A Monitor, have not released studies reflecting the impact of COVID-19 as yet.

Choosing listed company comparables as a proxy for a small-business valuation has always required a leap of faith. Even before COVID-19, placing a value on a group of cell phone repair shoppes by comparing their operating ratios with BT required courage. Now, tens of millions of professional workers have lost their jobs (the US will likely record over 20% unemployment this month), millions of small businesses worldwide are shuttered and may not reopen—and the US stock markets, FTSE, and EURO STOXX are having close to their best quarters on record.

Louise Cooper, writing for The Spectator, asks a simple investment question that has broad implications for those valuing family businesses: ‘How can US shares be doing so well when the evidence of economic devastation is overwhelming?’

‘Most would assume the pandemic would highlight the benefits of the European welfare state and its ability to support households and businesses during difficult times. But that’s not what the stock market is telling us,’ she writes.

True, the S&P, FTSE 100, and EURO STOXX are down YTD, but Cooper finds much of the answer in the US Nasdaq, which is flat for 2020 because Amazon, Microsoft, Apple, Google, and Facebook have capitalised on the lockdown. ‘Thus the share prices of these tech giants have done well. Just these five firms are now worth more than $5 trillion. They represent 21 per cent of the market valuation of the S&P 500.’

If the FTSE 100 is down over 20% YTD as of June, and the five tech giants are stable, business valuers’ choice of comparables will make all the difference in any conclusion of value. Industry selects are more critical than ever, and the ratios derived or adjusted from a small group of comps can skew results beyond recognition.

Cooper, again, is quite eloquent on what’s happening to the value of the UK’s 6 million small businesses and their employees:

Many of these firms will suffer greatly during the pandemic but they are family owned, not listed on stock exchanges. Their pain and suffering and that of their employees is hidden from the FTSE indices.

The loss of value will also be hidden from any business valuation report that overrelies on poorly chosen listed company comparables.

BVWire—UK has been following the evolution of the property appraisal market as it switched to data-only valuations in response to COVID-19 (and mortgage lenders either stopped issuing new loans, or significantly reduced their maximum loan-to-value cap, effectively keeping most new buyers out of the market).

With last week’s news that physical inspections will again be allowed, all of the major lenders increased their LTV caps—for example, Platform and Hampshire Trust Bank went to 75%, while Coventry and Accord both returned to 85%.

Many lenders also changed their fixed rates—either up or down—but most of the changes are less than 10 basis points.

Most appraisers are reporting that sellers often won’t admit surveyors, so it appears a hybrid model may result for the near future—lenders will approve loans with a physical inspection if available, or without, if access is not possible.

As the COVID-19 crisis continues, it appears performance standards for real property valuation under RICS may be changed permanently.

The two big financial data providers, Refinitiv and SPGI, released improvements to their methodologies to score listed company performance across social value themes including emissions, environmental product innovation, diversity and inclusion, human rights, and shareholder access.

Few business valuers include social value and sustainability factors in their valuation reports, though most analysts realise either the cash flow or intangible brand impact of companies that align with good corporate values. More investors and financial analysts recognise that environmental and cultural behaviours do drive tangible results and intangible value. The Refinitiv and SPGI upgrades provide an easy way to measure this performance for guideline comparable companies for valuers who have access to either of these expensive platforms.

Refinitiv’s upgrade adds materiality features to their ESG scoring metrics to reduce industry size and transparency biases. S&P Global launched their Global ESG Scores with 20-year coverage of 7,300 companies. They base their scores on the widely recognized SAM Corporate Sustainability Assessment evaluations. These Global ESG Scores are available through SPGI’s XPressfeed.

Financial analysts often start DCF valuations with ‘operating profit’ as stated on the enterprise’s income statement and then adjust prior to deriving enterprise values. Many valuations have run into audit (and legal) problems because operating profit is not defined in IFRS, so many experts have failed to reconcile differences. These difficulties in comparing results finally led the IASB to issue IASB Exposure Draft: General Presentation and Disclosures on the presentation of operating profit last December. UK business valuers can now review (and submit comments on) this new statement. As usual, one of the best places to turn for thoughtful examination of the valuation issues these proposals created is ‘The Footnotes Analyst,’ written by Steve Cooper and Dennis Jullens, both of whom spent significant time at the IASB. Both support the Exposure Draft in principle, since previously so little guidance on income statement subtotals has been available, and NOPAT or EBITDA calculations may in fact start from different places, given the preferences of the valued entity. They hope the new presentation will provide ‘consistency and comparability at last,’ since:

[I]f enacted … companies would be required to present pre-tax income and expenses in three main categories: operating, investing and financing. The operating category is further split into operating profit and income from integral associates and joint ventures.… We strongly support the introduction of a mandatory subtotal ‘operating profit.’ This should improve comparability for investors and better facilitate equity valuation.

The following sample version of the new income statement presentation is included in the IASB’s Exposure Draft.

Source: IASB Exposure Draft: General Presentation and Disclosures, December 2019

IVSC Annual General Meeting, 14-16 October, Chicago

EACVA 14th Annual Business Valuation Conference, 29-30 October, Munich

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David Foster at ukeditor@bvresources.com.