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 ‘Normally, we get data that’s four weeks out of date from economics sources, but COVID has created the need for higher frequency.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 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.’

The short answer is ‘virtual.’ Nearly every organisation with an interest in business valuation training has moved online. Around the world, this is creating some new relationships and sources.

For instance, the iiBV, which does a lot of in-person certification training around the world, has partnered with the Hong Kong CPAs to provide new online seminars. RICS has partnered with BVR, NACVA in the US, GACVA in Germany, and others to create new offerings.

iiBV are also developing BV206 with TAQEEM, the Saudi business valuation organisation, focused on valuing startups and early-stage companies. The new course should be ‘on the streets’ for access by UK valuers by the end of the summer. It’s under final review at this point.

Similarly, ICAEW are adding regular BV webinars to their lineup of online CPD. Watch BVWire—UK’s ‘Dates for Your Diary’ for fortnightly updated training opportunities.

Investment trust Scottish Mortgage, managed by Baillie Gifford, provided a simple solution in April by cutting the value of private companies in its portfolio to recognise the fact that private-company valuations are not insulated from public markets.

Similarly, on March 31, the International Private Equity and Venture Capital Valuation Guidelines (IPEV) were updated with Special Valuation Guidance from the board in the light of the impact of coronavirus. They wrote:

It may no longer be appropriate for recent transaction prices, especially those from before the expansion of the pandemic, to receive significant, if any, weight in determining fair value.

Greater uncertainty translates into greater risk and increased required rates of return, which generally would indicate that multiples will decrease, even in the absence of recent transaction data.

Investment prices are also being reconsidered. One BVWire—UK reader commented that, ‘in the pre-pandemic private equity market, fair value would typically be determined by competing investors keen to take part in further funding rounds. However, in today’s market, there may be a lack of suitors looking to invest in follow-on funding.… Consequently, there is an urgent need for valuations of private companies to be reconsidered, both at the fund level and on an individual basis.’

In these circumstances, there has never been a more urgent need for an independent business valuation, whether for an investment committee, a family business, or a board of directors. This third-party assessment provides an additional layer of due diligence that counteracts market fragility and the lack of dependable market comparables.

A new research study—‘International Valuation: A Proposed Method Using the Constant Perpetual Growth Model,’ by Thomas J. O’Brien (University of Connecticut—Department of Finance)—attempts to reduce valuation mistakes introduced by cross-border foreign exchange and cash-flow risks. O’Brien’s model for international valuations uses the constant perpetual expected growth model (Gordon growth model). The author argues that this ‘proposed method accounts for a currency risk premium and the economic interaction between cash flows and exchange rates.’

‘The valuation profession has always played an important role in the financial reporting process. However, in a world where investment in intangible assets is becoming more mainstream, and at a time when market uncertainty places a particular emphasis on specialist valuation expertise, this role is becoming even more important,’ says IVSC ED Nick Talbot.

Recognising this, IVSC have posted a new interview with the leaders of the European Financial Reporting Advisory Group (EFRAG) recently. EFRAG is a private not-for-profit association established in 2001, with the backing of the European Commission, to develop and promote European views that inform the standard-setting work of the International Accounting Standards Board (IASB).

IVSC interviewed EFRAG CEO Saskia Slomp, chair of the EFRAG Technical Expert Group Chiara Del Prete, and Senior Technical Manager Rasmus Sommer to find out more about EFRAG’s work and how it interacts with the valuation profession.

You can read the entire interview transcript here.

A new report from Deloitte Middle East and Saudi Authority for Accredited Valuers TAQEEM, ‘The Future of Intangible Assets in the Kingdom of Saudi Arabia,’ presents a comparative analysis with Tadawul, the Saudi Arabian stock index, to establish that ‘the Saudi Arabian economy is at the start of a similar transition’ as those experiences in UK and North American markets. The report also examines recent M&A transactions in the Kingdom to conclude a new ‘focus on intangibles and their increasing contribution towards the value composition of a business.’

The ‘review of select recent regional transactions illustrates how intangible assets are becoming a major value contributor in the region,’ say the report’s authors, Ben Moore partner, Valuation & Modeling Services, and Mohammad Araj, director, Valuation & Modeling Services. Moore has worked with Deloitte-Dubai for a dozen years, since leaving their UK headquarters.

Like the UK markets, the report finds a greater percentage of value in intangibles, whether measured in terms of market capitalisation or as part of premiums paid over net tangible assets. ‘Intangible assets such as brand names, licenses, customer and supplier relationships, know-how and developed software are increasingly becoming key value drivers for businesses in Saudi Arabia,’ the authors conclude.

6 August: International Association of Certified Valuation Specialist Africa Charter (IACVS-Africa), Discounted Cash Flow Versus Capitalization of Earnings, free webinar, 15:00 BST

20-21 August: ICAEW Excel Modelling—Investment Appraisal, Valuation and Business Cases, virtual, 9:15-12:30 BST both days (repeated live 30 October and 4 December)

9-11 September: BVR/AAML Virtual Divorce Conference, virtual event

11-13 October: American Society of Appraisers International Conference, virtual event

14-16 October: IVSC AGM 2020, virtual event with further information to follow

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

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