The three approaches that could be used to determine the estimated price of VAS are the Income Approach, Market Approach and Cost-based Approach. Although many pricing methods are used in practice, all such methods may be classified as variations of one of the three approaches.
The approach estimates pricing based upon market prices in actual transactions adjusted for differences as between the pricing subject and comparable properties. Such measures are appropriate in liquid markets, with homogeneous assets and where substantial information is available.
The approach bases pricing on the estimated future cash flows which the assets generate over their remaining useful life. It is more appropriate in illiquid markets, where the assets are heterogeneous and there is little information on completed transactions.
The general principle behind the Cost-based Approach is that the pricing of an enterprise is equivalent to the pricing of its individual assets net of its liabilities. It must be recognized that while this basis may form an acceptable basis to be used in share pricing in circumstances which for various reasons preclude the use of other bases, the pricing so may not necessarily reflect the eventual worth of the shares to a prospective buyer or seller. For example, it may not properly reflect the earnings potential of the company.
Market Approach -GPCM and GTM:
When applied to pricing an interest in a business, the market approach includes consideration of the financial condition and the historical and expected operating performance of the company being priced relative to those of publicly traded companies or to those of companies acquired in a single transaction that:
(1) operate in the same or similar lines of business
(2) are potentially subject to corresponding economic, environmental, and political factors; and
(3) could reasonably be considered investment alternatives.
These two methods are further described as follows:
In the application of the market approach, we have used the GPCM and GTM.
This method employs market multiples derived from market prices of stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market. The application of the selected multiples to the corresponding measure of financial performance for the subject company produces estimates of pricing at the marketable-minority level.
Also referred to as the "transaction method" or "merger and acquisition method", this method relies on pricing multiples derived from transactions of significant interests in companies engaged in the same or similar lines of business. The application of the selected multiples to the corresponding measure of financial performance for the subject company produces estimates of pricing at the marketable control level.
Pricing multiples applied:
In developing our analysis, we computed pricing multiples based on the relationships between:
GPCM: the market pricings of the Guideline Public Companies as of the Estimation Date and various measures of their financial performance. For each Comparable Company, we analyzed pricing multiples as at the Estimation Date based on publicly available data from Capital IQ as well as from our internal analysis.
GTM: transacted values of the Guideline Transactions and various measures of their respective target's financial performance. For each Comparable Transaction, we extracted pricing multiples from Merger market.
Given the business and nature of the VAS and the information collected for the Guideline Public Companies and Guideline Transactions, we considered the following pricing multiples to be most applicable for our analysis:
-Enterprise Value / EBITDA
-Market Value of Equity / Net Income
Enterprise value is minority-based value and Market value is controlled-based value.
DCF method in estimating the pricing of a business or business interest, the most common measure of economic benefit is net cash flow, also referred to as "free cash flow".
Net cash flow can be the free cash flow to equity holders or to all long-term stakeholders of the company. The free cash flow to equity holders ("FCFE”) represents an income measure reduced for required payments to debt holders (i.e., interest and principal) and increased for any additions to debt principal. The free cash flow to all long-term stakeholders, or free cash flow to the firm (“FCFF"), represents an income measure before payments to any capital holders, whether debt or equity. FCFF does not reflect interest expense on debt or changes in debt principal, and income taxes are calculated on earnings before interest charges. For the purposes of this pricing we have opted to use FCFF.
The income stream that is used in valuing an interest in a business will determine whether the method yields an estimate of a minority level or control level of pricing. If the income stream reflects income available to a minority shareholder, then a minority price estimate would result. If the income stream reflects the economic benefits of control, then a control level price estimate would result.
The DCF method relies upon different rates at which to discount the income stream. The discount rate is a rate of return used to convert a future monetary sum into present value. The discount rate is also referred to as the "required rate of return" or "cost of capital."
The discount rate represents the estimated cost of the capital generating the income stream. FCFE is typically discounted using an equity discount rate, which can be quantified using the build-up method, the Capital Asset Pricing Model ("CAPM"), or other methods. FCFF is typically discounted using the weighted average cost of capital ("WACC").
The CAPM is a model in which the cost of capital for any stock or portfolio of stocks equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the stock or portfolio.
The WACC is the cost of capital (discount rate) determined by the weighted average, at market value, of the cost of all financing sources in the business enterprise's capital structure.
When using an income approach to price an interest in a business, it is essential not only to clearly define the income stream representing the anticipated economic benefits, but also to use the discount or capitalization rate appropriate for that defined stream.
WACC represents investor's expected return to fund the assets of an enterprise. WACC is computed by summing the cost of each capital component multiplied by its proportional weight.
Generally an enterprise is funded by debt and equity. Hence, we can calculate WACC using following formula:
WACC = (E / C)* Cost of equity + (D / C)*(1- tax rate) * Cost of debt
C= Debt +Equity E= Equity D = Debt
Cost of equity
・ The required rate of return on equity capital is determined using the CAPM.
CAPM computes the required rate of return on equity as a function of the rate of return on a risk-free investment, plus an equity risk premium (the return stockholders expect above the return on a risk-free investment), multiplied by the "beta" for the investment.
Beta measures the relationship between the price movements of ownership participants for individual companies to price movement of a fully diversified stock portfolio.
The model is stated algebraically as follows:
Cost of Equity = Rf + UB * (E(Rm)-Rf) + SizePremium + Company Specific Risk
Risk associated with the asset (non-diversifiable or systematic risk) is measured by Beta coefficient. It can also be defined as the sensitivity of the asset returns to market returns. It is estimated by regressing the asset's excess return against the market portfolio's excess return. The slope of the regression equation is beta. As a proxy we have considered the median unlevered beta of listed peer group.
A beta greater than 1.0 indicates that the security is more volatile and riskier than the broad market. For example, a beta of 1.1 indicates a 1.1% movement in the security for a 1.0% movement in the index, regardless of the direction. We used the adjusted beta which is an estimate of a security's future beta. It assumes a security's beta moves towards the market average over time. Peer beta for the historical period of two year-period from the Estimation Date is extracted from Capital IQ. Such beta is then adjusted to reflect the difference in effective tax rate and capital structure of the peer company. The resultant beta is called "unlevered beta".
Such unlevered beta is again adjusted for the capital structure and applicable tax rate. The following formula is used to adjust for the difference in the capital structure and tax rate.
Levered Beta = Unlevered Beta * (1+(1- Tax Rate) * Debt Equity Ratio