CIGA Restructuring Plan: A valuer’s perspective 10 plans in
CIGA Restructuring Plan
Valuation approach
Market approach
Disclosure
The valuation of a company or asset is generally undertaken using a combination of three approaches – the income, market and cost approaches. No approach is by definition superior to another and a key part of a valuer’s role is selecting what combination of approaches is best suited to a given company in a given situation. Incorporating all approaches in some form is generally considered valuation best practice. The valuation should be of the company ‘as is’ reflecting the circumstances facing the company, as opposed to a valuation of the company following a successful restructuring. The nature of the relevant alternative will influence the choice of methodologies adopted and key benefits and limitations of each need to be considered.
Before making a decision to sanction a Plan – particularly one excluding or compromising certain creditors via a cram down - the court will want to be comfortable that all parties have had ample opportunity to interrogate and challenge the evidence and recent cases demonstrate that broad and early disclosure of the valuation analysis is valued by the court. In Smile Telecoms, the valuation and comparator analysis were provided to all parties to the Plan (and other stakeholders), subject to confidentiality agreements. The court took a great deal of comfort that the evidence had been shared early such that affected parties had sufficient time to consider their position. Similarly, in ED&F Man the relevant alternative and Plan outcome reports were disclosed in full to all creditor classes with the open approach being commended and the judge referncing an “informative report which provides clear evidence as to the financial consequences for the dissenting class in the event of the relevant alternative scenario.” It is also apparent that fullness of disclosure is valued, particularly in large or complex cases where a stand-alone narrative report supported by detailed schedules and outcome statements may be necessary for stakeholders and the court to make well informed decisions, as was noted in the ED&F Man case. A more summarised form of disclosure may be sufficient when it comes to SMEs accessing the Restructuring Plan, with courts showing a pragmatic approach in the Houst case, recognising the cost implications to smaller companies and striking a balance accordingly. In time a streamlined version of the Restructuring Plan may take shape for smaller companies, potentially reducing the process to one court hearing and driving further focus on the valuation exercise in order to minimise appeal processes.
The market approach relies upon establishing a maintainable level of earnings (typically EBITDA) and applying a market-benchmarked multiple (typically Enterprise Value / EBITDA) that reflects the market’s current pricing of companies vs their maintainable earnings. The approach’s principal benefit is the direct reference to live (or recent) indicators of market pricing, which is a vital consideration in any valuation if such pricing information is deemed to be reliable and sufficiently comparable. Challenges include determining a maintainable level of earnings before interest, taxes, and amortization (EBITDA) for a company going through a period of distress, and suitably adjusting multiples observed from comparable transactions or listed companies that are likely facing a different set of challenges, opportunities, growth prospects and risks. The market approach faces additional complexities during recovery from a global economic shock, such as the Covid-19 pandemic as valuation multiples remain skewed by the widely varying impact of the crisis on different companies (even within the same sector). Particular care must be taken in selecting comparable companies and adjusting multiples, whilst further modifications may be required to reflect cash-flow differences driven by factors such lower cash-conversion, working capital shortfall and capital expenditure catch-up.
Income approach
The income approach (most commonly applied as the discounted cash-flow methodology) has the benefit of being able to directly incorporate company and situation-specific factors into the projected cash-flows from which value estimates are derived. These include factors that financially distressed companies may face such as the risk of losing customers (who may seek alternative suppliers without going concern risk), working capital squeeze, tightening of capital investment plans and the risk of losing key personnel. Industry-wide factors such as changing demand, supply chain challenges and inflation in energy, commodities and wages can also be explicitly incorporated as deemed appropriate. A further plus-point of the income approach is its flexibility – being able to incorporate a variety of scenarios and sensitivities to demonstrate the impact on value of changes to selected inputs and assumptions. It can be well suited to assessing value under a range of possibilities, adding depth to the justification of the relevant alternative and why other possibilities were rejected or deemed less likely to unfold. Challenges with the income approach relate to the uncertain nature of cash-flow forecasting and appropriately assessing investor perceptions of risk. The relevant factors can be incorporated via direct adjustments to forecast cash-flows, risk-premia included in the discount rate, or an overall adjustment reflecting the impact of financial distress supported by statistical studies.
Cost approach
The cost approach is based on the assets that a business owns, and the value that would be received from their sale (or alternatively, the cost that would be incurred to replace them like-for-like). This approach is typically seen as a ‘value floor’ for unstressed businesses where going concern value may be greater than the aggregate value of on-balance sheet assets due to the contribution of intangible assets and goodwill to the earning power of the business. However, companies in operational or financial distress may find the value of their intangible assets and goodwill to be largely or entirely impaired, with value being upheld by the underlying assets that could be disposed of (collectively, individually or in groups) for a greater return than would be achieved in a going concern sale. The extent of reliance on the cost approach may be influenced by the definition of the relevant alternative – it may be of primary importance in a liquidation or solvent wind-down, whilst serving as a secondary measure or sense-check in an assumed sale of the business as a whole or in sub-divisions.
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