Page 4 - Asset Valuation

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Monday, May 16, 2016 | Asset Valuation
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Valuing Investments in Companies That Have Gone Dark
analysis, a company’s worth is equal to the current value of the cash that it will gener- ate in the future. dCF is an application of the time-value-of-money concept—the idea that money to be received or paid at some time in the future should be treated as having less value, today, than an equal amount actually received or paid today. Thus, the dCF calcula- tion determines the value appropriate today (the present value) for the future cash flow. dCF analysis uses future cash flow projections and discounts them, most often using the weighted average cost of capital, to arrive at the present value of the company.
An asset-based approach is a business valuation method that focuses on a compa- ny’s net asset value, or the fair-market value of its total assets minus its total liabilities. This approach is used where a business is not a going concern, or where a business is a going concern, but its value is tied directly to the liquidation value of its underlying assets and investments. The asset-based approach also provides a useful reasonableness check when reviewing the value conclusions derived from other valuation methods.
Collecting Data in Emerging Markets
When dealing with companies with prin- ciple operations in China or other emerging markets trading in U.S. markets, finding com- parable companies and comparable trans- actions is a real challenge. good comps are essential, however, to performing an adequate valuation pursuant to the market capitaliza- tion approach.1 It is possible to investigate and discover enough information to flesh out this or other traditional damage methods and so prove the most important part of any plain- tiff’s case—its claimed damage award.
To do this, the investor will need to engage a diligence firm with local operations in the province, city, or county of the operational arm of the enterprise in which it invested. Working with counsel, the diligence firm should be able to identify financial and operational components of the company. Ultimately, the financial and operational data gathered should be compiled into a report, and testimony should be elicited in a hear- ing or trial from someone familiar with the investigation and the facts it uncovered.
gathering reliable financial information from a non-reporting entity is often difficult. however, it is possible. An overseas company that fails to report its financial data to the U.S. markets is probably reporting to the govern- ment in the region in which its operations are ongoing. In China, for instance, corpora- tions that have long since gone dark in the United States will file yearly financial data with the State Administration for Industry & Commerce (the SAIC) as well as tax returns. The same is true for companies with principle operations in Cayman, hong Kong, BvI, Brazil, and many other countries. A well-connected investigator will be able to use local knowl- edge to obtain such financial data. Moreover, a skilled investigator with strong local ties may be able to obtain internal management accounts.
gathering reliable operations data is like- wise possible, if tedious. A strong diligence firm and investigator will work with counsel to identify the relevant governmental agencies in
By DaviD graff
Valuation of investor securities is a nec- essary process for almost all securities litigations commenced by an investor. Whether the investor seeks redress for being squeezed out of a company through insider- led schemes to conceal operations or financial information, or the investor is precluded from engaging in a corporate takeover by an inter- mediary such as a broker dealer, the investor will need to show what it would have been entitled to “but for” the misconduct of his defendants.
Presenting that “but for” in a manner that will convince a judge or jury is always a com- plex task—and all the more so when essential information is not readily available in public sources. This article will explore the proofs that an investor must develop to win a dam- age award accepting the investor’s “but for” calculation—even when obtaining the under- lying information requires unusual diligence.
The standard mechanical damage models that are accepted in various fora—courts, arbitrations, mediations, or the more exotic— have long been understood as discounted cash flow, market capitalization, the compa- rable methods, and the asset-based valuation method. All of these methods rely on valid and reliable inputs. Such inputs include accurate historical and current income statements and balance sheets produced by the company or comparable companies; comparable trans- actions (for the market capitalization tech- nique); and operations reports identifying assets owned by the enterprise as well as comparable assets.
History of the ‘Going Dark’ Phenomenon
These data inputs have been readily avail- able for most public companies because of the SeC requirement and investor expectation that publicly traded companies will regularly file all such information for public consump- tion. In recent years, however—particularly since 2011—certain offshore and onshore enterprises that had raised capital on the U.S. markets stopped reporting their operations and financial reports to the SeC and public investors. Consequently, public investors found themselves in a position similar to that of a passive or minority investor squeezed out of the corporate know. For the first time public investors could no longer value posi- tions purchased in some companies.
Accordingly, such public investors fol- lowed the path of many squeezed-out private
DaviD graff is co-chair of Anderson Kill P.C.’s corpo- rate and commercial litigation group and practices in the firm’s New York office. He can be reached at [email protected].
investors and sought recourse in the courts— and, like their private market predecessors, started such actions with no ability to value what might be awarded if the court ruled in their favor. Without inputs such as current financial data and operations reports, it seems impossible to assess the value of an equity position with certainty.
Many of the public companies that had “gone dark” and not reported to the markets operate and maintain all their assets in the People’s republic of China. This phenomenon commenced in or about 2008 when Chinese companies reverse-merged through a series of wholly owned subsidiaries. often, the main- land China-based entity was wholly owned by a hong Kong subsidiary, which was in turn owned by subsidiary in the British virgin Islands (BvI), which ultimately was owned by a U.S. or Cayman Island parent company. These reverse mergers enabled the Chinese subsidiary to access the U.S. capital markets and raise capital through debt or equity offer- ings. however, many such companies did not recognize the intense scrutiny and require- ments for audit that U.S. public companies are subject to and subsequently delisted.
While some of the companies that went dark doubtless simply decided that continued communications to the U.S. markets were too difficult, others allegedly stopped reporting as part of more nefarious efforts to manipulate the U.S. share price downward in prepara- tion for an insider-led privatization. The plan
in such cases was allegedly to buy back the capital raised in U.S. markets for pennies on the dollar—or, simply to abscond with inves- tor cash. Such apparent schemes provided an interesting testing ground for innovative valuation techniques.
Blanks to Fill in: Standard Valuation Methods
In seeking to value companies that have gone dark, the challenge is to obtain by indi- rect means information that will satisfy tra- ditional valuation methods. The next section reviews the means of obtaining the informa- tion demanded by the following methods.
Comparable company methodology is a relative valuation technique used to value a company by comparing that company’s valuation multiples to those of its peers with similar operations. In particular, a group of comparable companies includes companies from the same industry as the company that is being valued with similar products, cus- tomers, geography, and distribution channel. Typically, the multiples are a ratio of some valuation metric (such as equity market capitalization or enterprise value) to some financial performance metric (such as earn- ings/earnings per share, sales, or eBITdA). The rationale behind this methodology is that companies with similar characteristics should trade at similar multiples, holding all other variables constant.
Under a discounted cash flow (DCF)
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