PRIVATE EQUITY: INDIAS GROWTH CATALYST BY J. MAITRA & ASSOCIATES

TOPICS COVERED VALUATION CONCEPTS APPROACHES TO COMPANY & BUSINESS VALUATION PRIVATE EQUITY IN INDIA

VALUATION CONCEPTS

Valuations provide useful baseline to establish a value for a business as on today or a forecasted period It serves as an alternate - to the role that major stock exchanges play for public companies - for small/unlisted companies Assists in arriving at exit strategies for the Existing Owner & Prospective Financial/Strategic Investor to obtain value for their stake in the companies when they desire to sell ABOUT VALUATIONS

THE ESSENCE OF VALUATION Early Stage Investin g Simpler Valuation Process Derived from Capital the Company needs & % stake expected by VCs Valuation of Large Public- Listed Companie s Actual Stock Price on Exchanges - function of supply-demand and investor preferences Analysts Estimates They typically fall within a reasonable band Companies are often privately-held Project rapid growth Future performance subject to high degree of variability In India, most investment opportunities are in companies that lie between these two extremes

VALUATION UNCOVERS WORTH OF MANAGEMENT Is Derived Valuation > Expected Value ? Might be an Opportune time to sell Opportunity for Business Owner to work towards increasing Value of the Company YES NO THE UNDERLYING PRINCIPLE

APPROACHES TO COMPANY & BUSINESS VALUATION

INCOME BASED APPROACH Discounted Cash Flows Dividend Discount Model ASSET BASED APPROACH Net Asset Valuation MARKET APPROACH Relative Valuation using Multiples APPROACHES TO VALUATION

INCOME BASED APPROACH INPUTS Free Cash Flows – Forecasted Period Cost of Capital – Cost of Equity &/or Cost of Debt APPLICATIONS Generally used for firms likely to grow fast for few years & then stable growth Free Cash Flows to Firm discounted at Weighted Average Cost of Capital i.e.WACC ISSUES Easily Manipulated Not Directly Linked to Market Forecast Revenues & Costs – a Challenge Not Ideal Method for valuing Firms with trouble, under-utilized assets * Ke is calculated using Capital Asset Pricing Model (CAPM) adjusted for Small Company Premium & Specific Company Risk Premium if any Free Cash Flows to Equity discounted at Cost of Equity i.e. Ke* DISCOUNTED CASH FLOWS

INCOME BASED APPROACH Contd…. INPUTS Current Dividend Payout Growth in Dividends – High Growth, Tapering Phase & Stable Growth Duration of the Phase Cost of Equity APPLICATIONS Companies that pays out dividend without fail Companies where business model does not envisage growth but make reasonable cash DIVIDEND DISCOUNT MODEL ISSUES Applicable to limited number of companies Undervalues Companies that pays no or less dividends Investors, besides dividend also look for capital appreciation For Academic Purposes Only

ASSET BASED APPROACH INPUTS Current Value of Assets including Real Estate Current Value of External Liabilities Normalized Profit forecast for remaining period of Current FY Adjustments w.r.t non-realizable/redundant assets/liabilities APPLICATIONS For Strategic Investments For holding Companies Applicable for companies with significant tangible assets & Start Ups Generally, a Forward Valuation for current FY is carried out NET ASSET VALUATION ISSUES Limited Applicability for Operating Entities Not used when investments are financial in nature

RELATIVE VALUATION INPUTS Identification of similar Transactions or Listed Companies; the former is preferred Deriving Various Multiples – P/E, P/BV, EV/EBITDA, EV/Sales Adjustments to Multiples – Illiquidity Discount, Size Premium, Execution Risk, Control Premium if applicable Applying the resultant multiple to get Enterprise Value/ Equity Value of the company APPLICATIONS The most widely practiced approach as based on actual transactions RELATIVE VALUATION ISSUES Difficulty in finding similar Listed Companies/ PE/ M&A transactions

Final Valuation is a Derivative of Mathematical Weights applied to various approaches & Professional Judgment Both methods involve subjectivity Final Valuation should prove the test of Common Sense & Reasonableness Last but not the least, parties concerned Negotiate hard on arriving at a Value of the Company but the call is largely a gut feel valuation by the investor REACHING A CONCLUSION ON VALUATION

EXIT OPTIONS IPOs Mergers & Acquisitions Management Buy-out Sale to Another Fund Buyback by Promoter/ Company Stock Market EXIT OPTIONS AVAILABLE TO PRIVATE EQUITY FUNDS Duration of Private Equity/ Venture Capital Investment normally ranges from 3-7 years In case of Buyback by Promoter/Company, the value at which PE Fund would exit is IRR or market-based and is pre decided at the time of investment on a certain valuation

PRIVATE EQUITY IN INDIA

Very rapid expansion in number of India-focused funds –Risen from 8 in 1995, to 300+ in 2010 …Investor DilemmaCurrent PE Market… Large number of first time funds –~15 India-dedicated private equity funds with at least one fund vintage Evaluating managers without track records Selecting funds from a broad universe Gaining access to the best funds

VALUATION IS TEMPORARY BUT CONTROL IS FOREVER