‘Indian firms are valued at a discount’

Varun Gupta calls American Appraisal as the world’s only glocal valuation firm. American Appraisal touts itself as a firm owned by 900 employees with operations across the globe. Gupta, with 13 years of experience in valuation & financial advisory, is at the helm of American Appraisal’s Indian practice, set up in June this year. Gupta says his firm is focussed on valuations, which contributes over 95% of revenues. “Being a specialist gives us tremendous focus and an edge over big four accounting firms,” he says.

Gupta believes that sooner than later Indian companies will have to adapt to International Financial Reporting Standards (IFRS), and align with the accounting standards of the rest of the world. Prior to American Appraisal India, Varun was head of the valuation service line in Deloitte Financial Advisory Services India, where he led a team of 70 professionals. He spoke to DNA Money’s Ashish K Tiwari and Satish John. Excerpts:

What prompted this late entry into India?
There are various reasons that make us think why valuation services are going to be extremely important in India. The most obvious one being the fact that Indian companies are going global in their outlook whether they are accessing capital or making acquisitions abroad. Secondly, international accounting standards are more fair value-oriented. So you don’t state your balance sheet based on historical cost but based on what is the true and fair value of your assets.

And as companies start doing this more and more, when they access capital in the international markets they will have to restate their balance sheets on international accounting standards thus requiring a fair valuation to be done. We entered the Indian market three months ago and have already started getting good number of enquiries and have won a few engagements too.

What is the trigger for firms like yours to set up operations in India? The big four accounting firms already provide these services…
The implementation of IFRS is expected to happen in India by 2011. This will create tremendous opportunity for such fair valuation work. It is an area most corporate houses need to start addressing very proactively. It requires a lot of efforts as one has to be a mind reader sometimes to carry out a fair valuation.

For example, let’s say company A wants to acquire company B. And because the company A sees certain synergies in the acquisition they are willing to pay a certain price for company B. Now those synergies may not necessarily be documented in any place and are usually known only to the management of the acquiring company. And when we do the purchase price allocation post the acquisition, we analyse and try to divide it into various components. The purpose is to understand what the management thinks they would get out of it and thus ascribe a value to it.

All of that requires much greater level of scrutiny leading to detailed, in-depth documentation of information. That is something companies will have to start thinking about from now rather than waiting for IFRS to get implemented in 2011.

So most of these valuations are a result of various mergers and acquisitions taking place from time to time.
The valuation work certainly revolves in and around the transaction. Usually valuation is carried out prior to a transaction whereby the company wants to know what the right acquisition price to be paid is. That is something that makes intuitive sense. But now with the IFRS implementation, or Indian companies accessing capital abroad, one needs to carry out a valuation post the transaction as well. The purpose of this valuation is not to find out if the company paid the right price for the acquisition being made but to put together a break-up plan in terms of ascribing a value to say land and building, plant and machinery, patented technology, customer relationship and the brand.

How is the valuation process different  pre- and post-acquisition?
The difference is that when you are doing the pre-valuation work the approach is to look at the company as a whole. At that point in time, the focus is more on arriving at a right price for the company. Also to be taken into account is the fact that there would be three other bidders for the same acquisition. So the price arrived at should be able to outdo the counter bids. Also, the promoters will have to ascertain on an overall basis how much value will the company get them. Say if the company is worth $150 million so the acquirer will be willing to pay $100 or $120 million for the same.

And after the acquisition is being done at say $120 million, we have to divide into various components. Earlier the acquiring company may have thought about the various synergies and the brand they will get by acquiring the company. However, how much are they paying for the various components and the brand is something they weren’t really concerned about as the transaction was being looked at in a more holistic manner.
In the subsequent valuation process, since the promoter have more time and it’s mainly for reporting purposes one starts stripping down various layers and try to come out with a value for each layer.

Normally there is a lot of secrecy involved in the valuation process and since companies already have their CAs and or auditors for this purpose, what is the USP that you bring to the table? Why should any company hire your services?
A very large amount of the work that we do is actually post transaction. The confidentiality aspect is not as crucial at this stage as relevant announcements are already being made to the public and governing authorities at large. However, there is something the Indian market still has to witness like companies operating in the international markets. Despite the confidentiality issues, in the international markets, companies are getting people like us involved even before the deal has happened in order to ascertain whether the deal will be value-accretive or value-decretive.

This is because in the international markets, the company’s stock is worth whatever has been reported in the latest quarter. Let’s take the earlier example of $100 million acquisition. In the post-acquisition valuation $10 million each is allocated to plant and machinery and real estate respectively. The balance is allocated to an asset called in-process research and development.

What used to happen before is that the entire $80 million would get allocated to goodwill and it would never be amortised. However, under accounting laws the acquirer is required to expense the in-process research and development cost at once. And since amortising of that asset will have to be done immediately, it will have a significant impact on the company’s profit and loss account (P&L). Hence, in spite of reporting an excellent acquisition that will eventually give the company good amount of cash flows, the P&L statement gets affected considerably as a result of this amortisation. The market perceives this as a loss-making quarter thereby affecting the stock price.

How do you come into the picture and what is your firm’s role during such events?
When companies like us get involved in the deal process from the beginning, we are able to tell them that certain assets are going to fall under the category that will get impaired very quickly. So we are in a position to tell the promoters that from the market perspective it may not be such a good deal or it would possibly make more sense if they paid slightly less for the acquisition.

This approach has started seeping into the company promoters’ minds in the international markets since the last few years. I feel that Indian companies will soon wake up to this reality when IFRS become mandatory.

We are not going to be able to change anything as there is only some amount of play in the valuation. It is a soft science involving a lot of judgement and by taking different assumptions one can make some changes to the value. But the primary objective behind this exercise is to tell the management that this is what the implication will be from an accounting perspective.

Valuing intangibles is always a grey area. How do you value intangibles?
I have been valuing intangibles for about 3-4 years as we don’t get to do too much intangible valuation work in India. It is a fascinating science. Different intangibles are valued using different approaches. Like, for instance, a brand is typically valued using a royalty savings method and the implication is that if you own a brand you do not have to licence it from somebody. And what we tried to do once is that take a situation where one had to licence the brand how much royalty would you have had to pay. And for that you look at certain comparable transactions for which there are certain databases which are available as you cannot simply take a transaction that happened with a particular brand as your comparable benchmark. You have to apply judgement again. While certain things may be comparable there would be others that may not be. That’s one method of doing it.

You call valuation services a soft science. Can this profession be regulated?
We can ask ourselves whether we can take the judgement factor out of valuation. Because judgement also means some amount of subjectivity. We have to ask ourselves whether the process can be made more objective. The issue is that in valuation, we have to take into account the future cash flows. And discount them back to the present value.
The valuation profession should be regulated better. People who do the valuations have the necessary qualification to do the job. They need to have the right amount of skills. A bill called the ‘Valuation Professionals Bill,’ I think, is being tabled. The idea behind it is that all the valuation professionals need to be regulated in India. They have to follow the proper guidelines.

Minority shareholders on occasions complain that valuations undertaken for corporates are often skewed in the favour of promoters? How independent can you be? Audit firms can also double up as valuers for their clients?
Valuation professionals can be swayed. If people are found to sway at times, there needs to be some regulatory mechanism. It will be good for everybody. If that happens the liability of the valuations goes up. Anybody who is doing this has to take two things in mind. One is the relationship with the client and two is the global reputation which is absolutely essential for somebody in this business.

Is there a risk of getting it (valuations) wrong? Rating agencies these days have often been caught on the wrong foot and erstwhile international audit firm Andersen’s fall is also not that distant in the past...
Predicting the future is tough. If they got that wrong and they were relying on certain information that were provided to them and based on that they made some judgements. If you read the valuation reports, you’ll find that we are making a judgement.
That is the nature of the basis and we have to take certain calls. And these calls at times in hindsight need not be correct.

One person made a mistake in one part of the world and the whole firm (Andersen) globally came down. There are tremendous risks associated with our business and so we have to be extremely cautious in what we are doing. I am representing a firm which is $200 million strong. I don’t want to take a job which is Rs 5 lakh or Rs 10 lakh and do something untenable. That’s the reason why most of these firms are not corporatised. Each partner is personally liable. Huge corporations can make mistakes.

Will Indian companies get IFRS-compliant soon?
There is a reasonable level of awareness. It is for organisations like ours and the big four accounting firms to get this message across to corporations. Some think it is onerous and it will increase the costs to become IFRS compliant. Indian companies will speak the same language as global companies. Already 100 countries have adopted IFRS. Therefore, India is in a minority. So, if an Indian corporate presents its balance sheet to foreign companies or to foreign stock exchanges then the foreign community will not know that it is in accordance with global norms and they can take it at face value. So if Indian companies are IFRS-compliant, the compatibility gets greater. They become more reliant on accounts. Currently the discount rate for valuations of Indian companies is much greater than IFRS-compliant companies. There is a very clear distinction. If you are forced to raise capital, you are forced to raise at higher rates.

If you are doing those FCCBs you have to restate your accounts according to the global norms.

How are you different from some Indian firms who also call themselves valuers of assets and businesses?
Indian firms are focussed on tangible and real estate valuations. They are not able to business valuations. The other thing is that we have global reach, where we can undertake work for Indian companies who are looking at acquisitions abroad and would like to have an interface.

American Appraisal has been around for a few months. Do you sense a slowdown in mergers & acquisitions and corporate deal talk etc?
There is a slowdown. But in the current downtrend in asset prices there is a lot of opportunity. In these times, private equity firms view it as an opportunity. The state of M&A activity must go up. Some concerns about liquidity are there in the market but we expect it to go up.

Is there a need to make a drastic overhaul of our laws etc to make ourselves globally compliant?
If we make intensive efforts we will not be far behind. Even US is making a change from US GAAP to IFRS. Companies will have to state accounts with much greater disclosures and transparency.

Some things may have to change. The schedule 6 which is the prescribed format for balance sheets is not compliant with IFRS. So that has to be changed.

Do you see any more international valuation firms entering this turf?
I am not aware. Of course the big four accounting firms are active in this area. Then there is some talk of firms such as Duff & Phelps eyeing the Indian market. In the US, there are firms such as Navigant, Huron and a few firms in the Europe who specialise like us in valuating companies, but I am not aware whether they are setting up operations in India.

t_ashish@dnaindia.net
j_satish@dnaindia.net