Royal commission: Banks pledge transparency on valuations
As reported in the Australian Financial Review on 13 June 2018, “The major banks have pledged to be more transparent when they send investigators and valuers into a customer’s business, after the royal commission heard secret re-valuations had been used to trigger loan defaults. New submissions to the Hayne royal commission from the major banks say borrowers will be given full copies of valuation and investigative accountant reports, unless there’s a risk of interfering with a sales process.”
“The commission asked all the banks to address any reasons why valuations, or investigative accountants’ reports, ought not be provided to customers in circumstances in which the reports have been paid for by the customer and the bank wishes to take reliance, at least in part, on such reports.”
The findings of the Royal Commission have highlighted the importance of accurate and regular valuations of all investments held. In this regard I note the following:
Whilst a company may have its shares listed on the Australian Securities Exchange (ASX) (or other exchange), this may not necessarily represent market value. Key considerations relate to:
- Whether the shares are considered sufficiently liquid;
- If there are any major shareholding blocks;
- If the company has recently released any announcement which may have caused volatility in the share price; and
- If there has been any recent takeover activity/speculation which has caused distortion in the listed share price.
Often companies consider the initial ‘entry price’ (or acquisition price) as a reasonable proxy for the current market value. This is rarely a reasonable assumption!
- Price doesn’t necessarily equate to value – the consideration paid may not necessarily represent market value and will be dependent on many factors including; the circumstances surrounding the transaction, the seller’s motives and strategic rationale of the buyer.
“Price is what you pay, value is what you get,” Warren Buffet.
- Time marches on – as time progresses from the initial acquisition it is highly likely that value will fluctuate in either an upwards or downwards direction;
- Economic, company specific and industry factors change – any movement in external or internal factors that impact the business will likely result in changes in value, the extent of which could be significant and should be properly assessed; and
- Changes in underlying assumptions or risk profiles – somewhat seemingly small changes to underlying assumptions or the risk profile of the business, its cash flows and/or prospects can result in large value swings that should be considered by an expert and reported in an accurate, timely and transparent manner.
In each of the above instances, an independent valuation is required to assess an accurate market value. A fundamental valuation, typically using a Discounted Cash Flow (DCF) methodology or Capitalisation of Future Maintainable Earnings (CFME) (including the application of appropriate cross-checks) is critical in determining the true market value of any investment at a particular point in time.
An accurate valuation can be of use by many stakeholders, including banks, their subject customer, other key stakeholders (such as Boards of Directors, external advisers, Accountants and Auditors), and potential purchasers.
Valuations of businesses and/or equity are not straight-forward, and the complexity involved should not be under-estimated.
Below are recommendations in dealing with valuation complexities:
- Engage with an appropriately qualified expert.
- Ensure your valuer is operating under the relevant regulatory or other framework, of which there are many.
- Ensure the purpose, scope, perspective and premise of value is relevant and clearly defined upfront (as value can vary wildly, and even absolutely, depending on these items).
- Ensure the valuation is approached from multiple angles.
- Challenge the primary valuation approach and methodologies adopted.
- Check the factual accuracy of the key assumptions on which the valuation is based.
- Understand the impact and sensitivities of the key assumptions.
- Consider counter arguments and rebuttals to challenge the initial conclusions (use professional scepticism).
- Ensure the ultimate conclusions are commercially sound as well as being technically robust.
- Ensure the exercise is adequately documented.
If you would like further information please contact your adviser, or alternatively feel free to reach out to me directly, I would be pleased to assist with any required valuations and have considerable experience in the field.
Partner – Corporate Finance