Why Valuations need to be in the Spotlight
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Mergers and Acquisitions (M&As) are not common in Zambia. However, when they do happen most are seldom in the public domain making it difficult to build a profile for those investors who have an appetite for local assets. Knowing the profile of the investor gives us an idea of whether that investor behaved rationally when buying the asset or irrationally. To quote Mark Rubinstein, “although academic models often assume that all investors are rational, this assumption is clearly an expository device not to be taken seriously”. Financial Insight further contends that the “invisible hand” can also be at play in the decision process.

We recently published an article regarding two acquisitions made by IDC (Zampalm and Superior Milling). The sale price for the former was known but not the latter’s as it was an ongoing matter. One would therefore be correct to assume that there was a valuation method that was used to value these businesses for a price to be determined.

For an analyst looking at any business’ financials which are about to have a valuation method applied on them, it is a matter of prudence to ensure that the accounts are not laundered. Laundering of accounts comes about through creative accounting which can either be aggressive (reporting figures that show favorable earnings) or defensive (earnings reduced to show a more conservative position). This is done by performing a reliability analysis that assess the EBITDA against reported Operating cash flows.

According to Bob Ryan’s Corporate Finance and Valuation (Manchester Business School), there are basically four flavors (variants not limited though) of valuation methods which include Asset valuation, Relative valuation, Flow valuation and Contingent valuation. Asset valuation is considered an objective measurement of the market price of tradable assets plus value of expected future earnings. Relative valuation involves valuing some measurable attribute of the firm, such as its current level of earnings or book value. Flow valuation Value is determined by the Net Present Value of future cash flows to the firm. Lastly, Contingent valuation using option pricing theory.

In the Zampalm case, based on the 2016 Annual Report from ZAMBEEF which showed no recognized revenue that came out of the asset. Therefore, it can be inferred that the valuation was based more on either Asset (using revenue forecasts) or Relative valuation. The total sale value of the asset was south of the $21m (sale price was US $16 million with an additional US $2 million performance bonus) investment that was pumped into the project since 2009. Therefore, the corporate finance team must have agreed on a summary of the assets less the liabilities of Zampalm and valued them on some agreed basis.

Hypothetically, if this were the case then there are some challenges in the traditional method of valuation. This method is appropriate for valuation of assets at their replacement cost.  However, the investment that Zambeef made was over a period of time and hence issues of depreciation (farming equipment and any infrastructure) may come into play. Furthermore, some of the assets may not be tradable. Hence why the approach is often used for valuing small businesses that are slightly immune to entanglement and it is simple to use.

If on the other hand the Relative valuation method was used (based on book value), the approach would have entailed comparing similar businesses in the same industry with a comparable variable. Although the case for this is rather weak because Zampalm would have to be compared to a company that was listed (no edible oil company is listed on LuSE) this would imply that the corporate finance team would have had to go to a different jurisdiction (other stock markets) and get comparable data from there. Not a very good idea though because markets in different countries have different factors that affect a firm’s profitability.

Although this further weakness the argument that this may have been one of the valuation methods used, the method does apply the price to book ratio which appears to be useful in the relative valuation of companies. The rational of using this method is the idea that companies similar to Zampalm’s business would have similar financial fundamentals such as financial risk would carry the same value when scaled by their book value.

We confirm there is some level of thumb sucking regarding some of the assumptions that may be considered in valuing a company that has had no revenue. This actually makes the analysis of financial flows within the firm very interesting. The two financial flows that would be considered are cash flows and accounting flows. They allow for the determination of free cash flow which is a key ingredient in determining the value of a company.  In addition, consideration must be given to the forces of competition that determine how much revenue that company will be able generate.

Needless to say, the valuation process can be an arduous one hence why valuation firms get paid a lot of money in fees (justifiably so) for the service. Hence the importance for investors in Pension Funds, Hedge Funds (or any investment vehicles) to know what valuation method their management team adopted in making the final decision to purchase a business.

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