Date posted: 18/08/2020 8 min read

How do you value a business in the COVID-19 era?

COVID-19 has caused us to question the very concept of value. What are the four issues business valuers must consider?

In Brief

  • COVID-19 is changing how people define value in businesses.
  • Innovations forced on businesses during COVID-19 may set them up for a better future.
  • Valuers will need to construct plausible scenarios when forecasting business recovery from COVID-19.

By Felicity McLean

Have you tried turning it off and turning it on again? This year’s COVID-19-induced lockdown – shuttering business, grounding planes, and confining people to their homes – has been the greatest collective shutdown in recent history. The global equivalent not just of hitting ALT+F4 on a keyboard, but of unplugging the economy at the wall.

That’s not to say specialisations such as business valuation have been restored to their factory settings. Far from it. In fact, the COVID-19 crisis has caused us to question the very concept of value, and the valuation profession looks set to emerge stronger for it.

A changing view of business value

“There’s a different view of value that’s emerged around the business’ contribution to societal value during the crisis,” observes Richard Stewart OAM FCA, a corporate value advisory partner at PwC in Sydney and a member of the Business Valuation Standards Board of the International Valuation Standards Council.

“It’s given people a whole new insight into what it means to be a valuable business – it’s not just about the value you retain for your shareholders.”

Stewart cites the example of collapsed airline Virgin Australia, which entered voluntary administration on 21 April during the nadir of Australia’s COVID-19 lockdown.

At the time, there were calls for a federal government bailout, with proponents quick to point out the company employed 16,000 people, directly and indirectly, serviced 41 destinations (many of them in regional communities), and contributed about A$11 billion annually to the national economy.

“It’s not just about the value you retain for your shareholders.”
Richard Stewart OAM FCA, PwC Australia

To its many and varied stakeholders, Virgin Australia represented much more than 144 planes parked on the tarmac; its value was greater than the sum of its parts.

It is this new acknowledgment of value that underpins New Zealand’s COVID-19 Wage Subsidy and Australia’s JobKeeper scheme. Both are based on the idea of keeping employees linked to businesses – something that was lacking during the early 1990s recession.

“It’s a recognition that continuing businesses and good businesses create value for their employees, and that value is worth looking after,” says Stewart. “That, for me, has been the most interesting development.

“People talk about societal value but actually just by existing – by serving customer needs, and providing a good workplace, and paying taxes – many businesses create value for the societies in which they exist.”

“Continuing businesses and good businesses create value for their employees, and that value is worth looking after.”
Richard Stewart OAM FCA, PwC Australia

Finding business opportunity in the COVID-19 crisis

COVID-19 may prove a catalyst for change for those businesses being valued, too.

Manda Trautwein CA, chair of the CA ANZ Business Valuation Committee and director of business valuations at William Buck in Sydney, has seen several companies innovating in ingenious ways.

Sydney-based business Stagekings, for example, moved from making stadium scaffolding and massive pop-up stages – its team re-created Edinburgh Castle for the Military Tattoo event in Sydney – to producing “iso-desks” for people newly working from home and modular office partitions and retail counter guards for businesses returning to work.

By June, the company was offering 25 “IsoKing” products, ranging from desks and children’s activity tables to modular office partitions and retail counter guards for businesses returning to work.

Many William Buck clients have made lasting improvements to their businesses, including diversifying the supply base, pursuing digitisation strategies, and streamlining processes.

In particular, Trautwein has seen businesses use the enforced hibernation period as an opportunity to rethink their legal structure in regard to asset protection, ease of conducting operations, and tax effectiveness.

“That’s going to set some businesses up for a great future, adding enormous value down the track.”

What does COVID-19 means for business valuers?

Never has the volatility index (VIX), created by the Chicago Board Options Exchange, lived up to its nickname “fear gauge” as much as during COVID-19: it skyrocketed from 15% to 80%, before settling at about 30% – still twice the volatility of pre-pandemic markets.

Practically speaking, what does this mean for valuers? Stewart and Trautwein identify four issues for valuers to consider in the post-pandemic environment:

1. Model the shutdown impact

Most businesses will have a handle on short-term impacts of the shutdown now, and in many cases earnings forecasts will need to be revised downwards. The challenge is adjusting cash-flow forecasts in a meaningful way. Trautwein advocates taking a balanced approach.

“My concern is some valuers will adjust the cash-flow forecast down to assume a worst-case scenario and, at the same time, adjust other inputs in the valuation formula,” she says.

“In effect, they’re double discounting the value they’re assigning to the business and potentially materially undervaluing it.

“We have to be careful not to take too much of a glass-half-empty view.”

2. Plot the path(s) to recovery

Valuers will need to construct a range of plausible scenarios when forecasting the recovery. These should be based on the lessons learnt from previous crises, as well as forecasts from the broker community (which have a wider range than usual).

“Strategies can’t be set-and-forget,” advises Stewart. “They have to be flexible and adaptive to make the most of that trend.”

3. Consider a premium on capital

Heightened uncertainty is likely to lead to increases in the discount rate. PwC Australia has estimated a generic COVID-19 risk premium, which can be applied to the cost of equity. It suggests a risk premium of between 25 to 200 basis points be added to discount rates to factor in the uncertainty in unadjusted cash flows.

4. Review liquidity considerations

Liquidity concerns pose a challenge for those valuing equity instruments, which can create overhang for potential share issuance, placing downward pressure on minority values. Control premiums may also differ from those normally estimated and Trautwein advises valuers to go back to basics on working capital management and monitoring cash flows.

How should valuers deal with increased auditor scrutiny?

Valuers can expect greater scrutiny from auditors this year, stemming, at least in part, from the unprecedented market changes, which have created impairment triggers, and so increased the impairment risk.

How should valuers respond?

“The key, as always, is to document your assumptions,” says Stewart, adding this means a record of all of your assumptions, plus the evidence behind them.

“This is more important than ever because there are a range of plausible alternatives around most assumptions right now,” he says, “and your need to be able to justify your decision, including how you assessed the sensibility of your answer.”

To this end, Stewart recommends:

  • Educating clients on the demarcation of responsibilities between valuers and auditors
  • Ensuring the report is fit-for-purpose and the scope is not unrealistically extended
  • Providing enough detail for the valuation to be performed easily again
  • Setting out clear cross-checks that buttress opinions
  • Ensuring evidence for compliance meets valuation standards
  • Budgeting for a more extensive review with auditors this year.

“If valuers respond in a way that speaks of their professionalisms and diligence and their willingness to be examined, the profession will become stronger. And if the reverse is true, that will weaken it. It’s a fulcrum point for the valuation profession.”  

Valuation: Measuring and managing the value of companies

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