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For All It’s Worth TM Slide 1 Valuation Issues in Financial Reporting Measuring Value Creating Value Exchanging Value Recovering Value DFW SEC Reporting Group Dallas, Texas January 15, 2002
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For All It’s Worth TM Slide 2 5221 N. O’Connor Blvd. Suite 830 Irving, Texas 75039 main: (972) 831-7900 fax: (972) 831-7901 email: info@valueinc.com web: www.valueinc.com Contact Information
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For All It’s Worth TM Slide 3 Today’s Presenters David N. Fuller, CFA –Founding Principal –direct: (972) 831 – 7907 –email: dfuller@valueinc.com Presenter Information
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For All It’s Worth TM Slide 4 Founding Principal – V ALUE Incorporated Former Managing Principal – BVS Former Manager – Deloitte & Touche 15 years valuation experience Completed more than 750 engagements covering virtually every industry Chartered Financial Analyst (CFA) MBA Finance – Southern Methodist University, Dallas, Texas BA Economics – Austin College, Sherman, Texas Presenter’s Bio: David N. Fuller
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For All It’s Worth TM Slide 5 Clients Recently Served
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For All It’s Worth TM Slide 6 Range of Services Value Measurement Value Creation Value Exchange Value Recovery Service Overview
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For All It’s Worth TM Slide 7 Value Measurement Mergers & Acquisitions –Fairness opinions, ESOPs, & buy/sell agreements Financial Reporting –SFAS 123, 133, 141, 142, 144 Tax Reporting and Disputes –Gift & estate, charitable contributions, IRC 482, 83b, 338 & 903 Litigation –Breach of contract, tortuous interference, shareholder oppression, marital dissolution Service Overview
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For All It’s Worth TM Slide 8 Independence Auditor independence rules proposed by Arthur Levitt Sarbanes-Oxley –Section 201(g) Prohibited Activities - …it shall be unlawful for a registered public accounting firm that performs for any issuer any audit….to provide to that issuer, contemporaneously with that audit, any non-audit service, including….(3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports. Who can provide the services? Financial Reporting Standards
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For All It’s Worth TM Slide 9 Financial Reporting Standards SFAS 123 – Stock-Based Compensation SFAS 133 – Derivative Instruments and Hedging Activities SFAS 141 – Business Combinations SFAS 142 – Goodwill and Other Intangible Assets SFAS 144 – Impairment or Disposal of Long-Lived Assets Financial Reporting Standards
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For All It’s Worth TM Slide 10 Fair Value The amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and are to be used as the basis for measurement, if available. If quoted market prices are not available, the estimate of fair value is based on the best information available in the circumstances. Financial Reporting Standards
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For All It’s Worth TM Slide 11 SFAS 123 – Stock-Based Compensation Recommends a fair value based method of accounting for stock-based compensation plans and for equity given in exchange for goods and services. Replaces ABP Opinion 25 under which intrinsic value was the measure of value. Requires footnote disclosure about stock-based compensation grants, whether applied or not As of year end, 139 public companies have elected to expense options. Financial Reporting Standards
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For All It’s Worth TM Slide 12 SFAS 123 – Stock-Based Compensation Applies to Stock Grants Stock Options – Public Company Stock Options – Private Company SARs, Phantom Stock Measurement methods Black-Scholes option valuation model Modified Black-Scholes Market pricing Financial Reporting Standards
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For All It’s Worth TM Slide 13 SFAS 133 – Derivative Instruments and Hedging Activities Standardizes accounting for derivative instruments, including those embedded in other contracts by requiring they be recognized and measured at fair value. Provides for matching the timing of gain or loss recognition on the hedging instrument with the earnings effect of the hedged asset or liability. Financial Reporting Standards
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For All It’s Worth TM Slide 14 SFAS 133 – Derivative Instruments and Hedging Activities No hedge transactions – gain/loss in current earnings Fair value hedge – gain/loss in both hedge instrument and hedged item in current earnings Cash flow hedge - gain/loss in both hedge instrument and hedged item in comprehensive income (outside earnings) and reclassed to current earnings in same period as future forecast transation Financial Reporting Standards
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For All It’s Worth TM Slide 15 SFAS 133 – Derivative Instruments and Hedging Activities Identification of derivatives Valuation of derivatives Financial Reporting Standards
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For All It’s Worth TM Slide 16 SFAS 141 – Business Combinations Requires allocation of purchase price to all financial, tangible, and intangible assets separable from goodwill Intangibles are separable from goodwill if They arise from contractual or other legal rights, or If it is separable, that is, capable of being separated or divided from the acquired entity and sold, licensed, rented or exchanged. Also requires determination of remaining useful life Financial Reporting Standards
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For All It’s Worth TM Slide 17 SFAS 141 – Business Combinations Marketing-related Trademarks, domain names, non-competes Customer-related Customer lists, contracts, relationships, backlog Artistic-related Books, music, video, photographs Contract-based Licenses, leases, use rights, franchise agreements, royalties, permits Technology-based Patents, software, databases, title plants, trade secrets Financial Reporting Standards
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For All It’s Worth TM Slide 18 SFAS 141 – Business Combinations Assets are depreciated/amortized over their remaining life Goodwill is not amortized, instead… Financial Reporting Standards
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For All It’s Worth TM Slide 19 SFAS 142 – Goodwill and Other Intangible Assets Supersedes APB Opinion 17 Presumes that goodwill is not a wasting asset, rather it has an indefinite useful life Requires annual tests for impairment of goodwill, and interim tests are required if any question exists Upon adoption, impairment write-downs are shown as changes in accounting policy Thereafter, impairment write-downs are shown as operating expense Financial Reporting Standards
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For All It’s Worth TM Slide 20 SFAS 142 – Goodwill and Other Intangible Assets Testing is to be done at the reporting unit level Reporting units are defined as operating segments or one level below operating segments Discrete financial information is prepared Segment management regularly reviews operating results of that component Financial Reporting Standards
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For All It’s Worth TM Slide 21 SFAS 142 – Goodwill and Other Intangible Assets Test 1 – Estimate reporting unit’s market value and compare to its carrying value If no impairment is indicated, stop Test 2 – Go to SFAS 141… Financial Reporting Standards
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For All It’s Worth TM Slide 22 SFAS 144 – Impairment or Disposal of Long- Lived Assets Supercedes SFAS 121 Retains requirement to recognize impairment only if carrying amount is not recoverable from its undiscounted future cash flows Measures the impairment as the difference between carrying amount and fair value Financial Reporting Standards
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For All It’s Worth TM Slide 23 Other FASB Interpretation 45 - Fair value of Guarantees A liability must be recognized at inception of guarantee for “stand ready” obligations The sum of the probability-weighted present values in a range of estimated cash flows, all discounted using the same interest rate convention Financial Reporting Standards
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For All It’s Worth TM Slide 24 Three Valuation Approaches Income Approach – value is a function of future income generated to owners Market Approach – value can be estimated from observation of market prices for similar assets Cost Approach – value is a function of the replacement cost of the asset, adjusted for depreciation and obsolescence Valuation Methodology
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For All It’s Worth TM Slide 25 Income Approach Overview Single period versus DCF Allows consideration of company’s specific characteristics Requires forecasts of future financial performance Requires estimation of required rate of return (discount rate) Valuation Methodology
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For All It’s Worth TM Slide 26 Market Approach Overview Guideline company – stock prices of public companies Market transactions – prices paid in mergers and acquisitions Objective in that few judgments or projections are required May require adjustments to reflect company’s specific characteristics Valuation Methodology
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For All It’s Worth TM Slide 27 Cost Approach Overview Replacement cost is in current dollars 3 Forms of depreciation/obsolescence Physical Functional Economic Requires that the asset be replaceable Valuation Methodology
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For All It’s Worth TM Slide 28 Typical Approaches Trademarks/trade names – market Software - cost Patents – market/income Customer relationships – income Non-competes – income Databases - cost Goodwill - residual Valuation Methodology
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For All It’s Worth TM Slide 29 Fair Market Value Balance Sheet Valuation Methodology Current Liabilities Equity Debt Current Assets Tangible Assets Intangible Assets Enterprise Value
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For All It’s Worth TM Slide 30 Fair Market Value Balance Sheet Valuation Methodology Current Liabilities Equity Debt Current Assets Tangible Assets Intangible Assets Enterprise Value Kd = 7% Ke = 12% WACC = 10%
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For All It’s Worth TM Slide 31 Fair Market Value Balance Sheet Valuation Methodology Current Liabilities Equity Debt Current Assets Tangible Assets Intangible Assets Kd = 7% Ke = 12% WACC = 10% Kx = 7% Kz = 14% WACC = 10% Ky = 10%
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For All It’s Worth TM Slide 32 Capital Charges Concept of economic rent Building up the capital charge Start with the principal and interest payment over economic life Gross up for taxes Subtract the present value of the depreciation tax shield Consider cash flow and tax implications of salvage value Valuation Methodology
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For All It’s Worth TM Slide 33 Allocation of Cash Flow Valuation Methodology
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For All It’s Worth TM Slide 34 Fair Market Value Balance Sheet Valuation Methodology Current Liabilities Equity Debt Current Assets Tangible Assets Intangible Assets Kd = 7% Ke = 12% WACC = 10% Kx = 7% Kz = 14% WACC = 10% Ky = 10%
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For All It’s Worth TM Slide 35 SFAS 141 Valuation Process Valuation Methodology Enterprise Value Asset Values Capital Charges WACC
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For All It’s Worth TM Slide 36 SFAS 142 – Goodwill and Other Intangibles Financial Reporting Standards
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For All It’s Worth TM Slide 37 SFAS 142 – Goodwill and Other Intangibles Financial Reporting Standards
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For All It’s Worth TM Slide 38 Questions and Answers Valuation Methodology
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