Valuation in the time of Covid19

Business valuations need to consider short to long-term effects of the Covid19 crisis. Commonly accepted valuation approaches are (i) model-based business values that focus on future financial benefits and (ii) fair values based on observable market prices (IFRS13). Stock prices should in theory reflect the business ability to generate positive cashflows for the shareholders, but investors (or traders) behavior often leads to a complete disconnection between this principle and observable market prices.

For cash flow-based valuations, scenario, sensitivity analyses and liquidity considerations must play a core role in the analysis. A deep understanding of the business model, its value driver, the market and its environment, alongside with scenarios and simulations reviews, are crucial to help understand how Covid19 might impact cashflows.

Multiples based approaches need to be considered even if results might be highly volatile even in times of no crisis.

We should also consider how long this situation is expected to remain and the unprecedented measures taken to ease Covid19 effects. However, it is difficult to project until when these emergency measures will support the growth of businesses revenue.

Other implications of Covid19 to consider that we need to mention are the cost of capital calculation, the beta factors, and impairment testing.

We can illustrate how Covid19 impacts valuations by mentioning a case law.

"On August 7, 2020, the Bankruptcy Court of the Eastern District of Pennsylvania addressed how Covid19 impacts valuations.

The question of how to value a fitness club in the context of Covid19, and the economic uncertainty that comes along with it, was the central theme of this case. Both parties’ valuation experts disagreed on the extent that Covid19 had on the value of the business. The creditor’s expert failed to account for the current market condition due to the pandemic. The debtor’s expert valued the company based on a liquidation value of its intangibles. The Court rejected both experts’ valuations and performed its own.

The Facts

The debtor owned three fitness studios in Pennsylvania and filed for Chapter 11 bankruptcy in January 2020. Two locations would remain closed; however, the debtor wanted to reorganize one of the fitness centers and he filed a Chapter 11 reorganization plan for one of the locations. In response to this bankruptcy filing, First Bank, which had an unpaid balance of $970,000, filed a claim to position itself as a secured creditor. The debtor objected to this election and, under its reorganization plan, offered to treat the bank as a secured creditor, but only up to $317,000.

Debtor’s Expert Valuation

According to the debtor’s valuation analyst, due to the Covid19 pandemic, the debtor could not sell the business as a going concern and its only value was in liquidation. His opinion was based on the fitness industry as it currently is.

Creditor’s Expert Valuation

The creditor had two experts, an appraiser of the fitness equipment and an appraiser for the business. The equipment appraiser valued the equipment at a worth of $130,000. The business appraiser opined that the value was $170,000 using a market approach—of that, $125,725 was the value attributable to the tangible assets. His opinion was based on : (i) sales of 30 fitness businesses; (ii) stock market recovery.

Statement of The Court

The Court said that the value needs to consider the purpose and the proposed use of the property. Because the debtor intends to use the assets in the reorganization, the Court could not agree on the use of the liquidation value used by the debtor’s expert.

The Court further noted that the creditor’s expert did not fully consider the economic condition of the industry and the effects of Covid19.

The Court stated it was unlikely that an investor would buy the debtor’s business as a going concern except at a substantial discount. Per the Court, neither side’s experts’ position was satisfactory, and both failed to factor in the impact of the pandemic as it relates to the valuation. The Court concluded that a buyer would be willing to pay $50,000 over the $30,000 value of the tangible assets. The Court found that the creditor’s interest in the debtor’s assets was worth $80,000, which did qualify as inconsequential when related to the total claim of $970,000 and, therefore, the Court said First Bank was precluded to have its claim treated as fully secured." © Nacva - adapted