NILAI KOMBINASI INTELLECTUAL PROPERTY DALAM VALUASI

 

 

Pengadilan Pajak di California, Amerika Serikat yang melibatkan harta kekayaan (Alm.) Michael Jackson antara Estate of Michael J. Jackson (Deceased) (selanjutnya diacu Estate saja) dengan Kantor Pajak Amerika Serikat (the Internal Revenue Service, atau disingkat IRS) menarik perhatian terkait nilai pasar wajar dari hak publisitas (right of publicity) almarhum mencakup nama dan citranya.

Sebagai latar belakang case ini bisa dibaca di tulisan Robert W. Wood berjudul “Even After Death, Michael Jackson Has to Deal with the IRS”.

http://www.americanbar.org/publications/blt/2013/10/03_wood.html (diakses pada tanggal 18 Februari 2017).

Bahkan Blomberg menurunkan satu artikel pada tanggal 1 Februari 2017 menarik yang ditulis oleh Devin Leonard berjudul “Michael Jackson is Worth More Than Ever, and the IRS Wants Its Cut”, yang mengulas sengketa terkait valuasi Estate of Michael Jackson. Di sini IRS mengklaim bahwa Estate seharusnya dinilai sebesar USD 434 juta, dan bukan sebagaimana yang dinyatakan oleh Estate hanya sebesar USD 2.105. Estate mengklaim hanya nilai USD 2.015 karena pada saat wafatnya, almarhum sedang menghadapi banyak masalah skandal.

(lihat https://www.bloomberg.com/news/features/2017-02-01/michael-jackson-is-worth-more-than-ever-and-the-irs-wants-a-piece-of-it, diakses pada tanggal 18 Februari 2017)

Tulisan Michael Cohn pada tanggal 8 Februari 2017 juga membicarakan hal ini, dimana diberikan judul “Court Hears IRS Dispute over Value of Michael Jackson Estate”).

(lihat https://www.accountingtoday.com/news/court-hears-irs-dispute-over-value-of-michael-jackson-estate, diakses pada tanggal 18 Februari 2017)

Dalam prapengadilan, pihak Estate mengajukan permohonan agar pihak Pengadilan Pajak tidak menggunakan (exclude) laporan valuasi yang diterbitkan oleh ahli intellectual property Weston Anson (CONSOR) dengan pertimbangan beberapa alasan. Salah satunya, pihak ahli Anson memasukkan nilai untuk usaha yang sangat spekulatif, seperti Michael Jackson taman bermain (theme park). Namun sebagai alasan terbesar keberatan pihak Estate adalah bahwa laporan valuasi mencakup kombinasi (mash-up) dari berbagai hak (rights) yang berbeda-beda, dimana pihak Estate menyebutkan hal ini menyalahi ketentuan peraturan di Amerika Serikat bahwa setiap item intellectual property wajib dinilai secara terpisah. Kombinasi hak-hak yang berbeda-beda disebutkan meliputi nilai nama Michael J. Jackson dan foto/gambar (likeness), dan katalog hak-hak penerbitan (publishing rights), bersama-sama dengan nilai aset lainnya yang dimiliki almarhum pada saat wafatnya, yaitu hak dagang (trademarks), hak cipta (copyrights) di musik dan hak almarhum sendiri untuk menerima royalty sebagai penampil (performer).

Menarik membaca tanggapan dari hakim Pengadilan Pajak di Amerika Serikat, Mark V. Holmes yang menyatakan bahwa laporan valuasi Anson tidak seharusnya dikecualikan atau tidak dipertimbangkan.

Dikutip seutuhnya, dikatakan:

This is an especially interesting legal question. In a world without transaction costs, it wouldn’t matter if publishing rights, performance royalties, trademarks, etc. were valued separately because a rational buyer would value them as if they could be put together in the most profitable way even if they were bought separately. But it is entirely possible that trial will show that these separate rights would be more valuable if used together. If so, and if the Estate owned these separate rights, it might well be the case that they are worth more together than they would be if summed separately.

Terjemahan bebas:

Ini adalah pertanyaan legal yang cukup menarik. Dalam suatu dunia tanpa biaya transaksi (catatan: Penulis teringat dunia ideal teori M&M dalam manajemen keuangan), bahwa tidaklah menjadi masalah jika hak-hak penerbitan, royalti penampilan, hak dagang, dan lain-lain dinilai secara terpisah atau tersendiri-sendiri karena seorang pembeli yang rasional akan menilai seluruh hak-hak tersebut seakan-akan seluruh hak-hak tersebut dapat ditempatkan dan dimanfaatkan dalam cara-cara yang paling mendatangkan keuntungan, sekalipun masing-masing hak-hak tersebut diperoleh secara terpisah. Akan tetapi sangat mungkin bahwa pengadilan akan dapat menunjukkan bahwa hak-hak yang terpisah ini akan lebih berharga (atau nilai keseluruhan akan lebih tinggi) jika hak-hak tersebut dipergunakan secara bersama-sama (catatan Penulis: akan ini berarti manfaat sinergi?). Jikalau demikian, dan jika pihak Estate memang memiliki hak-hak terpisah ini, ada kemungkinan yang baik bahwa keseluruhan  hak-hak tersebut akan memiliki nilai yang lebih tinggi daripada kalau nilai masing-masing hak-hak itu dijumlah secara terpisah.

 

Keputusan Hakim Mark V. Holmes tertanggal 3 Februari 2017 dapat dibaca dalam lampiran tulisan ini dalam bentuk pdf.

 

Membicarakan manfaat “sinergi” [Catatan: pihak Akuntan punya nama tersendiri, yaitu “goodwill” untuk kehadiran sinergi?]  dalam valuasi dan kemudian berusaha memecah-mecah ke dalam masing-masing aset (baik tercatat atau tidak tercatat di neraca atau laporan posisi keuangan), merupakan tantangan tersendiri. Banyak hal-hal yang berusaha diperkenalkan oleh para ahli valuasi, terkait ini, misalnya dalam konteksi valuasi nilai korporasi atau bisnis, adanya konsep “normal or normalized earnings/margin”, “[positive, negative] abnormal earnings/margin”, “excess earnings/margin”, “competitive margin”, yang kadang bisa menimbulkan interpretasi yang berbeda-beda, termasuk data yang akan digunakan. Isu yang lain, apakah dipakai “accounting [book value] earnings/margin” atau “economic earnings/margin”?

 

Penulis juga teringat akan buku Determining Value: Valuation Models and Financial Statements oleh Richard Barker (Essex (England): Pearson Education Limited. 2001. Halaman 109), yang menyebutkan:

 

An intractable valuation problem is that this total value cannot be disaggregated across each of the assets individually. This is due to synergy between assets. A company does not create value simply by holding assets. It creates value by means of a judicious combination of expenditure decisions, in areas as diverse as recruitment, product, developments, plant construction, advertising, service delivery and operations management. It is the combined effect of each of these resource allocations that gives rise to an income stream, and thereby to a value for the company as a whole. Viewed in this way, it is unclear what the term “value” means when applied to individual assets in the balance sheet. An individual asset may have a market price, as discussed above, but its value to the company will depend inextricably upon its relationship with all other resources deployed by the company. [Catatan: bagian yang dipertebalkan, disengaja untuk penekanan].

 

 

Dari yang dikatakan oleh Richard Barker, kehadiran “sinergi” antara aset berwujud (tangible assets) dan tidak berwujud (intangible assets), dan “item yang saat ini belum teridentifikasi (oleh akuntan), yang bisa ada wujud atau tidak berwujud, namun umumnya dalam level tertentu tetap ada wujudnya, misalnya hasil print-out (unidentifiable items)” sangat krusial untuk terciptanya “nilai” (value). Walaupun secara umum dikatakan bahwa terlepas apapun item tersebut, mau diberi label, termasuk yang saat ini belum banyak diberi “nilai” dalam laporan keuangan perusahaan misalnya manajemen, proses pengambilan keputusan, sumber daya manusia, standar prosedur operasional, rantai pemasokan (supply chain), teknologi informasi, bahan-bahan dan tepat sasar program-program marketing, eksekusi program yang terarah dan terukur, namun semuanya diyakini dan memang sudah terbukti, bersama-sama, melalui hubungan dan interaksi (relationship and interaction) yang kompleks akan sangat diperlukan guna terciptanya kemampuan perusahaan atau bisnis dalam menghasilkan pendapatan (revenue), laba (earnings) dan arus kas bebas (free cash flow).

 

Kemampuan masing-masing item dalam memberikan kontribusi bagi terciptanya kemampuan perusahaan/bisnis mendatangkan pendapatan, laba dan arus kas bersih, niscaya justru tidak signifikan, namun melalui interaksi itulah yang menjadi kunci sangat krusial. Artinya, masing-masing item mungkin saja bernilai rendah, namun pada saat dikombinasi, di-bundle dalam suatu proses, akan mendatangkan nilai yang tinggi.

 

Dua diagram ini di bawah ini bisa memberikan gambaran kehadiran “hubungan/interaksi” diantara para sumber daya menurut penulis jauh lebih penting dalam penciptaan nilai.

 

Diagram 1: Value Map – Identifikasi Sumber Daya

 

Sumber: Brand Finance Plc

 

Diagram 2: Value Map – Pengelompokan Sumber Daya dan Menaksir Nilai Kontribusi

 

 

Sumber: Brand Finance Plc

 

Kedua diagram di atas diambil dari tulisan Tim Heberden berjudul Intellectual Propery Valuation and Royalty Determination (yang dimuat dalam buku berjudul International Licensing and Technology Transfer: Practice and the Law, editor Adam Liberman, Peter Chrocziel dan Russell Levin. Pemuktahiran tahun 2011 yang diterbitkan oleh Wolters Kluwer Law & Business).

 

(berlanjut…..)

 

Jakarta, 18 Februari 2017

Lampiran

US Tax Court 2017 Estate of Michael J. Jackson vs Commissioner of IRS

 

DAMODARAN: FOCUSING on CASH FLOWS vs DISCOUNT RATE (COST OF CAPITAL)

Pada tanggal 26 Januari 2017, dalam blog-nya, Prof. A. Damodaran (Professor of Finance dari Stern School of Business New York University) memposting suatu tulisan berjudul “January 2017 Data Update 6: A Cost of Capital Update!”

http://aswathdamodaran.blogspot.co.id/2017/01/january-2017-data-update-6-cost-of.html

Tulisan tersebut cukup menarik untuk dibaca mengingat bahwa ada kecenderungan analis valuasi menghabiskan cukup banyak waktu berupaya untuk mendapatkan discount rate atau cost of capital yang dirasakan akan dapat mewakili profil resiko dari arus kas bisnis atau proyek yang bersangkutan, sehingga besar kemungkinan justru tidak banyak waktu untuk arus kas (=Free Cash Flow) dan laba (EBITDA, EBIT). Pertimbangan bahwa cukup dengan menganalisa data-data historis dan pembanding, akan memadai untuk mempertahankan proyeksi arus kas bisnis/proyek yang bersangkutan.

Tulisan Prof. A. Damodaran tersebut secara khusus mengingatkan pentingnya analis untuk kembali ke focus Arus Kas. Tulisan tersebut disajikan dengan memberikan data-data terkini untuk awal tahun 2017 terkait valuasi dan cost of capital, termasuk tingkat imbal hasil historis, implied equity risk premiums, premi resiko negara.

Prof. A. Damodaran dalam kesimpulannya terkait Cost of Capital menyebutkan dalam

When your valuations go awry, it is almost never because of the mistakes that you made on the discount rate and almost always because of errors in your estimates of cash flows (with growth, margins and reinvestment)

Tiga key driver yang disebutkan yaitu growth, margins dan reinvestment, adalah yang penting untuk difokuskan untuk memastikan sejauh mungkin bisa diperoleh proyeksi arus kas yang “akurat”, dan telah menggambarkan atau mencakup seluruh resiko bisnis yang ada. Dengan demikian, analis diharapkan justru tidak terlalu terobsesi dengan hal-hal kecil terkait Discount Rate.

Yang menarik, bahkan Prof. A. Damodaran memberikan tip untuk penentuan Cost of Capital apabila analis tidak memiliki banyak waktu, yaitu untuk valuasi perusahaan dengan tingkat resiko rata-rata, maka Cost of Capital sebesar 8% dapat dipertimbangkan untuk digunakan, atau kalau masuk dalam kategori bisnis yang sangat beresiko, maka 10,68% dapat digunakan sebagai dasar.

“An approximation works well : When I am in a hurry to value a company, I use my distributional statistics (see graph above) to get started. Thus, if I am valuing an average risk company in US dollars, I will start off using an 8% cost of capital (the global median is 8.03%) and complete my valuation with that number, and if I still have time, I will come back and tweak the cost of capital. If it is very risky firm, I will start off with a 10.68% cost of capital (the 90th percentile) and gain revisit that number, if I have the time.”

Sebagai penutup tulisan, Prof. A. Damodaran menyebutkan:

All in all, if your find yourself obsessing about the minutiae of discount rates in a valuation, it is perhaps because you want to avoid the big questions that make valuation interesting and challenging at the same time.”

Berk dan DeMarzo dari Stanford University menyampaikan nada yang sama dengan Prof. A. Damodaran di atas. Dalam buku teks Corporate Finance, dikutip bahwa

“Given the evidence for and against the efficiency of the market portfolio, what method do managers actually use to calculate the cost of capital? A survey of 392 CFOs conducted by John Graham and Campbell Harvey found that 73.5% of the firms that they questioned use the CAPM to calculate the cost of capital, as indicated in Figure 13.11. They also found that larger firms were more likely to use the CAPM than were smaller firms.”

 

 

“In short, there is no clear answer to the question of which technique is used to measure risk in practice—it very much depends on the organization and the sector. It is not difficult to see why there is so little consensus in practice about which technique to use. All the techniques we covered are imprecise. Financial economics has not yet reached the point where we can provide a theory of expected returns that gives a precise estimate of the cost of capital. Consider, too, that all techniques are not equally simple to implement. Because the trade-off between simplicity and precision varies across sectors, practitioners apply the techniques that best suit their particular circumstances.”

 

“When making a capital budgeting decision, the cost of capital is just one of several imprecise estimates that go into the NPV calculation. Indeed, in many cases, the imprecision in the cost of capital estimate is less important than the imprecision in the estimate of future cash flows. Often the least complicated models to implement are used most often. In this regard, the CAPM has the dual virtues of being both simple to implement and reasonably reliable.

Dikutip dari Jonathan Berk dan Peter DeMarzo. Corporate Finance. Edisi ketiga. MA (USA): Pearson Education, Inc. 2014. Bab 13 : Investor Behavior and Capital Market Efficiency. Halaman 466.

Menarik juga dikutip dari buku teks klasik Principles of Corporate Finance oleh Brealey dan Myers:

Profits that more than cover the opportunity cost of capital are known as economic rents. These rents may be either temporary (in the case of an industry that is not in long-run equilibrium) or persistent (in the case of a firm with some degree of monopoly or market power). The NPV of an investment is simply the discounted value of the economic rents that it will produce. Therefore when you are presented with a project that appears to have a positive NPV, don’t just accept the calculations at face value. They may reflect simple estimation errors in forecasting cash flows. Probe behind the cash-flow estimates [catatan penulis: tidak disebutkan untuk mengecek Cost of Capital atau Discount Rate yang digunakan dalam analisa tersebut, tapi pada key drivers di belakang pembentukan estimasi arus kas], and try to identify the source of economic rents. A positive NPV for a new project is believable only if you believe that your company has some special advantage.”

Dikutip dari Principles of Corporate Finance. Richard A. Brealey dan Stewart C. Myers. Edisi keenam. USA: The McGraw-Hill Companies, Inc. 2000. Bab 11: Where Positive Net Present Values Come From. Halaman 297.

Respons dari Ignacio Velez-Pareja (Jan/Feb 2017)

100% agree!

That is why we care very much about the detailed financial model. Remember that my financial model captures investments and debt when needed. Once you have that model, the CF is crystal clear (because it comes from what I call the Cash Budget). 

This part of the work is the most time consuming. Remember as well, that Cost of [financing] Capital (CofC) basically depends on one or two numbers: beta and equity risk premium. CFs depends on MANY input variables.

And finally, you end up sensitivizing ALL variables, including of course, beta and ERP!

This doesn’t mean that we consider CofC secondary, nevertheless. The issue is that many scholars devote LOT of time and effort to define with complex econometric models what beta and ERP should be and pay much less attention to the CFs. More, many still use the idea of plugs to check and match forecasted financial statements from where you derive CFs! This makes no sense at all.

Karnen’s view:

We need to see whether the horizon is short-term or long-term. In long-term, CFs error is critical as interest rate historically quite in predictable range, we have 10-yr government bond being traded in market. Something similar for CFs that we can’t find. Most of valuation didn’t happen not because of discount rate, but the CF doesn’t show up in the first place. Discount rate is just needed because we apply time value of money and compare more than 1 project with different pattern of cash flows being generated.

I give here a very simplified example of the impact of the error we made for cash flow forecast vs discount rate/cost of capital both for short-term and long-term projects.

 

Short-term projects: Assuming a generated cash flow of IDR 100 mio next year with the discount rate of 10%.

10% cash flow estimation error: cash flow put as IDR 110mio next year

10% discount rate estimation error: discount rate used at 11%

Analysis:

 PV correct = 100/10% = IDR 1,000

PV cf error (10%) = 110/10% = IDR 1,100 (=10% error from PV correct above)

PV dr error (10%) = 100/11% = IDR 909 (=9% error from PV correct above)

In this simplified short-term project, the error made in CF yields bigger impact to the PV).

Long-term projects: assuming the cash flow to be generated in 25 years, instead, next year.

PV correct = 100/[(1+10%)^25] = IDR 9.2

PV cf error (10%) = 110/[(1+10%)^25] = IDR 10.2 (=10.00% error from PV correct above)

PV dr error (10%) = 100/[(1+11%)^25] = IDR 13.6 (=20.25% error from PV correct above)

From the simplified long-term project example, the error being made from discount rate has much bigger impact to the PV, compared to that 10% estimate error on the cash flow.

Will this mean that for the long-term projects, estimating correct discount rate is more important than getting the a better estimation of cash flow forecast?

Not really, this could mislead us, since we are talking two things of estimation that are not apple-to-apple to compare.

Estimating cash flows into the next 25 years are quite challenging, and I could say 100%, we will totally be like a fortune-teller than a person coming out from valuation course. The uncertainty will be extremely high over longer horizons. On the other side, the uncertainty in estimating the cost of capital in the long-term tends be “predictable” in the sense, we could use 5-year, 10-year, 30-year bonds as a starting point to look at. Historically, the interest rate range is not that wide enough to make it too hard to predict that in the long-term.

Other thing error is not about what we put there in cash flow forecasting but the execution issue. Meaning forecasting error might not be the issue.

Ignacio Velez-Pareja’s response:

You are right. However, this is the most common approach to valuation: a point use of the tool. No. As you say, management is something dynamic. You should not use the tool to get a magical number and close a deal. My idea is that the valuation tool, the financial model, should be used permanently as a management tool to keep value in line with the goal. 

The market is full of Value Management courses, seminars and workshops. However, they do that is on the thin air. How could you manage value without knowing it? The financial model to value the firm today should be used PERMANENTLY as a management tool to track and keep value in line with the goal! Follow?

It is crazy to think that forecasts will be achieved without the hand of management. It is a permanent fight between reality and plans. Of course that reality will deviate from plans and the manager should have the tools to CORRECT what reality makes on our plans. And here the financial model is the clue. Reality changed my plans and the calculated value. What should I do in order to “recover” the value lost this month or this year? How much should I change my strategies and which of them to keep value on track?

What I teach is that valuation should not be used to know the value today, close a deal and forget what is in the valuation model. It should be considered a management tool to manage by value! That is the clue of all this we do on valuation. It is beyond determining a value at a point in time. It is a dynamic process and the financial value model is the proper tool to manage Value.

This makes a lot of difference.

Back to Prof. A. Damodaran’s blog, I agree that we need to keep an open mind when we are building the projected cash flow and discount rate, and be aware of that the error behind cash flow might play a bigger role in yielding “veered so far from the mean”.

5 February 2017

 

 

 

QUICK DISCUSS Ignacio Velez-Pareja on the Book : PRINCIPLES OF CASH FLOW VALUATION

Karnen

FCF under Tax and No Tax can’t be the same

I prefer

Under no Tax

FCF = CCF = CFE + CFD

 

Note :

 

FCF = Free Cash Flows

CCF = Capital Cash Flows

CFE = Cash Flows to Equityholders

CFD = Cash Flows to Debtholders

Ignacio Velez-Pareja (IVP)

 

Of course not

Under Tax

FCF (above) – Corporate Tax + TS = CFE + CFD

 

Did I say it was the same?

 

NO

The equilibrium equation for cash flows is CCF or Total Cash Flows = FCF + TS = CFD + CFE. In all cases FCF, CFE are after taxes

FCF comes from EBIT (1-T) always. T could be 0 or >0

 

Karnen

That is clearer

but

EBIT (1-T) is not always correct

I prefer FCF – Corporate Tax

Corporate tax is not necessary EBIT * T

 

IVP

 

Sure, EBIT (1-T) is not always correct

 

Karnen

 

This is why

Under No tax

FCF = CCF = CFE + CFD

under Tax

FCF (under No Tax) – Corporate Tax + TS = CFE + CFD

this is what I think it correct

 

IVP

Listen, I teach all the recipes for CFs. BUT what I also teach and do is to construct the CB and from there I just change the sign to the Net Cash Balance of the modules for debt and equity nd you have the CFD and the CFE. Knowing interest paid (or in general financial expenses), you know TS

 

Karnen

Totally agree with that

IVP

 

Not correct – Corporate tax

 

Karnen

but the way in your book

saying under No Tax, the FCF is the ssame like under Tax

I don’t think it’s correct

FCF (under No tax) – Corporate Tax + TS = CFE + CFD

 

IVP

 

Listen, there is a problem with some names in the literature.

First, unlevered value is in reality as if there were no taxes. The issue comes from 1958 M&M. They said the pizza doesn’t change in size whatever the way you divide it. Hence unlevered or unlevered is the same. Later what they said? They said, listen, when taxes the way you divide the pizza is relevant BECAUSE there are TS. Then the difference is in having or not taxes.

 

Second, it is not – Corporate Taxes. It is minus corporate taxes ON EBIT

FCF is defined as unlevered cash flow. And it is EBIT(1-T) (of course not always correct). Depends on the relation of EBIT and financial expenses

 

Karnen

I agree with you

I guess I got something from your book

many standard textbooks didn’t say this unfortunately

IVP

 

It is not Corporate taxes. It is EBIT after corporate taxes and adjust it by investment working capital etc

 

Karnen

Yes

however, in your book  as you use FCF

IVP

 

Then what is the problem?

we don’t use FCF

 

Karnen

I read chapter 1 or 2 where you gave the expression 

under no Tax

FCF = CFE + CFD = CCF

under Tax

FCF + TS = CFE + CFD

this could confuse the readers

FCF from the above two equations are not the same

FCF under Tax = FCF under No Tax minus Corporate Tax

IVP

 

Well, it is understood that FCF in the first case is with no tax and the second FCF is under tax

no tax

of course they are different

you might be interested in this paper: http://papers.ssrn.com/abstract=1604082

IN short: all variables the same with no taxes FCF = CFE+ CFD. With taxes FCF = CFD+ CFE – TS. You are concerned with FCF equal or not. However, the same has to be said for CFE.

 

Karnen

Under “Tax”, FCF should be less as there is outflows to Tax Office,
though with the presence of the Debt, this tax liability is not that
high, since there is a tax shield from interest deduction.

What do you think?

IVP

Probably the basic idea is there and you have read that before under not taxes CFE is different from CFE with taxes. That is obvious

agree?

 

Karnen

Yes thanks for bringing this to me

many things that I don’t find in the standard book

I believe unless they read your book or papers

not many finance people have this understanding

even though they are finance professors

even M&M

but yeah…M&M is the first bringing this to light

IVP

 

sure!!

See how getting the CFs from the CB! How easy is getting

As I told you we have developed a methodology to help the reader on linking the forecasted data to the ongoing firm’s Financial Statements. The basic idea is to solve every mismatch at the time it appears and not letting mismatches to accumulate.

 

 

Karnen

By the way, I am now on page 97. My comments, the book doesn’t always use consistent terms and what it is really meant. For example, CRO is in deed cash and cash equivalents, yet this cash and cash equivalents as we know include as well excess funds placed at less than 3 months’ time deposits. So it is not really purely Cash Required for Operations. The book’s approach is to come up first with the projected (assumed) CRO change and ultimately Cumulative Cash Balance at end of year. However, from outside, it is not too easy to get the ideas about how much cash balance in the balance sheet that is really needed to be kept for operations. I guess it is mainly because as analyst, we don’t always the luxury to access this information and by only have one balance at one point of time once in one year, it will be almost impossible to be sure about the operating cash.

“That chapter is also using marketable securities and short-term investments, but have no explanation what is the difference.” but I think I answered it.”

IVP

I see you are very fond of our approach to explain traditional WACC and Ke (and other non traditional approaches).

Well, in fact, CRO is cash in hand. It doesn’t include quasi cash items (read this a short term investments and similar). In practice what I do for this, is to define a policy of maintaining cash in hand. That policy arises either from firm’s or industry’s historical financial statements as a % of some item say expenses, or sales (policy = Cash in hand/Sales, for instance).

In our model, we use in fact the pecking order approach. This is that when we require funds for an investment, we start using the internally generated cash (this is Module 1 (Operating module) where we have inflows from sales and AR minus any payment for purchases in cash and/or AP, plus income taxes.”. Didn’t I? Let me see if there is something additional…

I guess this is one. I have not answered it. I will.

 

 

Karnen

 

I just finished reading chapter 6 The Derivation on Cash Flow.  One small comment, even though that chapter gave a lot of detailed reconciliation among many numbers of EBIT, NI, CB, Total FCF, Operating FCF, Total CCF, Operating CCF, etc, etc, yet I don’t see any suggestion about which FCF or CCF the author is to use. I guess it might confuse the readers. It seems to me, the favorite one for Authors is CFD +CFE taken from CB.

Back to this Operating and Non-Operating of CCF and FCF, I guess the authors want to show that in valuation context, Operating CCF or FCF excluding the change in marketable securities is the one to use. If that’s the case I agree, since in my practice I took out time deposits of more than 3 months’ due and other marketable securities from FCF, and add them up onto the Enterprise Value, which means we don’t have to value them. We took their face value as of valuation date. In certain exercise, I read other book, the analyst even took out the cash on hand and in banks (probably because the analyst finds it relatively difficult to split the portion belonged to operations and non operations (excess cash that is temporarily being kept at bank). However, I guess, your point is we need to value separately marketable securities or any excess cash as they earn interest rate different (mostly lower) than cost of capital.

 

IVP

 

Well, the first question is about how to calculate FCF. We show, the traditional methods starting from, say, EBIT or NI. From CB what we do is FCF = CCF-TS= CFD + CFE – TS. TS IS NOT included in the CB. It has to be calculated with a formula that covers the three cases we have discussed months ago.

This is

case a) EBIT+OI > Fin Expenses (FE) TS = Tx*FE. Case b) 0<EBIT< Fin Exp TS= Tx*EBIT and c) EBIT<0. TS=0.

case b) might be frequent in startups and even in ongoing concerns. There is a compact Excel formula to take account of ANY of the three cases.

The minus sign i FCF = CFD + CFE – TS is because FCF has no TS effects, it is unlevered (this is a misnomer, because it should be named as with no TS effects.. and as you can see, the equilibrium equation (that comes from M&M) says FCF + TS = CFD + CFE.

The xls formula for TS is =Max (T*Min(EBIT+OI;FE);0)
All variables come from the Income statement. I prefer to define FE and not Interest because there are financial expenses different from interest or, in general, not linked to Kd. For instance losses in exchange, bank commissions, Inflation adjustments to financial statements. Even it could be some deductions on dividends paid as it happens in Brazil. They can deduct a % on dividends paid.

Karnen

Ku is the better way in doing that, no circular and TS could be addressed separately. The key issue is how to get this Ku? Do you have the paper showing us as to how to derive implicitly this Ku from the market or public data. Pls don’t tell me we could have this Ku by doing interview with the market participants (big smile). You could download Pepperdine University Research Report to see the research on cost of capital for private markets. I am a bit worried that with all so many valuation books, at the end of the day, all we need to do is just conducting questionnaire, survey, etc to obtain cost of capital. What a waste of time in reading all those books.

 

IVP

Thanks for your comments.

 

Two issues: circularity and direct method to get Ku.

 

Assuming Ku as discount rate for TS does not grant absence of circularity. Circularity exists on methods that use CFE and Ke and FCF and WACC for the FCF. The methods with no circularity are CCF and APV. Also, with Ke as discount rate for TS you can get a method without circularity.

 

The issue of Ku. This is a promising area of research. As you let me know years ago, there are some work for that applied to non-traded firms. Remember?

 

Meanwhile, what I usually do is to rely on Bu estimated by Damodaran unlevering levered beta for traded firms. In this case, I “validate” Bu and/or Ku, yes, interviewing the specific investor (in the case of a non-traded firm).

 

I think there is a lot of work to be done in this area.

 

The problem is to properly asses the Ku !!! That is it!

 

On the other hand, as ALL methods result in the same value, given a discount rate for TS, the conclusion is very simple: use the easiest and simplest method or formula (non circular). In other words, there is no such thing as the best method for valuing X, Y or Z type of firms! All methods are good for ANY firm.

 

Additionally, it is important to note what are TS about and what are TS for.

 

I don’t remember if we presented there the idea of three pieces formula for TS. This is,

 

  1. TS = T*FE if Ebit + OI > FE
  2. TS = T*Ebit+OI if Ebit + <FE but >0
  3. TS = 0 if Ebit+OI <0

TS = Tax Shield

T = Tax rate

FE = Financial Expenses (net of Interest Income)

OI = Other Income

EBIT = Earnings Before Interest and [Corporate Income] Tax

The other idea you should stress is that thinking on TS as KdDT is an over simplification. TS might be generated by other sources different from Kd. For instance, Losses in exchange rate when you have debt in FX. For that reason I use FE financial expenses, in the above three-pieces formula and not KdTD.

Karnen

On potential dividends, I guess I agree with your ideas, this potentially increases the FCF and the calculated value. One question, if you take out from FCF for those cash and quasi cash being kept temporarily at Balance Sheet, I believe we need to value it separately from, let’s say, cost of funding capital, instead apply the interest rate that the company could earn at the going market rate. Agree?

 

IVP

 

The issue is this, when you have your model, eventually you have excess cash that you invest at short term. This clearly has a poor return and that “penalizes” cash flows. When you have the N CFs, at the end you include a Terminal Value calculated somehow with a perpetuity. But that is not all you have at time N. At N you recover what I call trapped cash. Trapped cash is the result of taking the cash and quasi cash items plus AR discounted at the discount rate minus AP discounted as well. This becomes what I call the Adjusted TV that is composed, as said, of the perpetuity plus the trapped cash (I know that trapped cash has a different meaning as seen at https://www.treasurers.org/node/8474) but that is literarily the name we have in Spanish.

 

The short-term funds usually earn much less that the cost of capital due to the low risk it has; however, it should be penalized discounting the returns at your cost of money. In fact, ANY stockholder might claim not to invest at low rate but distribute it to owners. As it is not distributed, that is a loss that should be reflected discounting the CFs from that bad investment. Assuming Potential Dividends is a fiction because you in fact, don’t distribute it and yet you keep it invested in Certificates of Deposit or similar. Follow?

Karnen

Could you kindly elaborate this:

But that is not all you have at time N. At N you recover what I call trapped cash. Trapped cash is the result of taking the cash and quasicash items plus AR discounted at the discount rate minus AP discounted as well. This becomes what I call the Adjusted TV….
I understand that FCF being taught at many textbooks are not correct, since this FCF includes the excess cash which is in fact, not distributed (though distributABLE), yet the fact still it is staying at the company’s books, and in many cases, doesn’t earn as much as the cost of capital. In other words, it is invested at much lower rate (bank saving rate) than the cost of capital being used to discount the projected FCFs.
However, I am a bit not clear about how to adjust this excess cash out of Terminal Value. But I guess, this is really dependent on how we calculate the TV. There are so many ways in this case, but if we use such as FCF_t x let’s say 5, this is not correct, since FCF_t includes the excess cash which we could and should take it out.
IVP
Well, let me tell you something that perhaps you are not aware of it. Usually traditional books define Working Capital, WC, as Operating Working Capital. This means that they EXCLUDE cash and quasi cash from it. The effect of doing this is that when you increase/decrease cash and quasi cash, the effect is to distort the FCF, when you subtract the change in WC.
We define Working Capital as it is defined in Accounting: Current Assets – Current Liabitilies including ALL items (except ST debt). This means that an increase in WC will be subtracted and reduce the FCF (or the CFE). Hence, we don’t have Potential Dividends in our analyisis. Potential Dividends are a fiction.
Given that, we have our FCF (or CFE) without fictions. If the funds are in the BS we don’t distribute them. Why? because they are either in the vaults of the firm or in the bank. Impossible to distribute something that you keep in hand or in the bank.
Now we go to the TV. The TV for us, has 2 components: a perpetuity + liquidation of current assets available. Remember that TV is calculated from NOPLAT and assumes that ALL generated operating cash will be available from N+1 and on. HOWEVER, a real firm, has AR, AP to be received and paid say, at N+1 plus cash or quasi cash that you have in hand. If you disregard this you have some value lost: the cash in hand, the AR and AP (net) at N+1. You will agree that leaving those funds in the BS they will vanish! They are not captured by the CFs. Hence, what we do is to recover any cash or quasi cash we show in the BS, assume that AR and AP will be received/paid on N+1, hence, we discount them at WACC. This is what I call trapped cash. As AR and AP will be received/paid at N+1, what I do is to discount them at the WACC and add the result to the perpetuity.
Hence, as said, my total TV is composed of a perpetuity (from NOPLAT) that accounts for any funds generated from N+1 and on and the recovered cash from cash and quasi cash in hand plus AR discounted one period at WACC and minus the AP discounted one period at WACC. The assumption when using NOPLAT is that you don’t have AR, nor AP, nor cash or quasi cash on hand.
Adjusted TV = Perpetuity + Net trapped cash as said above.

Karnen

 

How to take out that trapped cash from TV. I guess, the key is lying on the FCF

TV is built in many formulas on the FCF_t

Need to be careful on that, not to include trapped cash

Is that what you are saying, right?

 

IVP

 

Yes. The FCF does not have AR and AP from year N included. Follow?

 

Karnen

AR and AP is part of the working capital. How come we took them out?

Excess cash, yes, I agreed, they are to be excluded but not AP and AR

Business relies on the AR and AP, the “bread”, excess cash is the ‘butter’.

 

IVP

Wait. I follow the idea of Copeland (Valuation textbook). TV = NOPLAT_n(1+G)(1-g/ku)/(WACC-G)

Answer this question: Are AR and AP included in FCF_N?

Karnen

 

Yes, of course, we can’t have FCF without those two very critical ingredients.

 

IVP

Ok. Then ask this one: When using NOPLAT_N or FCF_N in the TV Formula, do they have the AR and AP from N?

 

Do they? Explain how FCF_N includes AR and AP at N.

Karnen

The movement of AR and AP to come up with the cash flow, I am talking about “stock” but “flow” because only through the “flow” we could get the estimated FCF.

 

IVP

The AR and AP ARE NOT in the FCF!!! They are not received but until next period by definition

Have you received AR and AP from N at N?

Do we agree that with FCF_N we leave out AR_N and AP_N? Again: you have your BS at N. That includes AR_ and AP_N agree?

Karnen

How much big? FCF will come, FCF is the result, AR and AP is the ingredient.

In the extreme way, talking about perpetuity, I don’t care about AR and AP whether be part of FCF or not

It will be somehow realized to cash someday sooner or later

In finite cash flow context, yes, we care about the timing of the cash stream coming to the company pocket, but in perpetuity, it’s very different story.

 

IVP

Yes, but the idea in the indirect method is no eliminate all the elements that are not or should not be included in the FCF. When you subtract the change in WC what you did is to recover the AR and AP from N -1 and leave in the BS the AR_N and the AP_N.

 

Karnen

TV is at the end of 5th year, 10th year? Many valuation analysts put TV “too quick”

 

IVP

Wait. We have to clarify the ideas of what happens with AR and AP at N.

TV is the value of firm at N.

 

Karnen

But TV could be anything, we even could use whatever formula we want to see, EBITDA multiple, FCF multiples.

 

IVP

Do we agree that AP and AR from N are in the BS of N and not recovered with FCF_N?

[Using] Multiples are challenging.

 

Karnen

TV could be whatever concept we want to put there, liquidation, sustaining value.

AP and AR at end of projection formula, they are supposed to be sitting at Balance Sheet_N.

 

IVP

 

Ok, let be clear about what happens with AP and AR at N. If you use liquidation value at N then you recover your trapped cash.

Let’s do the TV as a perpetuity. Agree?

 

Karnen

 

Yes, in M&A – the seller will say, and could treat AR  and AP as “cash”. It means the seller will consider AR is “cash”, they want the buyer to pay that, net of AP of course. In that means at N, we could treat AP and AR as “cash”, or whatever you name it.

 

The seller and buyer want to put “cash” on that, you follow me?

AR = “cash” to receipt.

AP = “cash” to pay.

 

IVP

 

When you calculate the WC you don’t consider AR as cash.

 

Karnen

 

Both we could treat as “cash”, though sitting on the Balance Sheet, but from the M&A perspective.

 

IVP

 

Ok cash BUT at period N+1.

 

Karnen

 

They are “cash”, the seller/buyer want both (AR and AP) be considered in the price. Assume no AP, then

the price + AR.

 

IVP

 

They are AR, not cash. Cash is what you have in hands and/or in a Short-term investment.

 

Karnen

 

Because the seller knows in advance, the AR collection will come as cash to the buyer’s pocket once they signed the M&A, so AR = cash at terminal value.

 

Under finite stream of cash, this is different.

 

IVP

 

Ok. That is what we assume that happens to calculate the trapped cash. Only that I recognize that it is cash to be received at N+1.

 

Karnen

 

This is why I agree with your finite concept, that trapped cash in the perpetuity concept, not necessarily N+1.

 

IVP

 

That is the reason I adjust the AR by a discount factor.

 

Karnen

 

From the seller’s perspective, they could collect from the buyer, earlier even. We don’t even need discount rate, to assume AR = Cash on N+1.

 

IVP

 

Under normal conditions, you collect AR when they are due. Usually next period.

 

Karnen

 

But on TV?

 

IVP

 

On TV, there are not AR.

 

Karnen

 

The seller wants to collect/pocket it quicker, not N+1. The collection comes from the buyer’s money.

AR could be on average only [extendable] 30 days, not one year.

 

IVP

 

Sure but you can’t request the customer to pay now after he has had a term to pay later.

 

Karnen

 

Or even due within 1 day, if the buyer is the customer itself.

IVP

 

Ok, then change the period to months. No problem. All my valuations are done on a monthly basis. The problem is the same.

 

Karnen

 

The seller-buyer treats AR as “cash” on the terminal value.

 

IVP

 

Wait and explain. You are saying that a firm has some AR.

 

Karnen

 

Theoretically I am nodding my head in agreement with you, but in reality, talking about TV I meant, AR could be seen as “immediate cash” for the seller, not necessarily N+1.

You limit your analysis to normal condition, but in reality, once in M&A world, normality is an exception.

 

IVP

 

And the firm is merged or sold. Hence the new owner goes to the customer and says, “Well I am the new owner and I demand you to pay immediately your AP with my firm. The customer will answer: NO: I have been given a term of 30-60 days, whatever to pay and I will stick to it.

 

Karnen

 

The seller wants to pocket the money as quickly as possible, since they are going to lose the control immediately.

 

IVP

 

Explain how is it managed with the customer?

 

Karnen

 

Again, as I said, customer could be the buyer itself. You need to be clear in your analysis, in the case the buyer is the customer.

 

IVP

 

That is a special case. Forget that, take a more general example.

 

Karnen

 

No 30 days, but in TV again, it is all about negotiation.

[Under] Finite, it’s a bit different.

 

IVP

 

Ok fine. If that is the situation, you have the cash immediately at N (240 months from today).

 

Karnen

 

TV – we could put whatever both parties agree to put there.

 

IVP

 

Of course.

 

Karnen

 

Again, EBITDA multiple, EBITDAR multiples, etc.

 

IVP

 

Are we discussing general cases or specific cases?

 

Karnen

 

FCF, whatever, or even they could just grab the number from thin air.

AR = cash for the seller. They don’t even care whether the buyer will collect within 30 days or more

Follow? Negotiation could be a nasty thing, the seller wants to pocket something as quickly as possible.

 

IVP

 

Listen, when you model a situation you include whatever you think it is going to happens. If you say that AR will be collected immediately, then we can model that and no problem.

 

Karnen

 

TV is not easy to put a formula on that, we could come with very elegant formula.

if we can have one formula, life will be much easy for everybody, seller and buyer.

TV, I am going to go to sleep, if somebody tells me about TV. I like it when you said TV is a bit problematic.

 

IVP

 

Listen, when I teach this I get embarrassed because I do a lot of efforts in forecasting the financial statements and I have to end with a gross approximation such as the TV. Usually I use three estimates of TV:

1) liquidation value,

2) non-growing perpetuity and

3) growing perpetuity.

 

Karnen

 

Other than those 3 formulas, there are out there many formulas, even something that is not making sense.

 

Many M&A failed creating value, because it is so hard to define TV, please read the books on why M&A failed, too expensive price.

 

IVP

 

Even you can use that questionable TV to fix a pre-defined value of firm if you wish.

 

Karnen

 

Too much “goodwill”, this is because awfully difficult to say which TV is correct.

No good formula for TV. This is my conclusion so far, still a black and red box to me.

 

IVP

 

I give a **** for TV as a perpetuity.

 

Karnen

 

We could put into that box whatever we want, TV 80% – 90% of the value, very hard to believe.

 

IVP

 

Listen you are assuming CONSTANT inputs for perpetuities. THAT is similar to the questionable multiples.

 

Karnen

 

Yes..yes…, time constant rate of return, but everybody use that.

 

IVP

 

Usually I try that TV is not more than 25% – 30% of total value.

 

Karnen

 

TV is an elusive concept.

 

IVP

 

I say that and I say that in my courses. I tell my students listen, I am ashamed to arrive to this issue. We have been working hard to make the forecasting of financial statements and sharpening the pencil to put the better numbers as inputs to end with a questionable perpetuity.

 

Karnen

 

We must project the CF for into 30 years, sounds a “voodoo” to me, not an analyst.

 

IVP

 

Sure.

 

Karnen

 

A voodoo analyst.

 

IVP

 

Sure.

 

Bottom line: we agree that TV is a mess. TVs as perpetuities are a mess. No TV is nonsense, then what to put at N as value of the firm=? I have NFI.

 

Karnen

 

Use many formulas, that’s my suggestion, no single formula fits all sizes, all might be justifiably correct.

The seller in my experience, will pick up the highest value, and the buyer will pick up the lowest, that’s reality!

 

Ignacio Velez Pareja

 

This is my short criticism to the TV:

The calculation of the terminal value is a very risky exercise since it requires making very strong assumptions and a very simple tool is used for its calculation. However, experience indicates that this terminal value is often what defines whether a project is good or not. Some (including the authors) have observed that this terminal value can account for more than half of the present value of the flow of a project. It depends on the number of periods in the projection. This is understandable, because for a greater number of years in the projection, the relative value of the TV loses importance when discounting it to the period zero.

What do you think? Is it strong enough? Does it reflect my position posed yesterday?

 

 

Jakarta,  Jan-Feb 2017