Valuation & Biz-Modeling

Valuation Methodologies

Case 1: Miheer H Mafatlal v. Mafatlal Industries Limited (1996) 87 Com Cases 792 (Supreme Court).

Fair exchange ratio based on Manageable Profit Method, Net Worth or Break up Method and Market value accepted by the Court. In general parlance when the valuation has been worked out by a recognized firm of chartered accountants who are experts in their field of valuation, it is not for the court to substitute the exchange ratio .

Case 2: Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others (1995) 83 Company Cases 30) (Supreme Court).

The jurisdiction of the Court in sanctioning a claim of merger is not to ascertain mathematical accuracy if the determination satisfied the arithmetical test. A company court does not exercise an appellate jurisdiction. It exercises a jurisdiction founded on fairness. It is not required to interfere only because the figure arrived at by the valuer was not as good as it would have been if another method had been adopted. What is imperative is that such determination should not have been contrary to law and that it was not unfair for the shareholders of the company which was being merged.The hon’ble Supreme Court held “We do not think that the internal management, business activity or institutional operation of public bodies can be subjected to inspection by the court. To do so, is incompetent and improper and, therefore, out of bounds.”In the instant case the court accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the valuation was based.

Case 3: Duncans Industries Ltd. vs. State of UP (Supreme Court).

The Supreme Court in Duncans Industries Ltd. vs. State of UP held that the question of valuation is basically a question of fact and the Supreme Court is normally reluctant to interfere with the finding on such a question of fact if it is based on relevant material on record. The Court further observed that the authority relying upon the valuation has to also apply its mind while approving/accepting the report of the approved valuer, while fixing the reserve price.(Similar view in Balco’s Employees Union vs. Union of India, Anil Kumar Srivastava vs. State of U.P.; Ram Kishun vs. State of U.P)

Case 4: Dinesh Vrajlal Lakhani vs. Parke Davis (India) Ltd (Division Bench of the Bombay High Court)

In this case, it was ruled that the Court will not for instance interfere only because the valuation adopted by the valuer may have been improved upon had another method been adopted. The Court is neither a valuer nor an appellate forum to reappreciate the merits of the valuation. What the court has to ensure is that the determination should not be contrary the law or unfair to the share holders of the company which has been merged.

Case 5: Re: German Remedies Ltd (Bombay High Court).

The Bombay High Court in re: German Remedies Ltd held that it is not for the court to sit in appeal over the valued judgment of the equity share holders who are supposed to be commercial men. Commercial men who know their common benefit and interests underlying the proposed scheme, with open eyes, have Okayed the swap ratio by an overwhelming majority of 90 per cent in numbers and 99 per cent in value of the members present and voting. The limited jurisdiction of the court is only to see whether the ratio is wrong or the error is as gross as would make the scheme unfair or unjust or oppressive to the minority of the members or any class of them.

Case 6: Re: Brooke Bond Lipton India Ltd. (Calcutta High Court).

In the matter of Re: Brooke Bond Lipton India Ltd., the Calcutta High Court has held that in a scheme of amalgamation, if the ratio of exchange has been fixed by an experienced and reputed firm of chartered accountants, then in absence of any charge of fraud against them, court will accept such valuation and ratio of exchange. A mere allegation of fraud is not enough; it must be a proper charge of fraud with full particulars. In the instant case, there is no charge made or established.

Case 7: McCathie v Federal Commissioner of Taxation - [1944].

The dominance of profits for valuation of share was emphasised in “McCathies case” (Taxation, 69 CLR 1) where it was said that “the real value of shares in a company will depend more on the profits which the company has been making and should be capable of making, having regard to the nature of its business, than upon the amount which the shares would realize on liquidation”. This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.) (122 ITR 38).

Case 8: COMMISSIONER OF WEALTH TAX vs. MAHADEO JALAN & Others (Supreme Court) 1972.

The real value of shares which a deceased person holds in a company at the date of his death will depend more on the profits which the company has been making and should be capable of making, having regard to the nature of its business than upon the amount which the shares would realise on liquidation.

Case 9: Ascendas (India) Pvt Ltd. (Chennai Tribunal).

The Income-tax Department has recently started giving importance to adoption of DCF approach for valuation of equity shares wherever a valuation is required.

Case 10: Mrs Renuka Dalta, Companies Act, 2003 (Supreme Court).

The Valuer considered three methods of valuation. (1) Asset based (2) Earning based (3) Market based. While working out the earning based valuation, the value on the basis of capitalization of past earnings was adopted. The discounted cash flow method which is the commonly used methodology for future earnings based valuation was eschewed from consideration. The reasons given by the valuer are; (1) No independent (third party) projections have been provided; (2) Both parties have provided projections which differ substantially. Since the value of a company/business would be more influenced by its earnings value a higher weightage is given to the earnings value as compared to its asset value. The valuer considered the following weightage for determining the intrinsic value * Asset based value 1/3rd weightage. * Earnings based value 2/3rd weightage. The court well accepted the methodology of valuation done by the valuer.If the valuer adopts the method of valuation prescribed, or in the absence of any prescribed method, adopts any recognised method of valuation, his valuation cannot be assailed unless it is shown that the valuation was made on a fundamentally erroneous basis, or that a patent mistake had been committed, or the valuer adopted a demonstrably wrong approach or a fundamental error going to the root of the matter. Where a method of valuation is prescribed, the valuation must be made by adopting scrupulously the method prescribed, taking into account all relevant factors which may be enumerated as relevant for arriving at the valuation.Attorney-General of Ceylon v/s Mackie"Generally a valuation is justified with reference to the asset base of the firm, however in the above case, this method was not accepted because of the fluctuation of profits and uncertainty of the conditions at the date of valuation."

Case 11: CGT v/s Kusumben Mahadevia and CGT v/s Ambalal Sarabhai (Supreme Court).

"Hon’ble Supreme Court held that if a company is a going concern, then only yield method is appropriate method and break-up method cannot be adopted to determine value of unquoted equity shares." It held that the correct principle of valuation applicable to a given case is a question of law. The parties can agree upon a principle permissible under and recognized by law. If two or more alternative principles are equally valid and available, it might be permissible for the parties to agree upon the alternative modes of valuation in preference to another.

Case 12: Tolley, Re Elder's Trustee & Executor Co. Ltd. V. Commissioner of Succession Duties, 1932, S.A.S.R.

Buyers & sellers in the open market would be more directly influenced by the apparent earning power than by complex calculations on net assets, but those assets would be regarded generally for assurance that returns would be maintained.

Role of Court

Case 1: Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. (Rajasthan High Court).

The Regional Director raised an objection that no valuation report has been filed and that the exchange ratio for amalgamation has not been worked out by an independent valuer. The Hon’ble Court overruled this objection and sanctioned the scheme of amalgamation by holding that there was no legal or factual impediment to grant sanction to the scheme of amalgamation.

Case 2: Advance Plastics (P) Ltd vs Dynamic Plastics (P) Ltd (Bombay High Court).

The shares are the properties of the shareholders and they are the ultimate and the best judge of the value they would put on their charges. There is no requirement in the Companies Act that in such a case (i.e. amalgamation) the ratio of exchange has to be determined on a valuation made by a chartered accountant and auditor. In the present case, no shareholder has challenged the amalgamation. In the circumstances, valuation report is not necessary.

Case 3: Division Bench of the Bombay High Court in Anup Kumar Sheth vs Reliance Industries Limited and Others

In this case, it was held that in absence of any material contradicting the conclusions reached with respect of valuation of shares and its fairness, it would be difficult to come to a finding that the conclusions drawn by expert were absurd.

Stamp Duty

Case 1: Delhi Towers Ltd. v. G.N.C.T. of Delhi MANU/DE/3152/2009 (Delhi High Court).

There are no judicial precedents that have held that the court is empowered to consider the merits of the terms on which the scheme for amalgamation has been proposed by the consenting parties. On the contrary statutory provisions mandate and judicial precedents have held that even a modification suggested by the court is required to have the approval of the shareholders and the creditors before it can be incorporated in the scheme. No adjudication is involved. The role of the court is merely supervisory within the contours of the broad parameters noticed hereinabove without ruling on the merits of the schemes placed before the court and its consideration is confined to the issue that the scheme was not violative of the principles of law, public policy and, was not opposed to public interest.

Case 2: Li Taka Pharmaceuticals Ltd. v. State of Maharashtra and other Bombay High Court.

Valuation on the instrument of the amalgamation scheme sanctioned by the court, after due verification, is to be determined by the stamp authority only on the basis of the price of the shares allotted to the transferor company or the consideration, if paid, but not separately valuing the assets and liabilities.

Discount on lack of marketability (DLOM)

Bharat Hari Singhania , wealth tax, 1994 (SC).

The Court has accepted the Net Asset Value less 15% in deciding the value of shares of unlisted company in accordance with the erstwhile CCI Guidelines

Control Premium

Case 1: Murdoch's Perpetual Trustee Co. V. Federal Commissioner of Taxation (re Sir James Murdoch) 65 C.L.R. 573.

It is evident that Parcel of shares sufficient to carry special resolution may have higher value than parcels which are insufficient for that purpose.

Valuation of Infrequently Traded Shares

G.L. Sulatnia and another; H. L. Somany and Others & R.K. Somany and Others v. SEBI (2007) 137 Comp Cas 658 (SC) .

Valuation of infrequently traded shares came up for the consideration of the Supreme Court in the case of G.L. Sulatnia and another; H. L. Somany And Others & R.K. Somany And Others v. SEBI (2007) 137 Comp Cas 658 (SC). In that case, the grievance of the appellants before the Securities Appellate Tribunal (SAT) was that the Securities and Exchange Board of India (SEBI) as well as the concerned merchant banker had not properly valued the shares of the target company in accordance with the parameters laid down in regulation 20(5) of the SEBI Takeover Regulations.

In the words of the Supreme Court,” What the aforesaid regulation, however, mandates is that the parameters expressly laid down therein must in all cases be considered by the valuer since they are basic and essential to the valuation of infrequently traded shares of a company. If the valuation report discloses non consideration of any of the enumerated parameters, the report shall stand vitiated for that reason. That however does not prevent the valuer from considering other relevant factors according to accepted principles of valuation of shares”.

In other words, what the apex court has stipulated is that every valuer is required to strictly adhere to the requirements of the said regulation 20(5) and any failure on the part of the valuer to take cognizance of any of the parameters stipulated therein could prove fatal to the valuation. At the same time, it should also be noted that no single parameter can itself be decisive. What it implies is that due weightage should be given to the different factors that go into the process of valuation. However, as remarked by the apex court, the exact factors would have to be left to the wisdom, experience and knowledge of the experts in the field of share valuation.

Therefore, it is pertinent to remember the words of the apex court that, “Mathematical precision and exactitude are not the attributes of share valuation, for at best the valuation arrived at by an expert is only his opinion as to what the value of the share should be. No doubt the variation may not be very wide between two valuations prepared honestly by two valuers applying the correct approach and the correct principles, but some variation is unavoidable.

In case of any doubt about fair valuation, SEBI has been empowered to get valuation of such shares done by an independent merchant banker.

Cadbury India case law

Re: Cadbury India Limited

Facts of the case

Cadbury convened an extraordinary general meeting (EGM) on 16th November, 2009, in accordance with section 100 of the Act, and a special resolution was passed by majority approving, buyback of shares and reduction of capital.

  • Cadbury had obtained two valuation reports, by M/s Bansi S. Mehta & Co. and M/s SSPA & Co. which returned a value of INR 1,340 per share (Original Valuation Price).
  • However few small minority shareholders took exception to the Original Valuation Price, the Court directed for a fresh valuation to be done by an independent firm as Cadbury sought Court’s sanction to settle dispute with minority shareholders.
  • The independent firm first returned a value of INR 1,743 per share using the Comparable Companies Method (CCM), based on unaudited accounts up to July 2009. This report was later ordered to be updated to also factor in Discounted Cash Flow Method (DCF) method of valuation for the shares. The revised value returned was INR 2,014.50 per share (Revised Valuation Price), based on the unaudited accounts of September 2009 and with equal weightage given to DCF and CCM methods of valuation.
  • The Court finally approved the resolution on the basis of revised Valuation Report.
Minority shareholders’ contentions and the Court’s view on Valuation
  • Terminal growth rate has been estimated at 6% while sales and profits are growing by 20% and 40%, respectively. A conservative terminal growth rate is probably more accurate indication of a projection.
  • Income tax rate has been considered at a flat 33.99%. The submission is that since Cadbury India "enjoys various tax benefits, its profits are being taxed at the rate lower than 20% over the past few years. A flat tax rate in a projection might, in fact, provide a very realistic and fairer value than something that is presently at a lower marginal rate.
  • The second E & Y report was based on unaudited financial statements as on 30th September 2009. No fair valuation can ever be made on basis of unaudited accounts. There is neither logic nor material to support this. E & Y applied the weighted average P/E multiples on Cadbury India's consolidated Profit after Tax (PAT) for the year ending 31st March 2009. If, for instance, the PAT is unavailable for a given date for one of those companies, a valuer would be justified in falling back on the last available PAT figures.
  • E & Y adoption of Cadbury growth rate @ 6%, though its Comparable’s growth rate is 11% particularly Nestle. This however is untenable as product mix, divisions, process, market etc are issues that differentiate Companies. Evidently Nestle operates in much broader spectrum of markets & products than Cadbury.
Two E & Y Reports and their Valuation Methods

Discounted Cash Flow Analysis; to estimate value of investment using future FCF projections then discounted using the WACC.

  • The ‘Multiples’ methods. A CCM is essentially a snapshot at a given point in time. It will not easily capture business expansions, evolutions and changes; it is by definition static.
  • The first report makes it clear that E & Y did not take into account any premium, although the minority shareholders demanded this.
  • The first E & Y report lists various available valuation methods. It says that the DCF method was not used. Nor were any of the others, except the CCM method, and this was assigned a 100% weightage. The tabulation to the report highlights the comparison between Cadbury India and other companies.
  • Before a Court can decline sanction to a scheme on account of a valuation, an objector to the scheme must first show that the valuation is ex-facie unreasonable. To upset a Valuation, a wrong approach must be demonstrated clearly.
  • Is a fair and reasonable value being offered to the minority shareholders?
  • Valuation is not an exact science. It is always and only an estimation.
  • It is impossible to say which of several available valuation models are "best" or most appropriate. In a given case, the CCM method may be more accurate; in another, the DCF model. There are yet others. No valuation is to be disregarded merely because it has used one or the other of various methods. It must be shown that the chosen method of valuation is such as has resulted in an artificially depressed or contrived valuation well below what a fair-minded person may consider reasonable.

Surplus Assets

Case 1: Abraham V. Federal Commissioner of Taxation, 70C.L.R. 23.

The Judgment approved of estimated additional income from idle cash being included in future maintainable profits.

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