We are often asked by clients, what valuation methodologies should be considered in the era of COVID-19? There is no silver bullet answer to this question. Given the significant impact on capital markets and increased market volatility, a business appraiser must think “outside the box” and rely on multiple points that can affect the value of the company.
Two methods under this approach include the Guideline Public Company (“GPC”) method and the Guideline Transaction (“GT”) method. When performing valuation analyses using the GPC method, it is important to understand and assess whether the stock price and reported earnings of the GPC reflect the impact of COVID-19. Adjustments to the analyses may be appropriate if the valuation date falls on or after February 24, 2020 (known/knowable date for the COVID-19 impact in the United States).
Similarly, in using the GT method, the appraiser needs to determine whether the purchase price and earnings of the acquired company reflect the impact of COVID-19 and make the appropriate adjustments.
When performing valuation analyses using an income approach, discussions with management should address how the company’s business has been affected by COVID-19 and the outlook for the company post COVID-19.
Examples of questions that could guide the appraiser in assessing the company’s financial and operational performance are as follows:
- Does your company operate in a cyclical industry that is also prone to economic downturns?
- Is the company sufficiently capitalized to withstand the pandemic?
- When do you expect the company to return to normal operations?
- What types of adjustments are appropriate and whether these adjustments are temporary or permanent (i.e. labor resources, overhead expenses, etc.)?
- Are the government loans and stimulus payments reflected in the company’s future cash flows?
In most scenarios financial projections prepared in 2019 did not reflect the impact of COVID-19 and should be revised.
Cost of Capital
The estimation of cost of capital can be tricky during market downturns. Closer attention should be paid to the cost of equity analyses driven by changes in Treasury yields that could imply that the company is worth more than it was before COVID-19. Debt balances and interest rates also require further analyses and fair conclusion that the book value of a company’s debt is consistent with its market value.
Likewise, beta calculations may be distorted and require an additional assessment of how COVID-19 affects the company and its industry and whether the beta is correlated with the current volatility environment.
The past three months have demonstrated that the counter-cyclical and recession-proof industries have a better chance to survive the global pandemic. Driven by many variable factors like lower consumer consumption and supply chain disruptions, many businesses must reassess what a new normal would look like and when they will be able to return to their usual course of business. Estimating the cash burn rate, modeling various scenarios, considering availability of the stimulus payments, analyzing potential short-term financing options, and projecting the timing and amount of near-term debt payments have been best practices with many companies.
The application of traditional valuation methods in COVID-19 environment may produce distorted values that are not consistent with how the market and investors see it. It is important to consider and analyze whether adjustments to the valuation methods are warranted.