Corporate Valuation. Massari Mario

12 and 13 present respectively the theory and practice of multiple-based valuation for companies.

      The third and final section of the book comprises Chapter 14 and 15, which introduce the main elements of valuations in the market for corporate control and models to structure corporate valuations in the framework of M&A transactions.

      Chapter 16 features a topic, the valuation of right issues, seldom mentioned by corporate finance handbooks but which is becoming crucial in many financial markets.

      Chapter 17 closes by introducing a topic that is receiving increasing attention by investors and policymakers, namely the incorporation of environmental risks in corporate valuation.

      The key message of the book is that standard business planning and valuation, which assume high visibility of firms' future performances, tend to prove more and more inadequate. In the context of high market volatility and recurring disruptive economic events associated with the post-financial crisis business world, companies' operations face systematically new points of discontinuity and increased risks. As a consequence, traditional standard valuation techniques may provide insufficient information in an economic environment characterized by high uncertainty. This book treats risk not as one of the input variables used in the valuation process but as the main driver to be considered when approaching the estimation of corporate value.

      Acknowledgments

      Of course, we owe a very great debt of thanks to friends, colleagues, and students who have contributed to this work. First, we thank greatly Marco Villani, a valuation expert who read and commented on chapters. Second, Federico D'Agruma provided extensive and invaluable assistance for the preparation and revision of the manuscript. We would like to also thank Marco Ghitti who prepared the supporting materials for the book. We are also grateful to John Carusone, Alberto Maria Ghezzi and Kim Salvadori, who helped in the revision of some sections of the manuscript. We are immensely grateful to the Wiley team – especially to Meg Freeborn, Bill Falloon, and Caroline Maria Vincent – who assisted us in the book preparation and showed incredible patience with our consistent missing of deadlines.

      About the Author

      Mario Massari is Full Professor of Corporate Finance and former Head of the Finance Department at Bocconi University (Milan). He has written extensively on business valuation and corporate finance topics, and he is considered one of the leading experts in Italy in the field of Business Valuation. He serves as board member at several listed and unlisted companies and he is a member of the Executive Committee of the OIV (the Italian valuation principles setter).

      [email protected]

      Gianfranco Gianfrate is a Giorgio Ruffolo Fellow at the Harvard Kennedy School (Cambridge, MA) and a research affiliate of Tufts University (Medford, MA). He has authored several books and articles on business valuation and corporate governance issues.

      Previously, he was a consultant at Deloitte (Milan), a manager at Hermes Fund Managers (London), and served as member of the Investment Committee at Eumedion (Amsterdam). He has also been a member of the IPO Best Practice Committee at the Italian Stock Exchange, co-authoring the official Listing Guide for going public companies.

      [email protected]

      Laura Zanetti is Associate Professor of corporate finance at Bocconi University (Milan), where she teaches company valuation and is research fellow within CAREFIN, centre for applied research in finance.

      She has been the director of the Master of Science in Finance at Bocconi, visiting scholar at Massachusetts Institute of Technology (Cambridge, MA) and London School of Economics and Political Sciences (London).

      She published several books and articles on corporate governance, valuation, M&A, and industrial performance. She is a Certified Public Accountant, Certified Auditor in Italy, and board member of listed and private companies.

      [email protected]

Chapter 1

      Introduction

      1.1 WHAT WE SHOULD KNOW TO VALUE A COMPANY

      This book is based on the idea that mastering valuation techniques is possible only after having gained a sound theoretical knowledge. But theory is not enough. In order to evaluate an enterprise or an acquisition, an analyst should have enough first-hand experience: such experience usually does not depend on the quantity of the previous valuations carried-out but on the quality of the work done.

      A distinguishing feature of the valuation process is that to produce convincing valuations, analysts should master various areas of expertise, and three in particular:

      1. Industrial economics and business strategy with reference to the analysis of the industry and competitive context devoted to understanding the validity of the company's business model, its past results, and its future plans

      2. Theory and techniques of finance with regard to the basic principles of net present value, to the underlying links between leverage and value, to models that explain stock prices on financial markets, and finally to the techniques which correctly depict the business plan in terms of cash flow

      3. Economic theory, in particular with regard to the relationship between uncertainty and value1

      4. in all those cases in which the simplifications assumed in the standard models presented in the finance textbooks do not permit the development of convincing valuations

      Despite the fact that theoretical contributions in all three disciplines are widely known, valuation is more than a collage of knowledge and technique. In a valuation, critical drivers are so bound together that the real distinguishing element is the “glue” that holds them together. This glue consists of the ability to balance the different choices made in each phase of which the evaluation process is composed, of correctly weighing the empirical evidence, and of the ability to perform coherent estimates within the final objectives of the valuation work.

      1.2 VALUATION METHODS: AN OVERVIEW

      Finance textbooks offer several different options to perform the valuation of a firm or of an acquisition. Furthermore, financial institutions and consulting firms typically work out tailor-made models expanding the spectrum of available techniques. In the end, in assessing value of firms belonging to particular industries, several empirical techniques have gained quite a standing among practitioners.

Given the number of methodologies made available by theorists and practitioners, we find it useful, before getting into the core of this book, to explore a classification of the most widely used methodologies (Exhibit 1.1).

Exhibit 1.1 An overview of the main valuation methodologies/approaches

      Exhibit 1.1 shows that the methodologies available (excluding simplistic empirical approaches) can be grouped into four fundamental approaches, each a function of the relevant link between corporate value and relevant value driver. A methodology is then a choice of the relevant driver, chosen out of the above-mentioned four approaches in order to assess value:

      1. Income approach

      2. Economic profit approach

      3. Market approach

      4. Net asset approach

      The first approach expresses the value of a company or an investment as a function of the expected returns it generates. The so-called financial