Coronavirus

Implications for business valuation

There is also a continuing need for business valuations: time-bound transactions (squeeze-outs), pending proceedings (divorce, inheritance, settlements) or accounting and tax purposes (impairments). We will see distress sales and buying opportunities that necessitate valuation considerations. Below are some initial thoughts on business valuations in the context of the Corona pandemic.

Planning: “Rake” instead of “Hockey Stick”

The virus is a stress test for every business model and planning. Simplistic assumptions about the future are popular: “U” valley, “V” dip or “L” crash. However, most businesses will see a “rake”, i.e. they will experience a rapid downturn and hope for a quick recovery. Whether this can lead to pre-crisis levels depends on condition: Margins, reserves, liquidity. Any pre-crisis planning needs to be reviewed: Business model, revenues and profitability, investments, net working capital, liquidity. The detailed planning period may need to be extended until a sustainable, stable condition is reached.

Residual value, growth and probability of bankruptcy

Textbooks assume that companies have an unlimited lifespan and perpetual growth. However, the textbook does not provide for a virus, so these assumptions need to be critically examined: Alternatives to perpetuity – sale or liquidation – must be modelled in residual value. A positive growth rate will certainly have to be defended more strongly than before. The consideration of a probability of default – for example in the form of a negative growth rate – may be necessary.

Capital structure

All parameters based on a “peer group” are currently affected by the downturn in the capital markets. We recommend a critical review of market data or the use of reasonable estimates based on a multi-year historical period or a realistic financing policy. State aid – liquidity and/or credit programmes – is often associated with restrictions on dividend distributions (cf. Solidarity Guarantee Ordinance, Art. 6) and investments. The future-oriented financial model must take these circumstances into account.

Cost of capital

In our view, the Corona pandemic does not fundamentally change the methodology for estimating the cost of capital. The CAPM will continue to be best practice. The virus joins other events such as World War II, 9/11 and the financial crisis of 2008/09 and will therefore – hopefully – be an isolated event and not a long-term trend. It remains to be seen whether the Corona crisis will affect the level of the risk-free interest rate, the market risk premium or beta factors in the medium to long term. The de facto zero interest rate on the Corona emergency loan guaranteed by the federal government does not reflect the actual default risk of the companies. Therefore, cost of debt adjustments or the application of a “debt beta” should be considered.

This text is an outline of a detailed article that will appear in EXPERT FOCUS in June 2020 (in German).