Corporate Valuation Panel Discussion-Gary Roland

8/8/2019 Corporate Valuation Panel Discussion-Gary Roland

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2007 DELOITTE/FEDERATION OF SCHOOLS OF

ACCOUNTANCY FACULTY

Chicago

May 18, 2007

Business Combinations

Valuations Issues Intangible Assets


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Disclaimer

The views expressed herein are those of the author anddo not necessarily reflect the views of Duff & Phelps or of

colleagues at Duff & Phelps.


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Agenda

Fair Value Measurement Assumptions in Business Combinations

Market Participant Assumptions

Highest and Best Use

Unit of Valuation

Valuation Premise

Valuation Approach Examples

Multi-Period Excess Income Method

Intangible Assets Cash Flow Allocation Framework

Contributory Asset Charges

Customer Relationship Intangible Assets

Accounting Summary

SEC Staff Speeches

Customer Continuum

Practical Application Issue Examples

International Convergence


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Fair Value Measurement Assumptions in Business Combinations

If a present value technique is used in a FV measurement estimatesof future cash flows must be consistent with the objective ofmeasuring fair value

Reflect the reporting entitys own assumptions about the assumptions marketparticipants would use in pricing the asset or liability

Assumptions based on best information available, which may include reportingentitys own data

Need not undertake all possible efforts to obtain information about marketparticipant assumptions, but cannot ignore information about market participantassumptions that is reasonably available without undue cost and effort

Reporting entitys own assumptions must be adjusted if information is readilyavailable without undue cost and effort that indicates that market participantswould use different assumptions


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Highest and Best Use

Considers the use of the asset that is physically possible,legally permissible, and financially feasible:

Use by a market participant even if intended use of theasset by the reporting entity is different

Maximize the value of the asset or group of assets inwhich the asset would be used

Market participant assumptions


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Unit of Valuation

Highest and best use determines the unit of valuation andthe context for the measurement of the asset or liability:

Group: for example, an asset group, a reporting unit, or abusiness (in-use premise)

Standalone: for example, a certain financial instrument ora certain operating asset (in-exchange premise)


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Valuation Premise

The highest and best use of the asset determines thevaluation premise

In-use valuation premise

In-exchange valuation premise

In-use

Provides maximum value to market participants principally through itsuse in combination with other assets as a group

Based on a current transaction to sell the group of assets in which itwould be used

In-exchange

Maximum value to market participants principally on a standalonebasis

Based on a current transaction to sell the asset standalone


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Valuation Approach Examples

Cost or Cost Savings Approach:

Diversity in practice in its application

Historical costs to create the asset or

Prospective view that captures other lost profit elements

Approach dependent upon facts and circumstances

Staff has expressed concern about its reliability & ability to capture allrelevant costs.

Market Approach:

Frequently inseparable from a related asset and therefore difficult to identifycomparable transactions to determine fair value

Multi-Period Excess Income:

DCF analysis that values the subject asset through income allocation byresidual method


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Multi-Period Excess Income General Framework

2006 2007 2008 2009 2010

Total Revenue 1,000$ 1,000$ 1,000$ 1,000$ 1,000$

Attributable to current customers 100% 80% 60% 40% 20%

Revenue - Current Customers 1,000 800 600 400 200Gross Profit 650 520 390 260 130

Operating Expenses 200 160 120 80 40

Depreciation 150 120 90 60 30

Technology (Income allocation) 20 16 12 8 4

Brand Intangibles (Income allocation) 120 96 72 48 24

EBITA 160 128 96 64 32

Taxes 64 51 38 26 13

Debt-Free Net Income 96 77 58 38 19

Contributory Asset Charges:

Working Capital 20 16 12 8 4

Fixed Assets 30 24 18 12 6

Workforce 10 8 6 4 2

Excess Income - Current Customers 36 29 22 14 7


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Intangible Assets Cash Flow Allocation Framework

All of the excess income is attributed to an amortizable intangible asset and/or goodwill

Goodwill is created, in part, by the mortality of the current customers.

Time

Income

Contributory Assets (WC, PPE, AWF)

Brand Intangibles

Current Customer Relationship Intangibles

Residual Excess Income

Technology

Future Customer Relationship Intangibles


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Contributory Asset Charges SEC Staff Speech

December 11, 2006:

even when a registrant concludes that an incomeapproach is the most appropriate valuation methodology,the staff may nevertheless question the result obtained

when the underlying assumptions, such as contributoryasset charges, do not appear reasonable in light of thecircumstances


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Contributory Asset Charges

The principle behind a Contributory Asset Charge is that each subjectintangible asset "rents" or "leases" the underlying (or requisite) assets requiredto produce the total cash flows from a specified group of assets.

The analysis begins with the identification of the expected future income orcash flow attributable to a group, or portfolio, of assets utilized in conjunctionwith each other to generate future cash flow.

The presumption is that the subject intangible asset's cash flow stream cannot

be isolated (e.g. relief from royalty approach). The portfolio of assets is thelowest level of identifiable cash flows in which the subject intangible assetresides.

The Multi-Period Excess Earnings Method is applied to estimate the FV of the

subject intangible asset after a consideration of the contribution of all otherassets to the realization of cash flow from the portfolio.

By deducting the annual returns on and of all other assets from the total cash

flow of portfolio of assets, the residual return can be isolated and discounted atan appropriate rate of return to estimate the FV of the subject intangible asset.


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Accounting Guidance

FAS 141 39: An intangible asset is recognized as an asset apart from goodwill if itarises from contractual or other legal rights. Alternatively, it is recognized if it is capableof being separated or divided from the acquired entity and sold, transferred, licensed,

rented, or exchanged (individually or as part of a group).

A customer relationship exists between an entity and its customer if (a) the entity hasinformation about the customer and has regular contact with the customer and (b) thecustomer has the ability to make direct contact with the entity. Relationships may arise

from contracts (such as supplier contracts and service contracts). However, customerrelationships may arise through means other than contracts, such as through regularcontact by sales or service representatives.

EITF 02-17, Recognition of Customer Relationship Intangible Assets Acquired in a

Business Combination: Expectations of future renewals

Must a contract exist at the date of acquisition?

Are purchase or sales orders considered contracts?


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SEC Staff Speeches

December 11, 2006:

Income approach may not always be the most appropriate

Relative value of customers may be low in those cases where othercompelling (and valuable) intangible assets, such as trade names, brandsand/or technology, are the source for continued customer patronage

December 5, 2005: Overlapping customer relationships

Income approach most appropriate (incremental sales)

Cost approach concerns

December 1, 2003:

Recognition of customer relationships

Useful life (indefinite rare)

Cost approach: excludes other valuable relationship aspects


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Little or NoCustomer

Value

SignificantCustomer

Value

Customer Relationship Continuum

Product Intangibles - enabling asset; customer demand is dependent on thecurrent products. (e.g., pharmaceutical, dominant brand presence).

Product Intangibles - enabling asset; customer relationship is dependent oncurrent and future Product Intangibles (e.g., consumer branded products)

Customers and Product Intangibles are both enabling; the allocation is basedon the facts and circumstances (e.g., most brands)

Product Intangibles do not provide exclusivity and are generally available inthe marketplace (e.g., electrical components)

No Product Intangibles sold to third parties; primary intangible asset is thecustomer relationship (e.g., consulting)


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Practical Application Issues Example 1

Fact Pattern: Acquired intangible asset will be discontinued (locked up or abandoned)by the reporting entity (acquirer), however, market participants would continueactively using the asset.

Day 1 Measurement & Lifing

Fair value measurement is based on market

participant assumptions:

Determine highest and best use

Determine valuation premise

What is the basis for the amortization period?

Paragraph 11 of Statement 142 states that

the useful life of an intangible asset to anentity is the period over which the asset isexpected to contribute directly or indirectly tothe future cash flows of that entity

If asset serves as a transitional asset tothe entity - period of transitional use?

If asset serves as a defensive asset tothe entity - period over which assetprovides defensive benefit to the entity?

What if asset is abandoned immediately?

Day 2 Impairment Test

Which cash flows should be included in the

recoverability test under Statement 144?

Paragraph 10 of Statement 144 states that along-lived asset should be grouped with otherassets and liabilities at the lowest level forwhich identifiable cash flows are largelyindependent of the cash flows of other assets

and liabilities Grouping might depend on the use of the

asset by the entity

Asset could fail recoverability test with entity-specific assumptions

Step 2 of the Statement 144 impairment test is afair value test

Asset could pass fair value test based onmarket participant assumptions

How can projected cash flows be developedfor an asset that receives no ongoing support

(i.e., if the entity has discontinued the assetbut a market participant would continue itsactive use)?


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Practical Application Issues Example 2

Fact Pattern: Acquired intangible asset will be discontinued (locked up orabandoned) by the reporting entity (acquirer). However, there is no evidence of adifferent use of the asset by market participants.

Day 1 Measurement & Lifing

Fair value measurement is based on marketparticipant assumptions:

Determine highest and best use

Determine valuation premise

Fair value would very rarely be zero. Typicallysome:

Transitional value, or,

Defensive value

What would be the basis for amortization of theasset (see paragraph 11 of Statement 144)

If asset serves as a transitional asset to

the entity - period of transitional use?

If asset serves as a defensive asset tothe entity - period over which assetprovides defensive benefit to the entity?

If asset is abandoned immediately write-off?

Day 2 Impairment Test

Transitional assets are straight-forward

Defensive Assets:

Which cash flows should be included (seeparagraph 10 of Statement 144)?

Should other assets be included in theasset group tested for recoverability (i.e.,

the protected asset)?

Asset grouping might also depend on theuse of the asset by the entity

For Step 2 of the Statement 144 impairmenttest (fair value test)

Determine the highest and best use of theasset by market participants at eachtesting date


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Memorandum of Understanding between IASB and FASB

The Memorandum of Understanding (MoU) between IASB and FASBwas published in February 2006

Document sets out a Roadmap of Convergence between IFRSs and US GAAP

for 2006-2008 Short-term convergence projects

Goal: By 2008, substantially complete short-term convergence projects toeliminate differences. Projects include, but are not limited to:

Fair Value Option Phase I of FVO completed by FASB with theissuance of SFAS 159. Phase II is to begin shortly.

Income tax Ongoing project. Objective: to reduce the differencesbetween IAS 12, Income Taxes and the US standard, SFAS 109,

Accounting for Income Taxes, and related U.S. GAAP

IPR&D Project in the research phase. The staff research consists ofidentifying existing differences between IFRS and U.S. GAAP

Impairment Project in the research phase. The staff is exploring theconvergence of the model(s) for impairment testing.

M d f U d di b IASB d FASB


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Memorandum of Understanding between IASB and FASB

Other joint convergence projects

Goal: By 2008, to have made significant progress on joint projects. Theprojects include, but are not limited to:

Fair Value Measurements- Single definition of fair value, relatedmeasurement framework and enhanced disclosures.

Business Combinations II Develop a single high-quality standard ofaccounting for business combinations.

Financial Statement Presentation Establish a common, high-qualitystandard for presentation of information in the financial statements.

Leases Comprehensively reconsider the guidance in FASB Statement No.13, Accounting for Leases, and IAS 17, Leases.

Intangible Assets Develop a consistent approach to recognition andmeasurement of intangible assets, including purchased and internallygenerated intangible assets not related to a business combination.

The above convergence projects are (or will be) carried out in the context of theongoing work by FASB and the IASB on their joint Conceptual Framework project.

Q&A Di i


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Q&A Discussion

Corporate Valuation Panel Discussion-Gary Roland

Documents

Transcript of Corporate Valuation Panel Discussion-Gary Roland