Appraisal Foundation Valuation Advisory Working Group #2 Valuation of Customer Related Assets PJ Patel, CFA, ASA

Transcription

1 Appraisal Foundation Valuation Advisory Working Group #2 Valuation of Customer Related Assets PJ Patel, CFA, ASA September 13, 2016

2 Background Task Force: Valuation of Customer Related Assets Supporting Organization: The Appraisal Foundation Purpose: to provide guidance around the valuation of customer related assets when they are being valued for financial reporting purposes. ASC805 (IFRS3r), ASC350, ASC360 1

3 Background - Why? Controversial issue list created by AITF in 2005 Address diversity in practice MPEEM or Cost Approach nothing in between Overlapping customer relationships Attrition Deferred revenue Inventory Limited information available SEC speeches 2

4 Background Who/When? Group Members: Daniel Knappenberger D&T Group Chair Chris Armstrong KPMG Peter Wollmeringer Alvarez & Marsal PJ Patel Valuation Research Corporation (VRC) Timing: Start: March 2008 Last Draft: December 2013 Finalized: Summer

5 Topics Covered in the Valuation Advisory Accounting Background and Overview Identification of Customer-related Assets Qualitative Value Considerations Valuation Methodologies Valuation Methodology Selection Other Considerations Backlog Deferred Revenues Inventory Overlapping customer relationships Settlement of pre-existing relationships Asset life and amortization Appendix on Attrition Rate Calculations Appendix of Case Studies 4

6 What are Customer Related Assets? When do they get valued? Separability criteria FV framework Examples of customer related assets: Customer lists Backlog Contracts Non-contractual relationships When? ASC805 PPA for Business Combination ASC350 step 2 goodwill impairment testing ASC360 impairment of long lived assets Off label usage? 5

7 Identification of Customer-related Assets and Value Considerations Qualitative issues: Industry Characteristics Company Characteristics Product/Service Characteristics Customer-related Asset Characteristics Other key factors to consider: Barriers to change Stickiness of customer relationships Switching costs Qualitative attributes are just as important as quantitative attributes in determining the value of customer relationships 6

8 Identification of Customer-related Assets and Value Considerations Industry Characteristics Concentration of firms monopoly vs fragmented Buyer power Barriers to entry Business Characteristics Type of business Relative asset class spend Promotional strategy Transaction structure and strategy 7

9 Identification of Customer-related Assets and Value Considerations Product/service Characteristics Product differentiation Switching costs Life cycle stage Protective rights CRA characteristics Purchase order vs long term contract Attrition Depth of knowledge 8

10 Continuum of Customer Assets Customer lists Transactional purchase order based customers Transactional customer relationships with MSAs Recurring customer relationships with switching costs Customers with long term contracts Take or pay contracts 9

11 Questions? {next section Valuation Methodologies} 10

12 Valuation Approaches Income Approach: Multi-Period Excess Earnings Method Distributor Method With-and-Without Model Cost Savings Approach Cost Approach Market Approach 11

13 Summary of Methods: MPEEM Residual cash flow model MPEEM based customer cash flow Company revenue/earnings Less: Taxes Less: Charges for contributory assets Equals: Cash flows related to Customer Assets Best used when: Customers are the primary assets or Margins are within a reasonable range of normal industry levels 12

14 Summary of Methods: MPEEM Key inputs: PFI esp Revenues and earnings for CRA Growth rate Attrition rate Life CAC s Discount rate 13

15 Summary of Methods: MPEEM Working Group discussion: How to account for synergies and dis-synergies? At what point should the life be cut off? Basis for attrition? 14

16 Summary of Methods: Distributor Method Residual cash flow model but isolates cash flows relating to customer relationships using market based inputs DM based customer cash flow Company revenue Earnings based on margins of market proxy Less: Taxes Less: Charges for contributory assets (based on market proxy) Equals: Cash flows related to Customer Assets Best used when: Customers are NOT the primary assets or A reasonable market proxy exists for the customer relationships 15

17 Summary of Methods: Distributor Method Key inputs: PFI esp Revenues for CRA Profit margin for market proxy Growth rate Attrition rate Life CAC s Discount rate 16

18 Summary of Methods: Distributor Method Working Group Discussion Can the DM be used in situations where an MPEEM is not used to value other assets? Use only for CPG vs use in virtually all situations What if no market proxy exists, can you use a non-distributor? Margin selection process judgment? CAC s company specific or related to market proxy? Attrition rate, growth rate, asset life 17

19 Summary of Methods: With-and-Without Value based on differential in cash flow between scenarios - with and without the customer asset WWM cashflow based on: Cashflow of business/entity with customer relationships Less: Cashflow of business/entity without customer relationships, where customer relationships are recreated Equals: Value of the Customer Assets Best used when: Customers are NOT the primary assets Customer relationships can be recreated Time to recreate the customer relationships is short No change the structure of the business 18

20 Summary of Methods: With-and-Without Key inputs: Forecast for both the With and Without scenarios Costs and time to recreate CRA Discount rate 19

21 Summary of Methods: With-and-Without Working Group Discussion Differential cash flow or differential value If differential value what discount rate? Account for customers as a single asset or smaller groups? If time to recreate is significant what happens to excess inventory, PP&E, capex etc.? 20

22 Summary of Methods: Cost Savings Approach Costs saved or avoided as a result of owning the asset. CS cashflow based on: Cost savings/avoided over the life of the customer asset Less: Taxes Equals: Cash flows related to Customer Assets Best used when: Customers are NOT the primary assets or Costs saved/avoided can be reasonably estimated Time to recreate the customer relationships is short 21

23 Summary of Methods: Cost Savings Approach Key inputs: Cost savings forecast Time Discount rate 22

24 Summary of Methods: Cost Savings Approach Working Group Discussion Does this approach differ from the WWM? Top down vs bottom-up? Is this the same as a cost approach adjusted for time and taxes? 23

25 Summary of Methods: Cost Approach Cost to re-create the asset Cost Approach Value based on: Direct Costs Plus: Indirect costs Plus: Developer s profit return on the investment Plus: Opportunity costs Profits lost while the asset is being created Equals: Value of customer relationships Best used when: Not the primary asset Short time to recreate Early-stage companies no revenues or profit; difficult to project 24

26 Summary of Methods: Cost Approach Key inputs: Cost to recreate the asset Indirect costs Profit margin for developer? Risk adjusted rate of return for opportunity costs 25

27 Summary of Methods: Cost Approach Working Group Discussion Does the cost approach appropriately value customer assets? Should costs be tax affected? Do developer s profit and opportunity cost account for the same factors? 26

28 Continuum of Customer Assets / Valuation Framework Customer lists Transactional purchase order based customers Transactional customer relationships with MSAs Recurring customer relationships with switching costs Customers with long term contracts Take or pay contracts Cost Distributor Model, Cost Savings, With-and-Without, MPEEM MPEEM 27

29 Questions? {next section Other Considerations} 28

30 Other Considerations Backlog Deferred Revenues Inventory Overlapping customer relationships Settlement of pre-existing relationships Asset life and amortization 29

31 Backlog Undelivered, non-invoiced contracted products/services Key issues: Value together or separately from other customer assets? Consider economic characteristics earnings, cashflow and risk Amortization 30

32 Deferred Revenues Liability resulting from payment of goods and services prior to delivery Key issues: What is the impact on customer value? Impact on year 1 revenue? Issues for a growing business vs declining business? Conclusion remove from revenue and earnings 31

33 Deferred Revenues CRA (MPEEM) Year 1 MPEEM Actual (no BusComb) Correct Incorrect BV of Deferred Revenues $1, Future Revenues $4,000 $4,000 $4,000 Total Revenue $5,000 $4,000 $4,000 COGS 3,500 2,800 3,500 S&M EBITA 1, % 20% 3% 32

34 Deferred Revenues Other discussion items: When is the cash received? Mid-year, end of year? Impact on the customer model? Are the expenses to fulfill the deferred revenue an attribute of the CRA or deferred revenues? Are multi-year deferred revenues handled differently? What is the impact on working capital? 33

35 Inventory Step-up Increase in the value of inventory to reflect portion of the earnings process completed pre-deal vs the portion to be completed post-deal Key issues: What is the impact on customer value? Conclusion adjust CACs (including depreciation) for usage of assets pre-deal vs post deal 34

36 Inventory Year 1 MPEEM No Step-up Correct Incorrect Revenue $1,000 $1,000 $1,000 COGS Depreciation Return on PP&E Return of WF Cash flows to CR

37 Inventory Step-up Other discussion items: What CACs should be adjusted? How do you handle G&A and R&D type costs? Can the cash flow in year 1 be negative? Should you ignore the inventory step-up and other related adjustments (except for issues with changes in the market price of inputs)? What is the basis for adjustment of CACs? 36

38 Attrition Customer attrition Revenue attrition Revenue remaining Attrition net of growth Management estimates Irregular attrition rates Partial period adjustments > Key Issue: Cash flow relating to the CRA 37

39 Other Considerations Overlapping customer relationships Market participant viewpoint Settlement of pre-existing relationships Above/below market contracts Pattern of benefits vs straight line amortization 38

40 39

41 Questions? {next section Case Studies} 40

42 Case Studies Case Study 1 Consumer Product Company Distributor method and review of alternatives Case Study 2 Defense Company MPEEM and review of alternatives Case Study 3 Packaging Solutions Provider MPEEM and review of alternatives Case Study 4 Hardware Company With and Without Method and review of alternatives 41

43 Case Study #1 CPG Key Considerations Acquirer Publicly-held multinational food and beverage producer Target Regional snack producer with brands that have achieved near iconic status Acquisition Rationale Immediate entry into Target s markets Target s portfolio of regionally dominant brands Cost synergies Ability to sell Target s brands in adjacent regions Prevent competitor from buying Target Buyer/Target Customers 100% overlap 42

44 Case Study #1 CPG Consider Alternatives MPEEM Distributor Method With-and-Without Method Cost Savings Approach Cost Approach 43

45 Case Study #1 CPG Value Summary Tangible Assets, 10.0% Goodwill, 35.0% Brands - MPEEM, 50.0% CR - DM, 5.0% 44

46 Case Study #1 CPG Alternative Value Summary Brands - RfR, 10.0% Tangible Assets, 10.0% Goodwill, 50.0% CR - MPEEM, 30.0% 45

47 Case Study #1 CPG Review Results Alt#1 Brands 50% CR 5% Alt#2 Brands 10% CR 30% Review Deal Rationale Brands Overlapping CR What makes sense? 46

48 Case Study #2 Government Contractor Key Considerations Acquirer Publicly-held government contractor Target Privately-held government contractor Acquisition Rationale Long-standing relationships within the DoD Target s workforce is highly skilled and cleared No technology 47

49 Case Study #2 Consider Alternatives MPEEM Distributor Method With-and-Without Method Cost Savings Approach Cost Approach 48

50 Case Study #2 Government Contractor Value Summary CR - MPEEM, 30.0% Tangible Assets, 6.5% Goodwill, 63.5% 49

51 Case Study #2 Government Contractor Alternative Value Summary CR - Cost, 5.0% Tangible Assets, 6.5% Goodwill, 88.5% 50

52 Case Study #2 Government Contractor Value Summary CR - DM, 30.0% Tangible Assets, 6.5% Goodwill, 63.5% 51

53 Case Study #2 Review Results Alt#1 CR (MPEEM) 30% Goodwill (including WF) 63.5% Alt#2 CR (Cost) 5% Goodwill (including WF) 88.5% Alt#3 CR (DM) 30% Goodwill (including WF) 63.5% Deal Rationale Customer contracts Workforce What makes sense? 52

54 Case Study #3 Packaging Solutions Key Considerations Acquirer Mid-size private equity firm Target Regional provider of packaging solutions Acquisition Rationale Acquirer co-invests with management in well-run, mid-size companies. Target is the leading packaging solutions provider in its region. Target is well known and respected within its niche. Its reputation is a business driver. Target s customers are highly recurring and stable. They are recurring due to high-quality products provided in a timely and cost-effective manner 53

55 Case Study #3 Consider Alternatives MPEEM Distributor Method With-and-Without Method Cost Savings Approach Cost Approach 54

56 Case Study #3 Packaging Solutions Value Summary Tangible Assets, 41.0% Trademarks - RfR, 2.5% Technology - RfR, 0.3% CR - MPEEM, 23.8% Goodwill, 32.4% 55

57 Case Study #3 Packaging Solutions Alternative Value Summary Tangible Assets, 41.0% Trademarks - RfR, 2.5% Technology - RfR, 0.3% CR - Cost, 5.0% Goodwill, 51.2% 56

58 Case Study #3 Review Results Alt#1 CR (MPEEM) 23.8% Goodwill (including WF) 32.4% Alt#2 CR (Cost) 5% Goodwill (including WF) 51.2% Deal Rationale Customer relationships recurring but no long term contract What makes sense? 57

59 Case Study #4 Hardware Components Key Considerations Acquirer Publicly traded tech company that develops hardware and software products Target Leading provider of hardware components that other manufacturers integrate into assembled systems Acquisition Rationale Strong existing technology platform Strong development pipeline of new projects Ongoing and recurring purchases of components by manufacturers integrating them into larger systems 58

60 Case Study #4 Consider Alternatives MPEEM Distributor Method With-and-Without Method Cost Savings Approach Cost Approach 59

61 Case Study #4 Hardware Components Value Summary CR - WWM, 1.3% Tangible Assets, 7.6% Trademarks - RfR, 1.3% Technology - MPEEM, 27.0% Goodwill, 59.3% IPR&D - MPEEM, 3.5% 60

62 Case Study #4 Hardware Components Alternative Value Summary CR - Cost, 1.0% Tangible Assets, 7.6% Trademarks - RfR, 1.3% Technology - MPEEM, 27.0% Goodwill, 59.6% IPR&D - MPEEM, 3.5% 61

63 Case Study #4 Hardware Components Alternative Value Summary CR - Cost Savings, 1.5% Tangible Assets, 7.6% Trademarks - RfR, 1.3% Technology - MPEEM, 27.0% Goodwill, 59.1% IPR&D - MPEEM, 3.5% 62

64 Case Study #4 Hardware Components Alternative Value Summary CR - DM, 2.0% Tangible Assets, 7.6% Trademarks - RfR, 1.3% Technology - MPEEM, 27.0% Goodwill, 58.6% IPR&D - MPEEM, 3.5% 63

65 Case Study #4 Hardware Components Alternative Value Summary CR - MPEEM, 15.0% Tangible Assets, 7.6% Goodwill, 69.1% Trademarks - RfR, 1.3% Technology - RfR, 5.0% IPR&D - RfR, 2.0% 64

66 Case Study #4 Review Results Alt#1 CR (WWM) 1.3% Tech + IPR&D (MPEEM) 30.5% Alt#3 CR (Cost Savings) 1.5% Tech + IPR&D (MPEEM) 30.5% Alt#5 CR (MPEEM) 15% Tech + IPR&D (RfR) 7% Alt#2 CR (Cost) 1.0% Tech + IPR&D (MPEEM) 30.5% Alt#4 CR (Cost) 2% Tech + IPR&D (MPEEM) 30.5% Deal Rationale technology What makes sense? 65

67 Conclusion Valuation is not mechanical Qualitative as important as quantitative Understand business, industry, MP rationale Judgement needed in approach/method Judgement needed to derive inputs Tools now available 66

68 Questions? {next section Attrition} 67

69 Attrition Customer attrition Revenue attrition Revenue remaining Attrition net of growth Attrition with no growth Management estimates Irregular attrition rates Partial period adjustments 68

70 Attrition What is the basis of the source data? Annual customer revenue Annual customer count Does the data cover one or more economic cycles? Does the data cover technology migration, if applicable? Should growth be separated from attrition or combined? Does the rate need to be adjusted for a partial period? 69

71 Methods: Revenue attrition Customer attrition Revenues related to lost customers Revenues remaining from existing customers (net attrition) Attrition excluding growth Age vintage analysis Iowa curves, Weibull distribution and other statistical methods Management estimates 70

72 Working Group Discussion Irregular attrition patterns shock churn, transactional customers Partial period adjustment Inconsistency between historical data and application Growth an attribute of the CRA? 71

73 Attrition Summary: Not a mechanical exercise judgement in approach and methods Many tools to arrive at a supportable conclusion Consider the basis of data (inputs) and how the data will be used Key Issue: Cash flow relating to the CRA 72