Valuing a company you might buy

The last chapter of the subject, and of the first phase of the course's foundations. It puts everything together on one decision: what is this company worth to us?

Three methods, deliberately

Discounted cash flow. Forecast free cash flows (chapter 6), discount at a rate reflecting the target's risk and financing (chapter 9), add a terminal value. The only method that values the business on its own merits.

Its weakness is that it is acutely sensitive to two unobservable inputs — the discount rate from chapter 8 and the terminal growth rate — and terminal value often exceeds half the total.

Trading comparables. Apply multiples at which similar listed companies trade. Fast, market-grounded, and it answers a different question: what would the market pay for this today?

Its weaknesses are chapter 17 and 18 of the Company analysis subject's: no two companies are truly comparable, and a multiple carries the market's current mood as well as the business's quality.

Precedent transactions. Apply multiples paid in past acquisitions of similar companies. These include a control premium, so they are usually the highest of the three.

Its weakness is that past deals were done in past conditions — and, from chapter 15, many of them destroyed value for the buyer. Anchoring on what others paid is anchoring partly on other people's mistakes.

Why the disagreement is the output

Three methods producing one number would be suspicious. The spread is information:

DCF below comparables suggests the market is more optimistic than your forecast. Either you are conservative or the market is. Both are worth knowing.

Precedents far above both suggests acquirers have been paying up — possibly for synergies, possibly through competitive auctions.

A narrow range suggests a well-understood, stable business. A wide one suggests the value turns on assumptions that have not been settled.

Working the problem

₹800 crore, ₹1,100 crore and ₹1,400 crore.

The recommendation is not ₹1,100 crore. Averaging three estimates produces a number no method supports and conceals the spread that was the useful part.

A defensible paragraph reads roughly:

The DCF supports ₹800 crore on our own forecasts. Comparables suggest ₹1,100 crore, implying the market is more optimistic about this sector than we are. Precedent transactions at ₹1,400 crore include control premiums paid in conditions we should not assume repeat. We recommend opening at ₹850 crore and walking away above ₹1,000 crore — a price at which the deal still works on our own numbers without requiring synergies we have not specified.

The walk-away price is the whole discipline, and it must be set before negotiating. Once in a room, with advisers paid on completion and a board that has been told a deal is close, the number drifts upward. Chapter 9 of the Risk subject made the same point about investment decisions: decide while calm what would change your mind, because you will not decide it well later.

Synergies belong on the buyer's side of the line

A target's standalone value is what it is worth to anybody. Synergies are what it is worth to you specifically.

Which produces the rule chapter 15's arithmetic demands: do not pay the seller for synergies you have to create. Every rupee of synergy value handed over in the price is value transferred before the work of realising it has begun — and with the risk of failing to realise it kept entirely on your side.

What constrains the structure

Valuation decides the price. Law decides what may be done with it. SEBI's buyback regulations are one example of a limit on returning or restructuring capital; takeover rules, competition clearance and sectoral caps are others. A transaction is a legal object as well as a financial one, and a valuation that ignores what the structure is permitted to do is incomplete.

What Phase 1 was for

Three subjects, forty-six chapters, and a single purpose: to make the rest of the course readable rather than memorisable.

Quantitative methods supplied the machinery — discounting, distributions, the difference between a sample and the truth, and the humility that a confidence interval forces.

Accounting supplied the inputs — and, more usefully, the knowledge that every input is the output of a procedure somebody chose.

Corporate finance supplied the decisions — what to build, how to fund it, what to return — and showed that each reduces to the same test: does the present value of what we get exceed what we pay?

Everything downstream now rests on something. Option pricing has distributions underneath it. Valuation has accrual accounting underneath it. Portfolio theory has covariance underneath it. That was the argument for writing these three first, and it is why the course is a syllabus rather than a collection.

The point

Value an acquisition three ways — DCF on your own forecasts, trading comparables for what the market pays, precedent transactions for what acquirers have paid — and treat the disagreement between them as the finding rather than averaging it away. Set the walk-away price before negotiating, because it drifts once the room is warm, and never pay the seller for synergies you must create yourself.