How reliable are company valuations?

In this blog I will be covering different valuation methods used to evaluate a companies’ worth. I will focus on William Hills’ recent failed takeover bid for betting company 888 Holdings.  The reason behind the takeover failing was due to a “significant difference in opinion” when valuing the company (BBC News, 2015). I will analyse the three basic methods companies may use to evaluate how much a company may be worth.

Takeover talks between William Hill and 888 collapsed, after one of 888’s founders refused to back a deal that would have given the UK’s biggest high-street bookmaker a leading online gaming platform (Shubber, Barrett & Massoudi, 2015).  888 rejected William Hill’s bid of £700m, which has since resulted in 888’s share price plummeting.

Company shares and valuations are important for both the owners of a company and their investors, however it can be complicated placing an accurate value on these.  The evaluation of a company is crucial for mergers and acquisitions and therefore it is vital to place an accurate figure on the target company in order for the takeover to be a success (Damadoran, 2012).

In practice valuing a company is a complex process, there is no science to distinguish a company’s worth it is argued to be more of an art.  One of the common methods used is Net Asset Value (NAV).  NAV simply put uses the balance sheet to sum up their total assets minus their long-term debt, to define the value. However, within NAV itself there are two main ways: Book Value and Net Realisable Value (NRV) (Arnold, 2013).  Book value bases the valuation on information that is publically available, this can be an inaccurate way to measure their worth as the assets can be valued at cost rather than market value.  Alternatively, NRV needs experts’ advice to value assets, these can include intangible and unique assets and a companies’ brand image.  NRV is the method used for companies going bankrupt, however this is not the case for 888.  Ultimately valuing items are down to an individual’s perception of their value.  Perception is likely to be responsible for the “difference in opinion” on value when William Hill placed their takeover bid.

Alternatively another method is Stock Market Evaluation (SME).  Both William Hill and 888 are publically listed making this method easier.  Typically, the market value is accurate if the ‘Efficient Market Hypothesis’ (EMH) applies, for more information on EMH please see my previous blog here http://acquisitionmarketefficiency.blogspot.co.uk/2015/03/bt-acquires-ee-markeyefficiency-due-to.html.  SME is simply the number of ordinary shares in issue multiplied by the current market price, this is also known as Market Capitalisation.  This method gives a vague minimum price they should be willing to pay for the target company and creates an initial starting point.  This can however be misleading, as a company’s shares are not always all quoted on the exchange, therefore giving an inaccurate figure.  Neither of the above methods takes future earnings into consideration, however as 888 is not reliant on R&D it is unlikely they will gain significant abnormal gains that would impact the valuation process.

Finally, William Hill could have used Income-Based Valuations.  This method determines the value through predicted future earnings.  Although, customer betting habits may be difficult to forecast, they could use figures based on their historical averages.  This can be seen as a risky method as some factors that would affect income such as the recession are hard to predict.

William Hill and 888 failed to agree on price in order for the takeover to proceed, therefore if specialists within this area are unable to value a company accurately, it shows how difficult it is for shareholders to evaluate how much the bid is worth to them.  The value created through mergers can generally be viewed with how the stock markets and investors react to the announcements, this gives a general consensus as to whether the shareholders approve.  Acquisitions that result in positive share price gains can be deemed as successful or value creating (Kale, Dyer & Singh, 2001).  However, how are shareholders supposed to evaluate the bid when the valuation methods are so complex?  And how do shareholders know if it is a good price to sell at or whether they believe the organisation should hold out for more?

In hindsight, 888 should be one of the easier companies to value due to the lack of unique and intangible assets and little to no investment within R&D.  Their income should be relatively easy to forecast due to upcoming racing events and historical patterns that emerge.  However, 888 have quoted “Due to a significant difference of opinion on value with a key stakeholder, it has not been possible to reach agreement on the terms of a possible offer and the board of the company has agreed with William Hill to terminate discussions” (BBC, News, 2015).  This is the third time 888 have been subject to a takeover bid as Ladbrokes tried and failed twice before, as 888 owners wanted more and more each time.  This is due to a difference in perception, the owners often regard an item more valuable due to bias, comparing this to asking a plastic surgeon if any work could be done, of course, they would say yes.  William Hill wanted access to 888’s online gaming software to reduce costs they pay to a third party, however 888 clearly believed it would be worth more them than their bid (Shubber et al., 2015).

Conclusion

Overall, it is clear to see valuing what a company is worth is a tricky business and it can be impacted by a vast amount of variables.  It is often questioned how reliable these methods are and how much you can rely on the valuations to be accurate.  It could be recommended a combination of methods should be used when deciding on a value rather than one alone, as this would give a more truthful representation.  When it comes to 888, should they have accepted the bid for £700m or was their rejection down to greed, you decide?

References

Arnold, G. (2013). Essentials of Corporate Financial Management. (2^nd ed.). Essex: Pearson Education Limited

BBC News (2015). William Hill and 888 end takeover talks. Retrieved from http://www.bbc.co.uk/news/business-31484672

Damodaran, A. (2012). Approaches to Valuation, Investment Valuation Tools and Techniques for Determining the Value of Any Asset. (3 ed.). New Jersey and Canada: John Wiley & Sons Inc.

Kale, P., Dyer, J., & Singh, H. (2001). Value creation and success in strategic alliances: alliancing skills and the role of alliance structure and systems. European Management Journal, 19(5), 463-471. Retrieved from http://www.sciencedirect.com/science/article/pii/S0263237301000627

Shubber, K., Barrett, C. & Massoudi, A. (2015). 888 Holdings rejects £700m William Hill approach.  Retrieved from http://www.ft.com/cms/s/0/c43b2efc-b5ac-11e4-a577-00144feab7de.html#axzz3ZXX0urp3