Special advisory: Impact of the corona crisis on company valuations

– Economic interpretation of current technical advisories of the Technical Committee for Business Valuation and Administration (FAUB)

The current uncertainty regarding how the global economy will change as a result of the risks of an increasing spread of the coronavirus (SARS-CoV-2) has so far led to significant price losses in the international stock markets. A distinction must be made between these “market prices” for company shares (a function of supply and demand) and the values of companies and company shares that are derived using fundamental analysis. These values are based on a consideration of what earnings can be distributed over the long term from the company to the shareholders or withdrawn from them. Due to the current economic changes the question therefore arises as to whether company valuations that have been derived based on an earnings value or DCF calculation result in lower values similar to what can be observed on the capital market in the case of listed companies.    

The Technical Committee for Business Valuation and Administration (FAUB) has addressed this issue and responded with a technical advisory concerning potential effects and how to handle the current uncertainty in the context of company valuations, e.g. in the case of capital investment changes, M&A transactions, impairment tests or expert appraisals – such as for tax purposes.

Necessary estimates concerning the extent and duration of the effects of the pandemic result in planning uncertainties

Company and sector-specific analyses are absolutely essential in the creation and plausibility validation of budget overviews. At present, it is expected that companies will be impacted for only a limited time in many cases. Corresponding downturns in demand, a temporary shortfall in demand or interruption of supply chains are generally limited in duration and in this respect are of minor importance for a long-term consideration of business performance. For instance, what is just a short-term drop in earnings may accordingly have a relatively small effect on the company valuation. In many cases, however, assessing the effect on earnings will be significantly more complex, especially when it comes to issuing forecasts about the duration of the economic or even sector-specific “recovery”. The recommendation here is to take account in the planning calculation of available forecasts made by recognized institutions (such as forecasts by the federal government, economic research institutes, and so on). The question as to whether there is a resulting impact on the company or the sector environment that significantly changes the long-term earnings level compared to the level prior to the “corona pandemic” is, however, fraught with uncertainty.

The reason for this may, for example, be a completely changed situation in terms of demand (e.g. new products and services as well as potentially also altered patterns of behavior). In this respect budget forecasts that were created prior to the “corona crisis” must be analyzed critically and questions must be asked about whether fundamental assumptions concerning the market environment and the competitive environment will continue to be valid over the long-term.

As part of planning preparation, in order to map existing uncertainties different scenarios that are deemed possible should be considered as a basis for deriving an “updated” corporate plan that takes the current circumstances into account. In the company valuation this budget overview must be critically assessed in accordance with a planning scenario that is deemed “most probable” and must be subject to a plausibility check.

Possible consideration of risks in the discount rate

Based on the current FAUB recommendation, no grounds are so far evident for a change in the way the discount rate is derived. The previous FAUB recommendations concerning the derivation of the market risk premium continue to apply and are deemed to also apply before the underlying long-term yield analyses. The currently highly volatile capital markets should therefore not be decisive in assessing expected returns over the long term.

Summary

With current company valuations, the extent to which the current uncertainty and resulting risks are taken into account in the budget overview of the company that is to be valued must be noted. Identified risks should ultimately be mapped primarily in the budget overview (e.g. in the form of scenarios). 

Jürgen Baur, Tax advisor, Sonntag & Partner