The impact of COVID-19 on valuations

It’s more difficult to arrive at a view on value in this climate but it’s not impossible

The COVID-19 pandemic has increased the focus on valuation; equity and debt holders are keen to understand their risks and returns, management teams and investors wish to take informed actions, and organisations still need reliable estimates of value to fulfil their regulatory responsibilities. But the extraordinary volatility in global equities and government debt yields, along with increasing debt margins, have made the process of valuing illiquid assets more challenging. As a result, we’ve seen a steady stream of questions raised by clients, investors and intermediaries as they try to address these valuation issues.

The important point is that while it’s far more difficult to arrive at a view on value in this climate, it’s far from impossible. Valuations will involve more judgment than before, certainly, but they can be done.

Established methodologies apply

First, it’s important to stress that established valuation methodologies such as discounted cash flow analysis and market multiples assessment remain the valuation tools of choice and still apply, even in these exceptional circumstances. However what needs to change is the information that flows into the valuation, and the adjustment of market inputs in cases of excessive volatility. For example, incorporating cash flow scenarios representing a range of future potential outcomes or considering normalising multiples or risk free rates (over a short time period) if a particular daily metric looks out of line.

There are a number of important points to bear in mind when approaching valuations. For example:

Purpose of the valuation

It’s essential to consider the specific purpose of the valuation when deciding how much of the market’s volatility to import into the valuation

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Wider impacts on cash flows

Valuations need to consider not only the volatility of public markets, but the wider impact of COVID-19 on growth rates and margins, as well as oil and other commodity price movements

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Public market trends

A valuation shouldn’t be slavishly matched to declines in public markets, nor should the valuation be insulated from a decline by using the argument that the whole market is distressed. Individual transactions may be distressed, but whole markets rarely are

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Discount rates movements

COVID-19 has created a high level of uncertainty, which typically implies a higher discount rate. If the use of CAPM suggests that discount rates have fallen since the end of 2019, adjustments may be needed to market inputs

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Scenario and sensitivity analysis

We expect to see far greater use of scenario and sensitivity analysis to take account of uncertainty and the many business impacts of the pandemic 

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Use of ranges

Valuation ranges will need to be wider than normal, and these ranges may well be subject to volatility as valuations are updated over time. It’s vital that this is communicated clearly to those that rely on them. In terms of financial reporting valuations, disclosures may need to be more detailed and make clear that valuations could change quickly over a relatively short time frame, particularly if the businesses are highly leveraged.

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Assumptions should be challenged

This is a time when all assumptions and information fed into a valuation should be challenged. Do management expectations fully reflect the implications of recent events, and are these captured in the cash flows? If a business has high levels of debt, limited headroom to service debt, or is burning through cash, should the valuation be on a going concern basis? If a business has short term liquidity issues, is there a risk it’s distressed? Is this consistent with an assumed orderly transaction, as assumed in a fair value context? If a business (perhaps in the travel sector) has built up large amounts of deferred revenue and orders start to decline, does it have a working capital shortfall? Has the market for buying or selling an asset stalled and if so, do we need an illiquidity adjustment to the discount rate?

Further guidance

We’ve had a lot of questions from clients on the topic of valuations in recent weeks – this is clearly an area with many challenges for management teams, investors, regulators, and other users of valuations. We’ve produced this detailed guidance, which discusses a wide range of valuations issues during times of uncertainty. Please get in touch if you have any concerns. 

 

Contact us

Kellie Gread

Kellie Gread

Valuations Leader, Consumer Markets, Industrial Products and Business Services Partner, PwC United Kingdom

Tel: +44 (0)7739 877541

Attul Karir

Attul Karir

Financial Services Partner, PwC United Kingdom

Tel: +44 (0)7931 735202

Charles Sword

Charles Sword

Tax Valuations, Deals, PwC United Kingdom

Tel: +44 (0)20 7212 3391

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