The ASA RPC PRESENTS: Introduction to Going Concern Valuation. Welcome

Transcription

1 The ASA RPC PRESENTS: Introduction to Going Concern Valuation Welcome

2 Introduction to Going Concern Valuation Your Presenters: Deane Wilson, MA, ASA AQB Certified USPAP Instructor The Blackwell Group Cell # Robert C. Schlegel, FASA, MCBA (Rob) Houlihan Valuation Advisors robschlegel@hotmail.com William P. (Bill) Wilson, FASA, CRP, CG-002 AQB Certified USPAP Instructor Wm P Wilson Company wmpwilson@aol.com

3 Intro/welcome GCV v. BV Going Concern definitions Discernment Rules Similarities between BV & REA Normalizing financial stmts. EBITDAR Net Cash Flow RELPS BV Data RE motel/data BV motel/data RE senior/data BV senior/data RE Fueling station/c-store/data BV Fueling station/c-store/data Questions for real property appraisers

4 Going Concern Valuation v. Business Valuation 1 st Some basics: Both from a business appraiser s position and from the real property appraiser s perspective Going Concern Valuation is not business valuation. The difference is when the property is being appraised: When a business appraiser is appraising a business it is called a business valuation. Their appraisal may (but may not) include real estate. However, they are trying to arrive at the net worth, they deduct debt and account for income taxes. We don t! We are trying to appraise the real estate only.

5 Specifically, the going concern appraisal experience requirement stipulates that a real estate appraiser must have completed within the last 36 months at least four going concern appraisals of special-use property equivalent to the property being appraised That s it.

6 Going Concern Valuation v. Business Valuation Rob will now add some more clarification.

7 ASA Glossary definition of a Business: A commercial, industrial, service, or investment entity (or a combination thereof) pursuing and economic activity

8 Real Property Valuation concerns the land and improvements. The improvements may be buildings and installed equipment that will be sold with the land. Business Valuation addresses whole or partial equity holding assets, liabilities, people, systems and strategies normally within a company structure. Assets of cash, receivables, inventory, and fixed assets may be quickly valued. Liabilities of payables and debt may be quickly valued. Goodwill of a going concern business, however, is not quickly apparent. Real Estate and improvements, if held within the business, are a component of the business value and specified under an asset approach. Business appraisers normally use market and income approaches, negating the need for independent real estate and equipment appraisals because the real property and installed equipment are necessary for the business to create revenue and earnings, and so are considered operating assets. Any excess land or equipment not needed in normal business operations should be independently appraised if the value is likely to be large.

9 Value Benefit Rate ~Cost, or Asset, approach is usually only relied upon by a business appraiser for holding companies, asset-heavy manufacturing companies, or non-going concern businesses (i.e., liquidation premise) ~Sales comparison, or Market approaches for a BV appraiser examines guideline public companies (GPC) and closely-held companies that have sold. Usually, a GPC method is used for large businesses. Sales of large closely held are noted in some databases, usually with acquisitions by large public companies. Small company acquisitions are represented in several small company databases. Geographic and recent date requirements are less stringent than RP appraisers seek. ~Income approaches include, like RP, income capitalization and discounted future earnings. RP typically examines latest year EBITDAR, while BV requires consideration of net cash flow to equity or net cash flow to invested capital. Cap rates imply that any future growth considerations of the buyer are imbedded within the multiple: DISCOUNT RATE GROWTH = CAP RATE

10 Let s start with the biggie... Going Concern virtually every publication that deals with valuation has a legion, a divers, a manifold, a plethora of articles dealing with the subject of going concern, (or a similar term to mean the same thing) been around since first special use properties were built.

11 The value so derived includes the contribution of land, buildings, equipment and machinery, and goodwill and other intangibles. The aggregate of each asset s Value in Use constitutes the enterprise's Going Concern Value ivs 2000 ivg note #5

12 Going Concern: A going concern is an established and operating business with an indefinite future life. For certain types of property (e.g., hotels and motels, restaurants, bowling alleys, manufacturing enterprises, athletic clubs, land fills), the physical real property assets are integral parts of an on-going business. (The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 63) According to Leslie Sellers, MAI: NOTE: Going Concern is an entity description not a value (e.g. going concern value in NOT an appropriate term) -Market value of a going concern -Market value of total assets of the business -Market value of specified assets of the business (must specify

13 How do you determine what properties are candidates for being a going concern????

14 according to me: more about this in RP401 Discernment Rules Decision Matrix Car Wash versus Self-Storage Discernment Rules Property Type Property Type Car Wash Self-Storage Discernment Rule #1 Physical Constraints Was the property built for special use or single purpose occupancy? Discernment Rule #2 Income Source Is the property income generated by the business and not by rent? Discernment Rule #3 Distinct Identities Yes Yes Yes No Is the property typically owned, operated and transferred as one entity, one transaction, with all the components Yes Yes including the business enterprise, the real estate, the furniture fixtures and equipment as well as any other items capable of being allocated? Decision of Going Concern Yes No

15 BV will usually (always?) consider normalizing adjustments to the historical financial statements both the balance sheet and the income statement. RP appraisers normally consider only the income statement from the last period (e.g., annual year or latest twelve months) Latest performance may not be a good indicator of future performance is the business is in a particularly good year or an unusually bad year: A profitable fueling station when Walmart has just purchased the land across the street An unprofitable hotel coming out of the 2009 recession EBITDA means Earning before Interest, Taxes, Deprecation, and Amortization. EBITDAR means that this level is before rent is subtracted.

16 Revenue how much is non-recurring? Less Cost of good sold will prices be the same? Gross Profit (Gross Margin) Less Rent stable? or from owned entity? Less Depreciation and Amortization book value adjustments realistic? Less Other selling, general and administrative expenses non-recurring, non-operational = EBITDA Less Interest this may change in future years = EBIT

17 Revenue Less Cost of good sold Gross Profit (Gross Margin) Less Rent Less Depreciation and Amortization Less Other selling, general and administrative expenses = EBITDA Less Interest EBITDA less Rent =EBITDAR = EBIT Less Interest = Net Income before tax

18 In RP, this is normally a simple calculation from existing income statements Check prior years for changes and consistency Look for possible adjustments to the normalized income statements Beware of RENT as reported if it is from a holding company owned by the owners of the business If the real property is held by the business, no rent should be reported. Therefore, EBITDA may not have any rent. Would you adjust EBITDA for normalized rent? Ensure the RENT reported is for the underlying real estate and improvements you are appraising. Sometimes RENT may be for other land and facilities that you are not appraising.

19 Equity Cash Flow Revenue less Cost of sales less Operating expense = Operating Income (EBIT) less Interest expense = Pretax income less Income Taxes = Net income plus Depreciation & amortization = Gross cash flow less Increase in working capital less Capital expenditures +/- Change in debt principal = Equity Net Cash Flow Invested Capital Cash Flow Revenue less Cost of sales less Operating expense = Operating Income (EBIT) less Taxes on EBIT = Net operating profit after tax (NOPAT) plus Depreciation & amortization = Gross cash flow less Increase in working capital less Capital expenditures = Invested Capital Net Cash Flow

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21 Examine the historical financial statements over a multi-year period Normalize income statements Construct an Economic Balance Sheet (adjustments from last report) Construct income models of future earnings and DISCOUNT or CAP rates Examine databases for (examples): Fueling stations laid in costs, environmental issues, trade name, gallonage C-Stores (free standing or embedded with fueling stations) yields, product mix Car washes competition, # cars/day, cost and pricing per wash These typically yield equity value multiples based on revenues and a level of earnings For some databases, cash, receivables, inventory must be added and all liabilities must be subtracted Other procedures must be applied to discount whole company value for a fractional, minority interest.

22 For small company acquisitions such as fueling stations, C- stores, Car washes: BizComps database Pratt s Stats database] Institute of Business Appraisers (IBA) database Specialized databases for industry (local, certain industries) For larger companies of these types of RELPS (Complex Properties) Pratt s Public Company acquisitions Merger Stat Other public company and large private company databases Guideline Public Company (GPC) data Tagnify, Bloomberg, others

23 Identify your Segment and Flag. Where does your property fall? Luxury/Upper Upscale Full Service Midscale with Food & Beverage Extended Stay Hotels Limited Service - Midscale and Economy Budget/Economy Chain hotel? (Flagged) or Independent? Franchise Issues: Does your property have a franchise affiliation, or is it an independent lodging establishment? Read the Franchise Agreement for important issues such as: Remaining years on agreement, Annual royalty fees, advertising fees, and/or assessment paid to franchise company, Property Improvement Plan (PIP) - Is there one?

24 Market Factors: Demand - Rate of demand growth; growth trends; forecasted lodging demand growth Supply - Number of Hotel Rooms Occupancy - What is average occupancy for region/area/neighborhood? What is the occupancy trend? Competition - Directly competitive hotels in subject's area, existing supply of rooms and rooms under construction. Room Rates of direct competition. EX: Compare Super 8 to a Best Western. Do Not compare a Super 8 to a Marriott Full Service Hotel. Value Factors: Occupancy-Not Vacancy (Never calculate potential gross income then deduct vacancy). Conclude the appropriate occupancy rate of the property based on history & competition. ADR (Average Daily Rate) (The rate actually received after all discounts are given.) Occupancy x ADR = RevPAR (Revenue Per Available Room) Total Room Income = # Rooms x 365 days x occupancy rate x ADR Example: 100 rooms x 365 days x 70% occupancy x $100 ADR = $2,555,000 Unit of Comparison for Sales Comparison Approach: Price per Room

25 Data Sources: Obviously CoStar &? PWC Hospitality Reports - U.S. Lodging Industry and Lodging Outlook Smith Travel Research (STR). - STAR Report - property performance compared to its competitive aggregate and general market. They also have a number of additional reports covering all facets including trends; food & beverage, income, occupancy, & room rates for competitive set; market forecast, and many others. HVS Specializes in the hospitality industry with many publications - Hotel Development Cost Survey. Helpful in estimating the value of FF&E.

26 First, see if a RP appraisal is available at or near to the date of value. This date may be different than the date of inspection. Understand how the RP appraiser treated land, buildings, and embedded equipment. This RP treatments should enhance the recorded assets, with value listed by the accountant based on tax allowed depreciation. A Going Concern (GC) business may be appraised by the RP appraiser with some element of goodwill, as in an active motel/hotel would sell rather than a dormant (dark) motel/hotel. This may overlap some goodwill reported in the databases. In many states, property taxes are paid in arrears and must be added to the liabilities. Second, examine transactions or GPCs for other market evidence. Third, construct income models with the GC business in operation. These are the normally the best methodology for minority equity since the minority owner cannot sell the property. Fourth, reconcile the different approaches and values to conclude the value of 100% equity. Any non-operational assets are added to these value indications. Apply additional metrics to obtain fractional minority interest equity, if necessary.

27 The common databases, BizComps and Pratt s Stats have entries often with flag types. Transactions of the flag can be found, leading to an estimate of the improvement in room nights, % occupancy, AVG daily rates, and necessary replacement reserve. GPC data is useful for gauging the upswing or down swing of the industry. A good BV appraiser will check LOOPNET, COSTAR, FACTUAL.COM and other RP databases to ensure consistency with RP evidence.

28 Usually, just the SCA & I/A SCA Usually $ per unit, not room But look at both, let the market tell you which. Income Approach You are appraising the revenue stream from the business operation Gross Profit Multiplier (GPM) Direct Capitalization on EBITDA All from sale data Reconstruct Operating Stmt. Use historical and industry financial info Gross Potential Income) GPM x GPI = Indicated value of Going Concern EBITDA Cap Rate = Indicated value of Going Concern

29 DATA (tons) Obviously CoStar &? NIC Data Service (National Investment Center) Senior Housing News Irving Levin (Google it) National Council on Aging Marcus & Millichap CBRE REIS? Little old lady from Pasadena

30 Very large Senior Housing and Assisted Living Facility Holding Companies are often comparable to Guideline Public Company analysis to estimate Fair Market Value (e.g., RP s Market Value). These indications suggest value of the whole entity from a control perspective, from which a Discount for Lack of Marketability would follow for a minority share. If a 100% equity value is required, a BV appraiser would normally rely on a qualified real estate appraisal, adjusting for additional assets and subtracting liabilities. BV appraisers should walk the property and interview management.

31 Irving-Levin database is the most widely-used transaction database Some reported in Pratt s stats GPC data is appropriate in many cases. Historical data on the sale or acquisition of the given property can be useful Comparison of similar properties that have been sold can be derived from local brokers, state/local databases, and interviews with sellers and potential buyers

32 All three approaches Cost approach straightforward Including FF&E, fueling equipment, car wash equip., etc. SCA No real elements of comparison Not bought and sold on physical features Regression Analysis GP/SF v. SP/SF Sales/SF v. SP/SF GP/SF v. Price Sales/SF v. Price Hope for R 2 SCA not given much weight BTW most of your data comes from NACS & your own data for both the I/A & SCA

33 Income Approach You are appraising the revenue stream from the business operation Gross Profit Multiplier (GPM) Direct Capitalization on EBITDA All from sale data Reconstruct Operating Stmt. Using historical & industry data (Gross profit margins on fuel & c-store) GPM x GP = Indicated value of Going Concern EBITDA Cap Rate = Indicated value of Going Concern Pool margins vary (profit/gallon) Usually, higher pool margin less gallons sold And visa versa, lower pool margin more gallons sold For FRT/SBA you are appraising the real estate only, that s why you do the cost approach

34 Fueling stations (gas stations) may be a complex property, with gas, C-Store, car wash, and fast food restaurant maybe all tied into one. SEPARATE THE INCOME STREAMS. BV appraisal databases do have transactions for separate gas stations (gross margin is the key), C-Stores (with liquor?) and fast food (flag? Separate kitchen?) Gas stations would typically add a real estate appraised value into the balance sheet. DANGER is understanding any overlap for embedded equipment and treatment of goodwill for a goingconcern property C-Store value is based on profitability considering cost of land/building (if held within the Company structure). Cash, inventory, and debt are key items. Car Washes may be self-serve or with attendants. If based on fractional interest valuation, earnings would be used. If based on a whole company, Real Estate appraisal would likely be necessary with adjustment for other assets and liabilities.

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36 proposed self-serve coin car wash CA = $490,000 SCA = $340,000 IA = $605,000 potential gross income/revenue $109,500 How many cars per day? Say $2.25/car $109,500/365=$300/day $300/$2.25= 133 cars! $3.25/car = 92 cars $4.25/car = 70 cars $5.25/car = 57 cars $6.25/car = 48 cars

37 A 3-screen walk in movie theater to show 2 nd run movies CA = $1,500,000* SCA = $1,500,000* IA = $2,600,000 potential gross income/revenue $900,000 *real estate only How many peoples per day? Say $7.00/person $900,000/365=$2,466/day $2,466/$7.00 = 352 peoples! $2,466/$8.00 = 308 peoples! $2,466/$9.00 = 275 peoples! Etc., etc., etc!

38 Questions?

39 Intro to going concern valuation Thank You Deane Wilson, MA, ASA Robert C. Schlegel, FASA, MCBA