- The impact of COVID-19 on markets and businesses has been significantly and dynamic
- The challenge will be modelling the impact of the pandemic and forecasting recovery scenarios
- Valuers must ensure their work is robust to meet increased scrutiny from auditors and stakeholders
Written by Richard Stewart, OAM, FCA
COVID-19: 4 issues for valuers to consider
Australia and New Zealand have been very successful in containing the spread of COVID-19. However, the financial implications of COVID-19 are still evolving. As such, business valuers have to understand these impacts and estimate business values in very dynamic circumstances.
Consider some of the changes we have seen over the past few months:
- Australia's benchmark index, the ASX200, first fell by a third and has now recovered to about 20%-down from 24 February.
- The VIX index – a measure of market uncertainty –ballooned from its normal levels of around 15% to over 80%, and has now returned to somewhere between 30 and 35%.
- Spreads on US BBB bonds have increased by almost 100 basis points, having blown out to 200 basis points at the height of the crisis.
- Deal volumes have dropped by about a third over the previous quarter, and are currently only one third of the value.
- While most sectors have been affected to some extent, the hardest hit have been tourism, travel and oil and gas-related stocks.
These changes are so significant that they demand a measured response from business valuers. Overall, the profession needs to consider the following four issues.
1. Shut down effects
For many businesses revenue declines during the shut-down have been precipitous. Most have been able to reconsider their cost base, and access available government assistance to offset some of this decline. By now, most businesses have got a handle on the short-term business changes and their cash flow impact.
This effect of COVID-19 on cashflow needs to be extended to when operations can resume in relatively normal conditions – which will of course vary by industry. This immediate impact can also be calibrated by observing short-term earnings revisions for listed comparables.
2. The road to recovery
Much of the challenge in assessing the impact of COVID-19 will arise from forecasting the recovery. It may also be impossible to forecast just one scenario, given the unprecedented nature of the shutdown. Therefore, valuers may need to construct a range of plausible scenarios.
These recovery scenarios will need to be based on the lessons learnt from previous crises – and forecasts from the broker community (which have a wider range than usual).
3. Uncertainty premium in cost of capital
The wide range of broker estimates and the level of uncertainty in the market has likely resulted in discount rate increases. At PwC Australia, we have estimated this increase using our normal discount rate calibration techniques. However, we recognise that the situation is fluid and differs according to industry. As a result, we are updating our estimates monthly.
At the date of writing, our best estimates of the increase in cost of capital vary from 25 to 125 basis points depending on industry. This uncertainty premium is different to an alpha factor related to forecasts that have not been adjusted for the shutdown and recovery – outlined in points 1 and 2 of this article. If these forecasts are used, the alphas should be cross-checked with plausible scenarios for both those two phases.
4. Liquidity considerations
For valuers who are valuing equity instruments – particularly on a minority basis – a further challenge will be the liquidity concerns prompted by the crisis. These concerns can create overhang for potential share issuance, placing downward pressure on minority values.
What's more, the broader liquidity challenges and their consequent impact on the deals market means that control premiums may be different to those normally estimated.
“Much of the challenge in assessing the impact of COVID-19 will arise from forecasting the recovery. It may also be impossible to forecast just one scenario, given the unprecedented nature of the shutdown. Therefore, valuers may need to construct a range of plausible scenarios.”
Auditor scrutiny will be higher this year
On top of these technical concerns, auditors will be keen to review valuation reports much more closely this year. Part of the reason for this is because the described market changes have created impairment triggers, therefore increasing impairment risk.
In addition to the concerns described earlier, valuers will need to focus on:
- Ensuring their scope is fit for purpose and not unrealistically extended. Market uncertainty and volatility are so significant that value conclusions won't be as durable as they used to be. This means valuers will need to work with their clients to ensure their reports will be useable for year-end processes.
- Making it clear to the client where the valuers responsibilities lie, compared to the auditors.
- Making the assumptions in their report clear, and providing evidence and rationale to back up them up.
- Providing enough detail to allow the valuation to be performed again easily.
- Setting out clear cross-checks that buttress their opinions.
- Ensuring evidence for their compliance meets valuation standards (certainly APES 225, but ideally International Valuation Standards as well).
- Being prepared and budgeting for a more extensive review and Q&A with the auditors this year.
The COVID-19 crisis has seen markets move dramatically. Valuers will need to consider the impact when they:
- model the shutdown impact
- plot the path(s) to recovery
- consider how the cost of capital might have changed
- review the impact of liquidity on equity values and transaction markets.
Work in these four areas will be subject to even more scrutiny from auditors and other stakeholders this year. This means valuers will need to ensure their reports are more robust in these challenging circumstances.
About the author
Richard Stewart OAM is a Corporate Value Advisory partner with PwC. He has been with them for 34 years in Australia, Europe and the USA, completing his first valuation in 1992.
Richard has helped his clients achieve great outcomes using his value skills in the context of major decisions, M&A, disputes and regulatory matters. His clients span both the globe and the industry spectrum. He holds a BEc, MBA, FCA, FCPA, SFFin, FAICD and is an accredited Business Valuation Specialist with CAANZ.
Richard has written two books: Strategic Value (2012) and Hitting Pay Dirt (2017). He is also an Adjunct Professor at UTS and a board member of St Vincent de Paul Society NSW Limited and Black Dog Ride Australia Limited.
The opinions expressed in this article are his own and may not necessarily reflect the views of PwC or the organisations of which he is a Director.