Valuation is an art, not a science. Lessons learnt of a strategic due diligence.


As you all may know, Vodafone is to expand its presence in Africa by buying a controlling stake in Ghana Telecom for £452m ($900m). The British firm will acquire 70% of the currently state-owned firm with the government retaining a 30% interest. But, how did we get to this figure? How can Vodafone be confident that they are paying the right price?

One of the top management directors I met in one of the most important private equity firms once told me: “Carlos, valuation is an art, not a science”.  And he is right. There is not an exact formula or method to arriving at a valuation figure. Analysts have many tools at their disposal, which give way to wide ranges of opinion. There is cash flow, net asset value, earnings, total enterprise value, revenue and book value, to name just a few of the popular metrics. A multiple is then applied to one of these figures to arrive at level of valuation. The multiple is where valuation becomes an art. There is no tried-and-true figure to apply to a company, which opens valuation up to much debate. Depending on the multiple, a company can be either overvalued or undervalued.

On top of this, the returns from any property cannot be judged properly without also assessing the risk that the investment may not meet the objectives of ownership. The means by which risk is assessed prior to investment is through the process of “due diligence” or “the study that ought to be undertaken”.

Any due diligence study requires contributions from specialist advisers from areas concerned with Finance, Legal, Property Management and Fixed Asset issues. We have been participating in at least 10 different due diligence processes in telecom related operations of the last year, such as One (Austria), Bite (Latvia), Bite (Lithuania), TCLM (Spain), Mobtel (Serbia). Mobilkom (Czech Republic), Caucasus online (Georgia – yes, you’re reading it right), etc. Having a leadership role in the due diligence process (see figure below), there are some lessons learnt to be shared with you.

Firstly, It is important that the professionals involved in each area of the due diligence study communicate effectively to ensure all areas are discovered, investigated and reported on as to their influence on the proposed investment.

Secondly, testing the commercial attractiveness of a deal involves validating both the target’s financial projections and any identified synergies using an external lens. Companies can achieve this by assessing overall market attractiveness and the competitive position of the target, and how these might change over time.
Whether the buyer is out-of-market (e.g., a financial buyer) or in-market (e.g., a competitor), this analysis is indispensable. However, for an in-market buyer, the commercial attractiveness issue may be more complex. The due diligence team involved in an in-market deal must gaze into the future and calculate the competitive position of the combined entity, including its impact on customers, competitors, and overall market dynamics. After all, customers and competitors will react to the merger in ways that will benefit them — ways that might threaten the combined businesses’ value-creation assumptions.

Finally, a company must make a hard internal examination of whether the targeted value of the deal can be realized by the management team of the combined enterprise, and, if so, whether the projected time frame is realistic. For an in-market merger, it is vital that all the associated risks, in terms of customer and competitive responses, technology issues, and culture challenges, be weighed. When they have been weighed, the salient question becomes, Can these potential risks be managed? If preserving increased market share is a key driver of value, for instance, leaders had better be sure that the executives of the new company know their customers’ needs, can meet them, and can fend off competitors who will surely try to pick off customers and clients during this period of uncertainty.

Vodafone has closed a good deal with Ghana telecom.  The challenge starts now.
Best regards,
CVA


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