Company valuations technical toolbox: April 2023

Technical toolbox bizval

Each month, bizval co-founder and technical expert The Finance Ghost shares his learnings from listed companies and examples of real-world deals and company valuations.

Company valuations – RCL Foods disposal of Vector Logistics

Whenever a listed company sells a business or division, there’s an opportunity to dig into how the sale was structured. Although every deal is unique, the mechanisms involved are not.

Before we get to the structuring of the deal, it’s worth touching on the rationale for the sale. RCL Foods operates in a tough market and still has a large poultry business, so management needs to be as focused as possible on the core business. Vector Logistics didn’t really fit with the rest, with the RCL board concluding that the right decision would be to sell it.

Generally speaking, investors in listed companies like to see focus rather than diversification. There’s an important lesson in that for entrepreneurs as well:

The likelihood of a far better exit is increased through building an excellent business with a singular focus, rather than a collection of average businesses.

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Moving on to the structure:

  • The RCL Foods shareholder loan was converted to equity before the deal – it’s always a good idea to speak to tax advisors about this.
  • There is a downward adjustment to the price to take into account share appreciation rights issued to Vector employees – this is a great example of a liability that stays with the company being sold, valued specifically by the purchaser and adjusted in the purchase price accordingly.
  • There is an earn-out and claw-back combination, in which the price can be adjusted by R100 million either up or down depending on EBITDA achieved in 2023 and 2024 vs. target EBITDA.

Company valuations and deal structures go hand in hand. Earn-outs are common with transactions. Claw-backs are not, as whoever holds the cash has a much stronger legal position. Once you’ve paid money across, getting it back is harder. Listed companies tend to behave properly and the purchaser here is a global infrastructure fund, so these are sophisticated parties who got themselves comfortable with RCL Foods receiving the full price up-front with a potential claw-back if target EBITDA isn’t met. RCL Foods also needs to trust the buyer in terms of a potential earn-out payment.

In a private deal, a claw-back is dangerous for the purchaser. By the time that claw-back is triggered, the money may not be easily recoverable from the seller. It’s rare to see claw-backs in private deals, but earn-outs are common.

As for the use of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), this is a common financial metric in deals and company valuations because EBITDA is not subject to:

  • The way the balance sheet is structured (vs. net profit that is negatively impacted by the use of debt and associated interest costs)
  • Changes in tax rates (something that is obviously beyond the control of the parties)
  • Depreciation and amortisation distortions, which are easier to execute than you think if the owner decides to change the accounting policy around remaining useful life

Company valuations – Northam Platinum invokes a Material Adverse Change clause

If you’re wondering what a material adverse change (MAC) is, the clue is in the name. A deal can sometimes take an exceptionally long time to be concluded, especially if there are regulatory approvals needed along the way.

To protect the purchaser, a MAC clause creates an escape hatch if something goes horribly wrong along the way. Purchasers should always push for these clauses and sellers should always argue against them, unless there is a mix of equity and cash changing hands in a merger, in which case both parties will want a MAC clause.

The rule of thumb is that whoever is going to end up holding shares should want a MAC clause.

Where a MAC clause is included, at least make sure that it is as objectively defined as possible. Nobody wins in a scenario with a fluffy MAC clause that becomes a legal dispute.

A great example of a well-constructed MAC is found in Northam Platinum walking away from the Royal Bafokeng Platinum deal after a long and hostile process with Impala Platinum as the other bidder. Walking away has been simple, as the MAC clause referenced prevailing platinum group metal (PGM) prices in the market.

There’s no debate around that. It’s an objective, observable market price. A poorly-worded MAC clause might have referenced the “likely impact on the targets profits” from a change in PGM prices, which then becomes highly debatable.

And finally: be Frank

When you are selling a business, just be honest. Company valuations look beyond just the numbers. Aside from the obvious ethical argument, it simply doesn’t pay to lie, as criminally charged Charlie Javice may find out.

Javice sold her financial planning platform Frank to JPMorgan Chase for $175 million in 2021. The champagne has been replaced by pain, as the bank alleges that the number of customers at Frank was “falsely and dramatically” inflated – oh dear!

By how much, you ask? JPMorgan claims that the startup had fewer than 300,000 customers when she claimed over 4 million.

It’s a rough journey from Forbes’ 30 Under 30 to being arrested instead, one that Javice isn’t alone in making. She finds herself in… esteemed company, alongside Sam Bankman-Fried (of FTX fame) and Martin Shkreli. Even Elizabeth Holmes once headlined a Forbes 30 Under 30 Summit!

Perhaps this is an award worth missing out on. More importantly, just be honest in a due diligence.