FOREIGN private equity firms will face stiff valuations when they decide to buy stakes in unlisted companies following a change in valuation norms by the RBI.
The shares in unlisted companies will now have to be valued using a discounted cash flow model. This will remove any discretion in price-fixing and also reduce the chances of lower valuation under the earlier guidelines that fixed the price at average of two different valuations.
The central bank has amended the provisions under the Foreign Exchange Management Act and a circular is expected shortly, an RBI official. Experts think the change is significant as it would ensure that the value of Indian business that gets transferred outside of India will not be less than the consideration received.
“A financial investor would typically invest at lower-than-market value depending on the risk profile of the asset. Imposition of discounted cash flow method for investments completely rules out commercial negotiations between a financial investor and the company,” said Akash Gupt, Executive Director, PwC.
The earlier method, as prescribed by the controller of capital issues or CCI, fair value of an unlisted company was taken as average of the net asset value method and the profit earnings capacity value method. This method allowed investors to price their assets conservatively as it was based, particularly in the profit earnings capacity method, on the current performance.
Discounted cash flow is based on the future earnings. Unless a venture is able to show good cash flows ahead it would not be able to attract investors. In that sense the new method is likely to yield better valuation.
All preferential allotments made by an Indian resident to a non-resident will also be governed by this new guideline, which are largely along the lines prescribed by the stock market wathchdog Sebi for listed companies. “CCI guidelines were very old and even CCI is not in existence now. The new guidelines only reflect the changed scenario,” said the RBI official who did not wish to be identified.
A foreign investor would now be investing at close to the realisable value, which has implications for sectors with longer gestation period such as infrastructure where investors demand higher returns.
Under the new rules, investments by parent companies into wholly-owned subsidiaries will also have to be at market value.
Discounted cash flow analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.
Helplinelaw can set up your session with quality and experienced lawyers to discuss and resolve your legal matters. You can avail consultation in form of sending questions, phone call or webchat discussion More