BVR survey reveals COE data sources of choice

While the Kroll Cost of Capital Navigator continues to be widely used and accepted for estimating cost of equity (COE), BVR’s Cost of Capital Professional has been gaining considerable steam since its launch in 2018, according to a BVR survey. Some other resources for estimating the cost of capital have also seen an uptick in usage.

Pecking order: A question in the Business Valuation Firm Benchmarking Guide, 2023 Edition, asked: “Which of the Following Resources Do You Use to Estimate the Cost of Capital? (check all that apply.)” Kroll’s Navigator topped the list, at 74%, and the Cost of Capital Professional followed, at 35% (see table). The survey was conducted during May 2023-July 2023 and had 192 respondents.

The 2018 BVR survey was done before the launch of the Cost of Capital Professional, but there have been other surveys since then. Jim Hitchner (Financial Valuation Advisors Inc.) has done regular surveys since 2019, finding that the Navigator has an 88% average usage rate versus 22% for the Cost of Capital Professional (click here for coverage). In the current BVR survey, the use of the Pepperdine studies and Damodaran’s data saw slight increases in usage, while the SBBI Yearbook showed a marked decline. Of course, all surveys have different sizes, demographics, and populations.

More steam? Given the recent hefty price increase for the Navigator, we would expect that the usage gap between the Navigator and the Cost of Capital Professional will continue to narrow. Also, more practitioners may look to the Pepperdine and Damodaran sources, which are free or of minimal cost. And, of course, this all depends on the level of price elasticity in the marketplace.

In any event, the Cost of Capital Professional has emerged as an effective lower-cost alternative for practitioners who do not need all the features the Navigator provides. Also, the two platforms (as well as the Pepperdine studies) produce “very close” results, according to tests Hitchner made. The question of “which source is best” is up to users to decide. The surveys show that some practitioners use several sources and compare the results, which is a welcome option for a process that is not perfect.

Valuation of business hit by COVID-19 in recent divorce case

If you haven’t done so already, sooner or later you will value a business affected by COVID-19. What do you do with several years of historical performance that the virus negatively impacted? Ignore those years? Assume the business will rebound? This was the issue in a recent divorce case in Arizona.

Typical scenario: The husband owned a construction company that had just one client: a company that owned and operated a number of hotels. During the height of COVID-19, the client sold off several of its hotels, putting a dent in the husband’s company’s revenue. Plus, the company stopped servicing several other of the client’s hotels (apparently due to the COVID-19-induced slowdown in travel).

In valuing the company, the husband’s valuation expert treated the prior years’ financials as outliers due to COVID-19 and used the current year for the numerator of a capitalized cash flow (CCF) analysis. The wife’s expert did not do that—he used an average of the past three years as his numerator for the CCF, three years that included pre-COVID-19 higher revenues. He justified this by saying that industry prospects “looked positive,” implying that the company could make up for the lost business. Of course, the two valuations were “wildly different.”

A court accepted the three-year look back and the wife’s expert’s higher valuation. The husband appealed, contending that those three years were impacted by COVID-19 and were not representative of future cash flows, which is what the numerator is supposed to represent. He argued that the numerator should be the current year’s cash flows, which represents the effects of the lost business going forward. But the appellate court affirmed the trial court’s decision, saying it did not “abuse its discretion.”

The case is Dawson v. Dawson, 2023 Ariz. App. Unpub. LEXIS 1003, and a case analysis and full court opinion will be on the BVLaw platform.

BVR kicks off ‘Two-Minute Practice Builder’ surveys

As any profession matures, the issue of practice management becomes more critical. Management and administrative issues that took a back seat when riding a growth wave must be dealt with when the landscape gets more competitive. BVR’s Business Valuation Firm Benchmarking Guide examines many practice management issues and allows firms to see what works for their peers. As a continuation of this project—and to delve deeper into certain areas—we’re kicking off a series of regular minisurveys with the help of Rod Burkert (Burkert Valuation Advisors), a former valuation practitioner who now devotes his time to helping others build their practices.

First one: Do you have a client “portal” to collect engagement information and documents? If so, what portal app or software are you using? Please answer these few questions by clicking here—it will take just two minutes. We’ll present the results here when we get a good response. Thanks for helping us help you!

NACVA to release two new databases in 2024

In beta testing at NACVA are two databases being developed with ValuSource software. One is for determining a discount for lack of marketability (DLOM) that has an expected release date during the first quarter of 2024. The other database is for estimating a company’s growth rate, slated for a second-quarter 2024 release. The two databases “will shake things up in the profession,” says Parnell Black, NACVA’s CEO in his 4Q23 CEO’s Message. Overseeing the development of these databases is the organization’s new Leadership Initiative Board (LIB), which is chaired by Ron Rudich (Business Valuation Group LLC).

AI studies top several McKinsey lists for 2023

Of interest to valuation experts are two works from McKinsey that examine artificial intelligence (AI). One is a report that we mentioned in an earlier issue that ended up as its No. 1 best-read report, “The Economic Potential of Generative AI: The Next Productivity Frontier,” which is available if you click here. A key takeaway of this report is that four areas of a company—customer operations, marketing and sales, software engineering, and research and development—could account for about 75% of the value that using generative AI could deliver.

The other is McKinsey’s survey, “The State of AI in 2023: Generative AI’s Breakout Year,” which ended up at No. 1 on its best-read survey list. The survey reveals the significant effects respondents expect on their industries and workforces. Some survey respondents reported that at least 20% of their EBIT in 2022 was attributable to AI use. Also, more than two-thirds of respondents say they will increase their investment in AI over the next three years. You can access the survey if you click here.

AI is a major trend that can impact a firm’s cash flow, growth, and risk, so analysts must consider it when valuing a company.

Kroll examines industry multiples in China

An analysis of the trading indices across various key industrial sectors in China as of Sept. 30, 2023, is contained in Kroll’s Industry Multiples in China 2023 report. Here are some highlights:

• Consumer discretionary. Trading multiples surged as the sector experienced a post-pandemic upswing. Profits more than doubled, and revenue and market capitalization recovered to prepandemic levels, indicating a robust recovery.

• Consumer staples. This sector witnessed a resurgence in net income, although trading multiples decreased year on year.

• Information technology. This vertical saw an increase in trading multiples due to a fall in net earnings. However, total revenues in the industry experienced a slight recovery, fostering optimism for a more competitive IT sector.

• Financial services. This sector demonstrated resilience despite distress in the property market, with trading multiples indicating confidence in its future prospects.

• Real estate. There are challenges in this sector, but the data suggest a slight recovery in net revenue. However, trading multiples reflected a decline in net earnings, influenced by high inflation and interest rates.

• Other sectors, such as materials, energy, and utilities, presented mixed signals, with varying performances and prospects.

To download the full report, click here.

BV movers . . .

People: The National Association of Certified Valuators and Analysts (NACVA) has named its outstanding members for the fourth quarter of 2023: Samantha E. Fisher, CPA, CVA, MAFF, a senior manager at Paradigm Forensics LLC, who has a specialty in divorce valuations and is chair of NACVA’s Valuation Credentialing Board as well as president of its MD/DC state chapter, and Tom Lusk, Ph.D., CVA, who has over 20 years of experience as a business analyst, consultant, and leader within the manufacturing sector. He currently is the president of NACVA’s Western Pennsylvania chapter.

Firms: Wayne, Pa.-based Stephano Slack has added Morgenstern Waxman Ellershaw (MWE) of Marlton, N.J., which specializes in serving privately owned businesses and high-net-worth individuals with accounting, auditing, tax, and advisory services, including business valuation … Atlanta-based Aprio has merged with San Antonio-based Ridout Barrett & Co. CPAs & Advisors, which has two Texas offices, in Austin and San Antonio, and provides accounting services with specializations in the construction and government contracting sectors.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

Business Valuation in the Context of Insolvency, January 11, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Pasquale Rafanelli (Empire Valuation Consultants). CPE credits: 2.0.

Learn the valuation nuances that one needs to consider when preparing a valuation analysis and report in the context of bankruptcy.

Valuation Approaches and Methods—Which Do I Use, When, and Why, January 17, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Andrew Mackson (InteleK Business Valuation & Advisory) and Mikhail Munenzon (InteleK Business Valuation & Advisory). CPE credits: 2.0.

A mix of high-level discussion and real examples illustrate which of the three valuation approaches and methods should be used, when they are (and are not) applicable, how to weight them, and, most importantly, why.