M & A
Introduction :
As referred in my previous article on ‘Valuation of
Intangible Assets’, a purchase price allocation process is one exercise where
valuation of intangible assets plays an important part. Purchase Price
Allocation (PPA) is relatively new in India. However with the amount of mergers
and acquisitions (M&A) activity happening and with the roadmap for IFRS
convergence chalked out (beginning 2011), it cannot and should no longer remain
new.
PPA, very crudely put, can be defined as a process of
assigning values to acquired assets and liabilities. Unlike a normal valuation
exercise where ones efforts are driven towards finding and arriving at a value
of the target, in a PPA the value of the target is already known and where the
valuation of target ends, the process of PPA starts. The focus in a PPA exercise
is to allocate the total value paid for the target to individual assets and
liabilities acquired.
Rationale :
Just as a PPA is the reverse of a normal valuation, in order
to understand the full meaning of a PPA, the words have also to be read in
reverse. Purchase Price Allocation is ‘the process of ALLOCATION of the PRICE
paid for the PURCHASE of shares or of assets.’ The process is carried out to
ascertain the rationale behind paying a purchase price. The process identifies
the tangible and intangible assets/liabilities that have been purchased/taken
over, for which the purchase price has been paid. Most of us would be surprised
to know how much more a price has been paid if we compare the price paid for a
target to the book value of the target and that surprise element is the precise
reason why carrying out such a process is required by standards under US GAAP
and IFRS and with India’s planned convergence to IFRS, the knowledge of this
process along with its application is imperative. With this process, not only
would the shareholders of the acquirer understand why or why not a particular
purchase price was paid for a target but it would also bring to light the
inherent value of intangibles which may not get captured in the book value or in
the share price of a company. The following are the primary reasons why a PPA
would be carried out :
- For transparency to shareholders
- For the management to ascertain the reason for overpayment/underpayment
- For
getting benefits of amortisation under revenue laws
Guiding Accounting Standards :
Currently the requirement of a PPA is mandatory only for
companies preparing financial statements under IFRS and US GAAP; however with
the much awaited convergence of Indian Accounting Standards with IFRS, the same
will be mandatory for companies preparing financial statements under Indian GAAP
as well.
Broad steps under the PPA process :
- Business Enterprise Valuation to estimate the Internal Rate of Return (“IRR”)
- Identification of Intangible Assets
- Valuation Analysis of Intangible Assets
- Reconciliation of Results
This is the first of the series of articles on PPA. Each
article in this series will explain the various steps in carrying out a PPA
process and how to value intangible assets forming part of a PPA. The series
will cover in detail the following aspects and the practical issues under each :
1. General Overview
2. Glossary of Business Terms and Definitions under a PPA
3. Computation of Purchase Price to be allocated
4. Calculation of IRR
5. Computation of Weighted Average Cost of Capital (‘WACC’)
6. Possible reasons for differences between the IRR and the WACC
7. Identification of Intangible Assets
8. Remaining Useful Life
9. Tax Amortisation Benefit Factor
10. Valuation Approaches and Methods
11. Tangible assets — Identification and
Valuation
12. Weighted Average Return on Assets
13. Reconciliation of Results
14. Non reconciliation of Results
15. Interpretation of Results
16. Negative Goodwill
17. Value additions
18. Case Study
19. Discussion of questions and answers received over the period of the series
20. Chartered Accountants as Valuers
21. Useful links and resources
