The JofA hosted a virtual round-table discussion with valuation professionals from the financial reporting sector to gauge how they are handling critical valuation issues in today’s climate and what their outlook is for the near future. Excerpts from that discussion were published in the JofA’s May 2009 issue (see “Valuations for Financial Reporting in Today’s Market,” which also includes a brief biography of each panelist). Here are additional comments from the panelists:
JofA: Has the economy affected the way you’re marketing your business or caused you toadjust fees?
Mike Morhaus: We’re working to improve the way we do things to help our clients: focusing on being more aware of the clients’ problems and helping them with bank terms. We’re also trying to do more cross-selling, which is something we should’ve been doing anyway. Overall, we’re trying to do a better job to keep the customer happy.
Carolyn Worth: The timing for a lot of valuations has accelerated, either because of reporting requirements or their resistance for impairment up to the very last minute. The timing of delivery in the work has reduced the ability of clients to negotiate. They’ve had to move so quickly that we haven’t seen a lot of pressure on scope or fees. As the market comes down, we may see more of that. My clients are looking at their customers to see which ones are more creditworthy, and they may be changing their credit terms as they continue to worry about future collections.
JofA: Is there any certain segment of valuation that’s been driving a business increase? Like litigation or fair value or impairment testing?
Worth: I review all of the proposals for KPMG and there’s been a definite switch from 141 to 142 [FASB Statement no. 141(R), Business Combinations, and Statement no. 142, Goodwill and Other Intangible Assets]. The volume of business for 141 has substantially decreased, while 142 is higher than I’ve ever seen it.
Dave Dufendach: The need to determine an estimate of fair value for some of these financial instruments that used to trade in active markets has grown quite a bit in the last few months.
JofA: Given the severe stress and chaos in the financial markets because of illiquidity, excessive leverage and financial mismanagement, how responsive will government agencies such as the IRS be to large valuation discounts assumed in estate valuations, real estate valuations and business valuations?
Kevin R. Yeanoplos: At the very least, we’ve noticed that it’s harder to sell companies, so the issue of liquidity may be bigger than other issues involving the forecast. There are some significant issues that have to be dealt with on a short-term basis, but there hasn’t been enough time to adequately address how any of the bodies, other than the SEC, would deal with these. I think there’s some very strong evidence for supporting some kind of an adjustment on a short-term basis.
Worth: Illiquidity is a function of volatility and duration. The longer the duration of the illiquidity and the higher the volatility, the higher the discounts. I would be very surprised if the IRS didn’t accept large discounts in this particular environment. I think they’ll be well-documented and easily quantifiable based on the market factors that support high discounts.
JofA: Are there any tools or resources that anyone’s finding particularly helpful right now?
Worth: In the last decade, fair value has quickly created a convergence on best practices. It’s the ability for all valuation professionals to see each other’s work, and getting exposed to a variety of different approaches and methods and practices. The Appraisal Foundation is taking steps to get better convergence on best practices, and hopefully FAS 157 [FASB Statement no. 157, Fair Value Measurements] disclosure requirements are going to provide better transparency to the capital markets on what valuation assumptions are being used. I hope this will carry through, not just to fair value reporting, but also to fair market value and any kind of valuation. Consistency and comparability are almost as important as being right. As these disclosures provide more insights as to how companies are coming up with the values used on financial statements, it’ll provide better guidance and better best practices for all professions.
JofA: What are the consequences of a long-term recessionary environment on the value of a business?
Yeanoplos: The easy answer is to say it depends on the business. Obviously there are businesses that haven’t been hurt by this environment, such as health care. From what I’ve seen, discretionary types of businesses are the ones that have been hit the hardest. Construction, of course, isn’t purely discretionary, but there are certain businesses that haven’t really been impacted by it. So it is important to consider what industry the business is in.
Morhaus: One of the biggest issues depends on whether the company was leveraged in the past. If they were less leveraged in the industry or had no debt, they’re obviously going to come out of this in better shape than competitors that have run a more risky capital structure. So we look at the leverage and the bank terms, etc., to see what’s going to happen, and at the end of the day, remember that we’re going to try to estimate cash flows and the risk of those cash flows.
Worth: My prediction is that the downturn is going to be broad-based with values being down across the board. I’d be surprised if there are too many industries, including sectors of health care, that will be untouched by this downturn, either through their customers, whose creditworthiness has been impacted, or in another meaningful way. In health care, the unemployment levels of people losing their health coverage is going to have a significant impact on health care payments.