IFRS and Valuation

IFRS – Importance for Analysts and Investors

IBS, Hyderabad

Agenda

Overview of IFRS

Key points for investors

Live examples to highlight importance of understanding IFRS

Accounting differences – Impact on multiples

Mitigating accounting differences

Moving to IFRS – Impact on share prices

22

AGENDA

Overview of IFRS

• Stands for International Financial Reporting Standards

• The IASB is the independent standard-setting body

• IASB Objective - To develop a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards (IFRSs)

• Currently there are 9 IFRS, 29 IAS and 29 interpretations

3

Developing standards4

IFRS across globe5

Towards one set of global accounting standards

Why important to understand IFRS6

Top 10 Global Capital MarketsUS US GAAP – moving towards IFRS

Japan Convergence to IFRS

UK IFRS

France IFRS

Canada Convergence to IFRS

Germany IFRS

Hong Kong HKFRS (equivalent to IFRS)

Spain IFRS

Switzerland IFRS or US GAAP

Australia AIFRS (equivalent to IFRS)

Agenda

Overview of IFRS

Key points for investors

Live examples to highlight importance of understanding IFRS

Accounting differences – Impact on multiples

Mitigating accounting differences

Moving to IFRS – Impact on share prices

77

AGENDA

Some key points for investors (1/2)

8

Accounting policy choices – Impairs comparability

IFRS is principle based standard and offers accounting policy choices

to companies.

Accounting policy choices are offered in financial instruments,

property plant and equipment, investment property, joint ventures

etc

Income statement - Cognizance of certain gains/losses

Gain on bargain purchase is recorded in income statement under IFRS.

This is a one time gain and not operating in nature.

Unrealized gains/losses due to fair value changes is recorded in

income statement for certain financial instruments.

Some key points for investors (2/2)

9

Management judgement/estimates – Infuses subjectivity

IFRS does not allow goodwill amortization. The same has to be tested

for impairment. This brings in subjectivity from management.

Fair value estimation

OCI– To be reviewed for income statement impact

Analysts/investors should look both the income statement and other

comprehensive income (OCI) when forecasting future cash flows.

Some portion of income/loss recognized in OCI is recycled back to

income statement in future years.

Agenda

Overview of IFRS

Key points for investors

Live examples to highlight importance of understanding IFRS

Accounting differences – Impact on multiples

Mitigating accounting differences

Moving to IFRS – Impact on share prices

1010

AGENDA

Example 111

Accounting requirement to fair value the remaining investment in case of loss

of control. (Moving from consolidation to equity method of accounting)

Please refer the case of Bezeq

Bezeq Press Release

Example 212

Accounting requirement to measure the own debt at fair value

For accounting purposes, Banks values its issued debt (e.g. bond issues) at the

current market price. Changes in this value are recorded in profit or loss.

FV of own debt

Example 3 EY research findings (Real Estate)

13

More than 90% of the surveyed companies have adopted the fair value option available in IAS 40

for the measurement of their investment properties

57% of the companies have disclosed the assumptions applied in valuation of investment

property

40% of the companies did not disclose information on impairment testing

Of those companies that have joint ventures (82%), 42% apply the equity method and 58% apply

the proportionate consolidation method. This suggests that, with the forthcoming changes under

the new standard Joint Arrangements (IFRS 11), we may expect some changes in accounting, e.g.,

changes from proportionate consolidation to equity accounting.

Report of one of leading Investment Bank pointed out the management subjectivity in impairment testing

Agenda

Overview of IFRS

Key points for investors

Live examples to highlight importance of understanding IFRS

Accounting differences – Impact on multiples

Mitigating accounting differences

Moving to IFRS – Impact on share prices

1414

AGENDA

Accounting differences –Impact on multiples

15

Consider two identical companies with 20 of goodwill on the balance sheet and 10 in pre-goodwill profit. Company A does not amortise goodwill while Company B amortises over 10 years (amortisation of 2 per year). (Assume share price of 200)

Will this impact the multiples?????

Since both companies have identical cash earnings they have the same value and should trade at the same share price (same number of shares assumed). This implies an earnings multiple of 25x for Company B. But it clearly would be wrong to conclude that Company A is cheaper than Company B. In fact, there is no information content whatsoever in the difference between the two multiples.

Agenda

Overview of IFRS

Key points for investors

Live examples to highlight importance of understanding IFRS

Accounting differences – Impact on multiples

Mitigating accounting differences

Moving to IFRS – Impact on share prices

1616

AGENDA

Mitigating accounting differences (1/2)

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Restate accounting data to a common format

Depreciation – Can be largely unrelated to the economic consumption of the asset. Factor maintenance

capex to mitigate these differences for cross-border equity analysis

Goodwill Impairment – Exposed to subjectivity by management. Consider an earning number before

impairment

Leases – Operating leases currently are shown off balance sheet. Capitalization of operating lease

required for analysis purpose

Income from associated – Should be considered as Non Core income for arriving at core EBITDA

Exceptional items – Should be excluded from EBIT/EBITDA for analysis purposes

Mitigating accounting differences (2/2)

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Focus on key statistics less affected by Accounting differences

Focus on cash flows when comparing companies instead of earning metrics

Comparing revenues (Still limitations will be there, not a preferred approach)

Using EBITDA – Has become the most common measure of performance (Ignores Capex and taxation)

Using OpFCF – Modified version of EBITDA (EBITDA – Maintenance Capex)

‘Maintenance capex’ is the amount an analyst estimates must be spent on fixed assets to maintain the profitability and competitive position of the company in real terms.

Agenda

Overview of IFRS

Key points for investors

Live examples to highlight importance of understanding IFRS

Accounting differences – Impact on multiples

Mitigating accounting differences

Moving to IFRS – Impact on share prices

1919

AGENDA

Moving to IFRS – Impact on share prices20

Convergence to IFRS will result in changes in the reported numbers be they revenues, costs, assets and/or liabilities.

New disclosures, changes in measurement and clearer performance and risk measures all potentially impact valuations.

IFRS can also impact cash flows that can impact the DCF valuation, e.g. change in accounting policy for revenue recognition.

IFRS can impact cost of capital if new disclosures changes investor perception for a company and the same getting reflected in investor’s required rate of return.

Moving to IFRS – Impact on share prices21

“Changing accounting standards to better reflect economic reality, is like buying a new pair of glassesto see the world around you. Just as new glasses can change your view of the world, a change inaccounting standards impacts perception of economic transactions. Although you know that theworld has not actually changed, it might be that you are better able to read signs with a new pair ofaccounting glasses”

Source: UBS