I don't quite understand the valuation method 2. I can see that being equal to the value of the "profits" generated by the reserves. If I assume that there is no growth, then the profit = free cash flow. It shows the value of the reserves to the firm. If correct, then shouldn't you deduct the loan, RCUL, and even the deferred tax liabilities to get to what is due to the shareholders. However, you have assumed that the value of the reserves all belongs to the shareholders. What is wrong with my view? < i4value.asia>
I see where you're coming from. That concern would be relevant when it comes to the loan and RCUL, as redeeming them would involve a yet unaccounted for cash outflow. However, their amounts are immaterial.
In contrast, the deferred tax liabilities and provision for decommissioning costs have already been deducted from the P&L statement of previous years. Hence, while their amounts are materially significant, they've largely already been accounted for and no longer need to be deducted from the NPV of future CF.
There may still be future changes to the latter, but since these are all speculative valuation exercises anyway, the point isn't to try and nail down a precise valuation but rather to determine if a sufficient margin of error exists.
I have an engineering background so I may be way over my head talking about taxes with you. But I was told that deferred tax is something that has to be paid. So if the company closes shop today, the deferred tax is still payable.
Along this line even though in deriving valuation 2 you have accounted for future taxes, what is currently owed should be deducted. I would have considered deferred tax as some sort of "funding" by the govt. I am not talking about deducting deferred tax from the NPV of future CF. Rather I have assumed that the future CF would have accounted for the future taxes and there are no additional deferred taxes.
So once we have the value to the firm, we should first "return" all the funds before counting what is left for the shareholders.
In fact irrespective of whether it is value 1 or value 2, shouldn't we deduct all the monies due to the "funders" before we count what is due to the shareholders?
The only way you can get away from deducting deferred tax is if you consider deferred tax as part of net working capital. But I always had the impression that deferred tax, unlike trade payables is not part of net working capital.
It's necessary to first understand how the Deferred Tax Liabilities figure on the Balance Sheet is derived. Normally when you are charged tax, it's accounted for by Dr Tax Expense (P/L) and Cr Deferred Tax Liab (B/S). Then when the tax is paid, you reverse it by Dr Deferred Tax Liab and Cr Cash.
Since the recoverable amount value in Intangible Assets is a profit amount, it has already accounted for future tax expense. Therefore deducting tax from it again would be double counting.
Thank you for taking the trouble. I am actually a self-taught value investor.
My 2 valuation gurus are Damodaran and Penman. They approach valuation differently - Penman is an accountant whereas Damodaran occasionally makes fun of accountants.
Like most things in stock investment, there are different views. Damodaran thinks that you should deduct the present value of the deferred taxes from the valuation of a firm to get the equity values.
So you can imagine the predicament to non-accountants like me. In practice, the companies that I look at have relatively small deferred taxes so it was not an issue. But the quantum in Hibiscus is large and can make a difference to the margin of safety.
From a conservative perspective, I would still deduct probably about half of the deferred tax (guestimate of the present value of the deferred tax at the end of the reserve life).
I don't quite understand the valuation method 2. I can see that being equal to the value of the "profits" generated by the reserves. If I assume that there is no growth, then the profit = free cash flow. It shows the value of the reserves to the firm. If correct, then shouldn't you deduct the loan, RCUL, and even the deferred tax liabilities to get to what is due to the shareholders. However, you have assumed that the value of the reserves all belongs to the shareholders. What is wrong with my view? < i4value.asia>
I see where you're coming from. That concern would be relevant when it comes to the loan and RCUL, as redeeming them would involve a yet unaccounted for cash outflow. However, their amounts are immaterial.
In contrast, the deferred tax liabilities and provision for decommissioning costs have already been deducted from the P&L statement of previous years. Hence, while their amounts are materially significant, they've largely already been accounted for and no longer need to be deducted from the NPV of future CF.
There may still be future changes to the latter, but since these are all speculative valuation exercises anyway, the point isn't to try and nail down a precise valuation but rather to determine if a sufficient margin of error exists.
I have an engineering background so I may be way over my head talking about taxes with you. But I was told that deferred tax is something that has to be paid. So if the company closes shop today, the deferred tax is still payable.
Along this line even though in deriving valuation 2 you have accounted for future taxes, what is currently owed should be deducted. I would have considered deferred tax as some sort of "funding" by the govt. I am not talking about deducting deferred tax from the NPV of future CF. Rather I have assumed that the future CF would have accounted for the future taxes and there are no additional deferred taxes.
So once we have the value to the firm, we should first "return" all the funds before counting what is left for the shareholders.
In fact irrespective of whether it is value 1 or value 2, shouldn't we deduct all the monies due to the "funders" before we count what is due to the shareholders?
The only way you can get away from deducting deferred tax is if you consider deferred tax as part of net working capital. But I always had the impression that deferred tax, unlike trade payables is not part of net working capital.
It's necessary to first understand how the Deferred Tax Liabilities figure on the Balance Sheet is derived. Normally when you are charged tax, it's accounted for by Dr Tax Expense (P/L) and Cr Deferred Tax Liab (B/S). Then when the tax is paid, you reverse it by Dr Deferred Tax Liab and Cr Cash.
Since the recoverable amount value in Intangible Assets is a profit amount, it has already accounted for future tax expense. Therefore deducting tax from it again would be double counting.
Thank you for taking the trouble. I am actually a self-taught value investor.
My 2 valuation gurus are Damodaran and Penman. They approach valuation differently - Penman is an accountant whereas Damodaran occasionally makes fun of accountants.
Like most things in stock investment, there are different views. Damodaran thinks that you should deduct the present value of the deferred taxes from the valuation of a firm to get the equity values.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/debttosubtract.htm
So you can imagine the predicament to non-accountants like me. In practice, the companies that I look at have relatively small deferred taxes so it was not an issue. But the quantum in Hibiscus is large and can make a difference to the margin of safety.
From a conservative perspective, I would still deduct probably about half of the deferred tax (guestimate of the present value of the deferred tax at the end of the reserve life).
Well feel free to make any necessary adjustments you deem fit. After all that's what the market is for.