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The valuation of companies I: Normality.

Given this extraordinary situation without any precedent, analyzing the value of anything in times of coronavirus is very difficult, even though it will always be the result of the market and what we are willing to pay for any given asset or company. There is a consensus that the value of a company is determined by its future cash flows, or more fundamentally by future profits (EBITDA), which in turn is discounted by the risk that these are not achieved. This is translated into multipliers (multiples of EBITDA), which serve as a comparative reference for valuation.  Today we find ourselves in a situation where forecasts, budgets, and estimates have been ruined. The risk of deterioration in the financial situation is great: delays in sales and collections, risk of customer insolvency, volatile internal situations, lack of inventories or misaligned inventories due to the lack of a reliable estimate of how regular suppliers and customers will react.  For example, let us take 2020 as something extraordinary, abnormal, and let’s try to imagine a normal, normalized EBITDA.  As the discount rate for future cash flows, we must use as a basis the risk-free rate (government bonds), inflation (which is assumed to be that of the previous period), the risk premium of the sector, and the risk of the particular company that is analyzed.  Inflation is no longer a problem, it is close to zero, so let us look now at deflation. In the coming months, inflation data will be unpredictable, since it is based on our consumption in normal times. For this reason, it must be treated as something extraordinary that must be normalized or it will not serve a projection well.  The current market multiples established are another influencing factor in valuations. Stock markets have collapsed but, if in 2021 the markets have normalized and recovered, the price multiples of listed companies will not weigh down the valuation of those that are not listed.  What there will be is a lot of money because companies are taking advantage of government aid to increase liquidity through plentiful cheap debt. The governments of Europe and the United States have committed eight trillion euros in loans to companies (8 times the GDP of Spain). This tremendous injection of resources into companies will increase the hunger for purchases and will play in favor of valuations.  In conclusion, the multiples will be adjusted to the forecast of what the year 2021 will be like. But the designs of the purchase-sales will change, since a percentage of the price will be left subject to the results of the following years, which we call profits. For example, if we agree, a transaction based on a multiple of 8 times EBITDA, the buyer today pays four times the estimated EBITDA for 2021 (50%), 2 times the EBITDA when 2021 closes (25%), and the rest in 2022.

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