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The Sunday Times Rich List, private companies and hedge funds: the art and science of company valuations revisited
14/05/2018 , Ian Orton

Private companies underpin the wealth of an increasing number of the constituents of the 2018 Sunday Times Rich List, not least Jim Ratcliffe, who heads the list with an estimated fortune of £21 billion and Andy Currie and John Reece, two of his business colleagues, who each own around £7 billion.

But private companies can be very difficult to value as the recent Signia Wealth versus Nathalie Dauriac court case illustrated. Here the valuations submitted by expert witnesses for a small and relatively newly established wealth management varied between zero and around £42 million.

So how do the compilers of the Sunday Times Rich List negotiate this problem?

According to its “Rules of Engagement” private companies are valued on a multiple of their profits “depending upon their sector, track record and strength of their balance sheets”.

The compilers appear to use very conservative valuations. Although the average multiple used in the FTSE 250 is 20 times profits the Rich List compilers use an average multiple of 10 to 12 times the latest profit figure, “depending upon the sector”. 

For Ineos the chemicals firm where Mr Ratcliffe has a 60 percent stake the Rich List compilers applied a multiple of seven times its profits of around £5.15 billion to produce a valuation of £35 billion.

This is probably a very conservative valuation.

BASF, a German publicly chemical company that is very similar to Ineos, trades at a multiple of 12.5 times earnings. Sinopec and Dow, two other big quoted chemicals firms trade at far higher multiples.

Ineos - and Mr Ratcliffe, Mr Currie and Mr Reece - could be worth much more if the Rich List compilers used a higher multiple.

Indeed this method of valuing a firm can produce a very wide range of outcomes depending on the multiple applied and the nature of the earnings figure. It also assumes that a company actually generates profits, although loss making firms can still have value, especially if the negative earnings reflect extraordinary one-off events.

Mr Justice Marcus Smith used EBITDA (earnings before interest, taxation, depreciation and amortisation) as the base from which to estimate the value of Signia in Signia versus Dauriac.

But this almost certainly would have produced a higher valuation than if he had focused on an “adjusted” pre-tax earnings figure.

The choice of multiple can also be very subjective and reflect the performance of a private firm’s publicly quoted competitors rather than the firm itself.

Then there are ownership premia and discounts to be taken account of, especially in firms like Ineos and Signia, where ownership is very concentrated.
 
So the Rich List compilers are probably correct in opting to use a relatively modest multiple.

When it comes to hedge fund management companies, however, the Rich List compilers appear to be more liberal  when it comes to valuations.

“We tend to value them at about 10 percent of their funds under management and their profit record”, say the “Rules of Engagement”.

Given that the typical multiple attached to private client assets at wealth management firms tends to be between two percent and three percent this seems rather large.  

This may have inflated the fortunes of the many hedge fund managers that populate the list.
 

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