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Purchase Price Allocation (PPA)  
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Chinasoft International Limited (00354.HK)
China Mining Resources Group Limited (00340.HK)
China Primary Resources Holdings Limited (08117.HK)
China Renji Medical Group Limited (00648.HK)
North Asia Resources Holdings Ltd. (00061.HK)
Hanny Holdings Limited (00275.HK)

Mergers and acquisitions ("M&A") is one of the successful paths for company growth by considering the synergies and inherent risks of target business, negotiating the transaction terms, conducting due diligence on seller's accounting and legal record with signing the formal agreement for sale and purchase. Before the deal is closed, the management should complete the business integration adjustments and fair value measurement by purchase price allocation ("PPA") in their books according to the accounting standards.

Challenges for Understanding Purchase Price Allocation
The acquirer always focuses on the purchase price of equity interest in terms of cash, debt and stock as settlement method in a M&A deal. The purchase decision is made by the acquirer's investment intention to the acquired business, which is reflected in the purchase price rather than its fair value.

The definition of fair value in HKFRS13 is the price that would be received to sell an asset or paid to transfer a liability in orderly normal transaction between market participants at the measurement date. For example, auction price for purchasing a specific asset is not represented fair value of the asset, as the buyer concerns the "investment value" based on individual assessment and make the highest bid price, which is not "fair value".

The fair value would be quantified if the hypothetical willing buyer and seller assumed that they will use the asset to its highest value and best use, and can generate economic benefits in accounting perspective. So the concept of fair value, as perceived by the acquirer, is far away from the investment strategic, operational and financial views that are considered in an acquisition in the first place. Therefore, misunderstanding on fair value may lead to misconception on the fairness of fair value.

 

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Our valuers have multiple valuation and professional designations which can fulfil clients' different needs. Our conclusion of value is based on facts and circumstances, as well as our experience and professional judgement, which will assist company in making logical and confident decision.

For more information about our valuation services, please visit www.gca-valuation.com.

Steps of Performing Purchase Price Allocation
In an acquisition's transaction, the acquirer is required to adjust its financial statements to reflect the assets acquired, liabilities assumed and any non-controlling interest in the acquiree at fair values in accordance with IFRS 3 (Revised) requirement.

Market value of assets may be different from the book value on the seller's book. As a result, the acquirer is required to perform asset valuation by valuation models and methodologies to determine the fair value conclusion in a PPA process. The five steps of performing a PPA are highlighted as below:


When performing PPA, the fair value of all tangible assets (e.g. properties), identifiable intangible assets and goodwill are required to be determined at the same time. Intangible assets include existing customer relationships, patents, trademarks, contractual agreements and self-developed technology which are expected to generate economic benefits.

PPA assessment and estimation on purchase consideration are required when share purchases agreement involving earn-outs, options and employee stock option plans. Through assessment and valuation by our professional valuers, we are able to pinpoint the value and market competitiveness of the target company.

The purchase price paid for acquiring a company exceeds the fair value of identifiable net assets acquired is called goodwill. We illustrate the concept of book value and fair value in the figure below:


Importance of Performing Purchase Price Allocation
We perform PPA in the early stage of a transaction and provide initiation evaluation on financial impacts of an acquisition. For example, the identification of intangible assets largely depends on the assessment of the acquirer's management. The related revenue stream attributable to the business and the useful life of intangible assets must be valuated and determined in accordance with IFRS and best practice in valuation. The valuation result of the acquired company disclosed and reflected directly in the financial position of acquirer's company.

As the ultimate value is sensitive to changes in underlying valuation assumptions, the results of PPA should conduct business impairment test after identifying intangible assets and goodwill as at valuation date. This is a key step to assess the potential risk of future impairment losses.

Application of Purchase Price Allocation
Company A acquired 100% equity interest of a target company for HKD 40,000,000. The target company is engaged in the provision of management service for private medical and dental practices, and integrated healthcare service for the general public in Hong Kong. The business value for 100% equity interest was HKD 35,000,000.

Valuated Assets Valuation methodology commonly used
Property interest Direct comparison approach
Trade name Income approach-Relief from royalty method
Assembled workforce Cost approach-Replacement cost method
Customer relationship Income approach-Multi-period excess earning method

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