Pricing the Pandemic: Valuation in the time of COVID-19

The valuation of private companies and assets is often said to be more art than science but never more so in the time of COVID-19. Amid an outlook of decreasing deal flows and market uncertainty, private equity (PE) and venture capital (VC) managers must use judgement to complement conventional metrics, according to panelists at RBC Investor & Treasury Services’ ‘Valuation in a COVID-19 Context’ webinar.¹

A cloudy market outlook

The first quarter of 2020 was a rollercoaster for investors as COVID-19 brought recession and volatility. The rebound in equities in Q2 raised hope of economic recovery, however, optimism remains checked by the lingering health crisis and the threat of repeated waves of infections. The uncertainty has meant unprecedented challenges in valuing private companies and assets, with whole industries shuttered and multiples skewed by market volatility.

Pricing in the coronavirus

The cloudy outlook has given rise to a new COVID-specific metric called EBITDAC—adding the ‘C’ of ‘Coronavirus’ to the conventional metric. The idea of companies adding back earnings lost to COVID-19 has proved divisive, however, given the difficulty quantifying such losses versus other factors. “There are some who are pricing firms just on an EBITDAC basis,” said panelist Victor Decrion, Chief Operating Officer at Rothschild & Co Merchant Banking. “The question is what is the COVID impact? And to what extent might there be a secondary COVID-19 impact in Q4 of this year and Q1 of next year?”

Using judgement in fair value

Fair value—the amount that would be received in an orderly transaction in the prevailing market environment—remains the ultimate benchmark for valuation, as reiterated by the International Private Equity and Venture Capital Valuation (IPEV) board in March.² IPEV cautioned that it may no longer be suitable for recent transaction prices, especially pre-COVID prices, to receive weight in the assessment of fair value. The body said valuers also need to weigh the crisis’ impact on operations, revenues, customers and supply chains, along with access to government subsidies.

“The idea is to normalize future cash flows, normalize EBITDA in a way where you would exclude the EBITDA that is impacted by the one-off lockdown,” said panelist Laurent Capolaghi, Private Equity Partner at EY. “It may be a bit difficult to do and judgements come into the equation.”

The uncertainty has
meant unprecedented
challenges in valuing
private companies
and assets

Olivier Younès, Founding CEO at EXPEN and Professor at HEC Paris and at Berkeley, noted that, “During the pandemic, VCs have also developed a down to earth industry-based approach, by applying discounts to traditional retail, hotel, and restaurant models, while applying premiums to digital platforms and ‘everything as a service’ business models in their portfolios.”

Dwindling deal activity means less market guidance

One ‘judgement approach’ is to choose appropriate multiples that reflect the current market environment, which may be challenging with a decreasing set of deals in the pipeline. VC deals activity dropped sharply in Q1 in both volume and value and is expected to moderate further in Q2.³

“I think both VCs and entrepreneurs were not really in the mood to do completely new deals,” said panelist Francois Paulus, Co-founder and Managing Partner at Breega, a VC firm. “The deal flow was a little bit down, but what we started (pre-COVID) we finished.”

Deal activity in private equity could also be softer, according to Decrion. “When it comes to new deals at the moment, there is still quite a bit of uncertainty in how to price those because the impact on earnings is only starting to be seen,” he said. “In particular, people are questioning the potential impact of a second spike in infections on earnings.”

Seeking value in proxies

It is not exact science,
that’s the artistic part
of valuation

Without equivalent private market metrics, managers are looking for proxies in public markets. Capolaghi said his team had extrapolated the COVID-19 impact on a sectoral basis via listed companies’ earnings releases to factor into valuations. “It is not exact science, that’s the artistic part of valuation,” he said.

Paulus said his firm had tweaked its Q1 reporting on portfolio companies to include tables that detailed the current and future impact of COVID-19 on valuations along with activities the firms had performed to mitigate the effect of the crisis.

“We tend to follow IPEV rules. We tend to take the bad news, rather than the good. By that I mean we discount from the last valuation,” he said.

Versatile firms warrant higher valuations

PE and VC firms alike marked down valuations in the first quarter. Four major PE firms, Apollo, Blackstone, Carlyle and KKR, reported paper losses of USD 90 billion on their portfolios in Q1, about seven percent of their assets under management.⁴ Steep discounts in valuations from previous rounds of funding have also been seen in the VC space.⁵

The outlook remains uncertain for industries reliant on social interaction, such as tourism, leisure and hospitality, where the impacts of COVID-19 continue to be of particular concern. Yet prospects are brighter for nimble companies that moved quickly to digitize operations, such as ‘click and collect’ in the retail space, agreed the panelists. Some portfolio companies whose valuations were marked down at the end of Q1 could ultimately be marked up after considering all available data.

“Q2 is the quarter where we see which companies managed to adapt in terms of generating earnings again,” said Capolaghi. “Equity markets are going well, there’s lots of money around and multiples are really on the rise.” However, caution would “still be the motto,” according to Decrion.