INTRODUCTION


Valuation, as a science, deals with, among other things, the following: (1) adherence of general accounting principles for the organization and presentation of the financial data of the business; (2) chronicalization of the facts associated with the historical growth of the business; (3) extrapolation of financial data into future time periods; and (4) calculation of various valuation ratios and statistical formulae ( & , 1999). These are, without question, critical dimensions to a business valuation, but they are not the only dimensions of a business valuation that are important. All too often, for a variety of reasons, individuals may fall into the trap of believing that business valuation is little more than a formulistic exercise. The interpretation of the financial statements published publicly by the companies are utilised by users of such information as an aid to decision-making, more commonly for making investments to the business firm. There would be no trouble in the presentation of the assets of the firm, as they are purely quantitative in nature, and is free of subjectivity. Non-current assets present a problem, though. The valuation of the same is normally expected to provide users of financial information with a ‘true and fair’ view. However, their constant revaluation poses a detriment to the presentation of the view that is the norm.


This paper is a critical evaluation of Ryanair’s system of valuing their non-current assets, based on the latest financial statements available for the international carrier, in comparison with other firms’ valuation of the non-current assets of their own.


BRIEF RYANAIR BACKGROUND[1]


Ryanair is a low-cost, low-fare airline headquartered in Dublin, Ireland, operating over 200 routes in 20 countries. The company has directly challenged the largest airlines in Europe and has built a 20-year-plus track record of incredibly strong passenger growth while progressively reducing fares. It is not unusual for one-way tickets (exclusive of taxes) to sell on Ryanair’s Web site for less than €1.00. See Exhibit 1 for an excerpt of Ryanair’s Web site, where fares between London and Stockholm, for example, are available for 19 pence (approximately US.33). CEO , formerly an accountant at KPMG, described the airline as follows: ‘Ryanair is doing in the airline industry in Europe what Ikea has done. We pile it high and sell it cheap…. For years flying has been the preserve of rich [people]. Now everyone can afford to fly’ (, 2005:  ). Having created profitable operations in the difficult airline industry, Ryanair, as did industry analysts, likened itself to U.S. carrier Southwest Airlines, and its common stock has attracted the attention of investors in Europe and abroad. The company went public on May 9, 1997, and shortly thereafter was voted ‘Airline of the Year’ by the Irish Air Transport Users Committee, ‘Best Managed National Airline’ in the world by International Aviation Week magazine, ‘Best Value Airline’ by the U.K.’s Which consumer magazine, and most popular airline on the Web by Google. The company emphasizes that it defines customer service by low airfares and safety, rather than by the quality of food, pleasantness of staff, and other peripheral items.


VALUING RYANAIR NON-CURRENT ASSETS


            A study of the consolidated balance sheet of Ryanair dated March 31, 2006 would show that their non-current assets comprise of property, plant and equipment, intangible assets and derivative financial instruments (see Appendix 1 for copy of consolidated balance sheet). IAS 16 prescribes the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about an entity’s investment in its property, plant and equipment and the changes in such investment. Ryanair complied with this standard, as they have in their balance sheet, said property, plant and equipment measured at their costs, and subsequent revaluation, depreciation and the residual values have been properly accounted for. Further, IAS 36, or that which prescribes the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount, was also conformed to by the company, evidenced in the section of their annual report which deals with the impairment of their assets, specifically their planes.


With respect to their intangible assets, IAS 38 requires that the latter be initially recognized at cost under certain requirements, and it is seen in the annual report of Ryanair that this standard has been complied with as well. The net book value (NBV) of the assets are already what is reflected in the balance sheet, which means that the value of the assets are already less than their respective depreciation and amortization. So as not to understate or overstate the value of an asset, net realizable value (NRV) is included in accounting standards, and this has been abided by the civil aviation firm, as they have indication that their non-current assets are fairly valued. Ryanair puts their assets in use according to their original intention. This is in compliance with the value in use (VIU) standard set by accounting regulators. The said financial statement was presented in Euro rounded to the nearest thousand, being the functional currency of the parent company and the majority of the group companies. They are prepared on the historical cost basis, except for financial instruments and derivative financial instruments, which are stated at fair value. Any non-current assets classified as held for sale are stated at the lower of cost or fair value less costs to sell.


The valuation used for the non-current assets of Ryanair seems to be the weighted average of adjusted net income, which is appropriate because the company’s history is not one of continuous growth and profitability. This the more traditional approach of not inputting a growth factor to the weighted average has been appropriately applied for the company’s non-current assets. An understanding of the economic environment of the business is fundamental to deciding the appropriateness of using such valuation method (, 2005). As previous years’ sales resulted from unusual and extremely unfavourable economic conditions, and if the general economic environment has changed since that time, then the past may not be a good predictor of future non-current assets activity, which was maybe the basis of Ryanair for using the weighted average of adjusted net income in the valuation of their non-current assets.


            Following the series of bad news announcements in Ryanair in early 2004, the investor community split into two camps: those that saw the downturn in profits and cash flows as the end of Ryanair’s strong performance run versus those that believed the stock price drop to be an overreaction to a company that retained strong fundamentals. However, an analysis of Ryanair’s profitability and operating, investment, and financing activities over the most recent years show that the overall picture is that of a financially healthy company with strong sales growth, high profitability, and negative net debt (i.e., interest-bearing liabilities less than cash and liquid resources). There are discrepancies in valuations, however, and they reflect divergent opinions on numerous issues that plague the airline sector, such as fare competition, cost containment, regulation, and macroeconomic vulnerability.


            Fundamentally, Ryanair is a consumer organic growth story. But, as mentioned earlier, as the company became more established, Ryanair sharply de-rated a couple of years ago, and has clearly traded below historical averages and even below averages for the last three years. It is also trading considerably below its closest peer, easyJet. In the category of financial performance Ryanair is at the top end of the peer group but valuation levels are only close to mid-range. It is therefore felt that derating risk is low and indeed there could be some further movement upwards in the multiple. The medium-term goal is for Ryanair to maintain stable net margins of 20%. Key sensitivities to the valuation are what level of margins and hence returns are assumed before fade-out and the cost of capital. It could be argued that having delivered relatively stable margins close to 20% for the last 11 years, Ryanair has a decent chance of repeating this for a few more years, given the strategic building blocks that are in place, such as the Boeing deal and its market position. Arguably the heavily weighted equity capital structure may be modestly addressed over the coming years, which could mean a modestly lower WACC going forward.


            The valuator should not, in  and ’s (1999) opinion, define ‘most appropriate’ based on the results that follow from the application of several methods. Doing a corporate valuation is not a mysterious process that is open only to the few (,  & , 2000). It does require, however, a different perspective from that taken by many managers. It requires focus on long-run cash flow returns, not quarter-to-quarter changes in earnings per share. It also requires a willingness to adopt a dispassionate, value-oriented view of corporate activities that recognises businesses for what they are – investments in new productive capacity that either earn a return above their opportunity cost of capital or do not. There are many areas in valuation where there is room for disagreement, according to  (2002). This includes how to estimate true value and how long it will take for prices to adjust to true value. But there is one point which there can be no disagreement: asset prices cannot be justified by merely using the argument that there will be other investors around willing to pay a higher price in the future.


Income statements and balance sheets describe aspects of the financial condition of the business, and hence, both should be examined. In fact, all financial information should be considered in detail. A fundamental and extremely important assumption that underlies all business valuations is that the financial health of the business is accurately characterized by its financial statements. If the financial statements are incorrectly prepared, or if they overstate or understate the true financial picture of the going concern for some accounting reason, then it follows logically that the valuation will be imprecise. Analysts use a wide range of models in practice, ranging from the simple to the sophisticated. The models enumerated previously belong to the general category. These models often make very different assumptions, but they do share some common characteristics and can be classified in broader terms, which makes it easier to understand where individual models fit into the big picture, why they provide different results, and when they have fundamental errors in logic.


Comparability is one of many pieces of information that a valuator brings to the valuation exercise (,  & , 2000). As with most non-specific pieces of information, care must be exercised in how such information is interpreted and utilized in arriving at the final valuation opinion. Therefore in order to fully determine the appropriateness of Ryanair’s valuation method used in their non-current assets, there is a need to look into other businesses’ (in the same industry, in this case, civil aviation) balance sheet and determine the valuation method that they use in valuing their own non-current assets. For this purpose, the company easyJet’s balance sheet, a close rival of Ryanair in the markets that the two companies are operating in, is examined.


            easyJet is a leading low-cost airline. It was founded in 1995 when new European Union rules allowed free competition in air transport and grew rapidly, becoming a plc in 2000 (, 2001). By 2001, the easyJet network consisted of 35 routes serving 17 airports in 16 cities ( & , 2005). Looking at their balance sheet as of (see Appendix 2). Their non-current assets include goodwill, property and equipment and principally capitalised software and software development costs, restricted cash, deposits paid in respect of Airbus aircraft to be financed by sale and leaseback which deliver in more than one year. Property, plant and equipment comprises principally owned aircraft, spares and deposits paid to Airbus in respect of the delivery of future aircraft which are not to be financed according to sale and leaseback arrangements. As seen in the (2006), the net book amount attributable to property, plant and equipment increased from £398.6 million at 30 September 2005 to £695.7 million at 30 September 2006. The increase is due to capital expenditure of £413.2 million, set out in more detail in “capital expenditure” below, set off against disposals of £88.7 million and depreciation of £27.4 million. The total of other non-current assets has increased from £30.7 million at 30 September 2005 to £31.1 million at 30 September 2006.


The choice of a valuation method requires thought and contemplation. The valuator should first learn about the business and then select the one valuation method that is the ‘most appropriate’ based on the relationship between the circumstances for understanding the valuation and the assumptions that underlie each of the valuation methods. The method for the easyJet valuation is the earnings valuation method. It may be the case that the most appropriate method to use to value a going concern is the said valuation method. It is, first and foremost, the most common way to valuation. It is an approach to valuing a company by capitalising its earnings, which generally involves multiplying one or another income statement earnings figure by some multiple (, 2002). The earnings-based valuations assume that the value of an entity is equal to the present value of future earnings that will be generated by the business. Further, this method is based on two elements, the price/earnings ratio and the post-tax earnings per share of a business, which, when combined, give the market price per share (, 2006). There maybe a different (higher or lower) future earnings estimate based on efficiencies arising from new management (higher earnings) or restructuring costs (lower earnings) that will gave an impact on price negotiations.


The earnings-based formulation has intuitive appeal. It implies that if a firm can earn only a normal rate of return on its book value, then investors should be willing to pay no more than the book value for the stock. Investors should pay more or less than book value if earnings are above or below this normal level. Thus the deviation of a firm’s market value from book value depends on its ability to generate ‘abnormal earnings’ (, 2002). The formulation also implies that a firm’s stock value reflects the cost of its existing net assets (that is, its book equity) plus the net present value of future growth options (represented by cumulative abnormal earnings). To further strengthen the argument, the AICPA’s Management Advisors Services Practice Aid, Valuation of Closely Held Businesses indicates that the Internal Revenue Service strongly recommends the use of earnings-based valuation models for valuing businesses (as noted by , 2005).


APPENDICES


Appendix 1. Consolidated Balance Sheet[2]



Appendix 2. easyJet Consolidated Balance Sheet[3]


  


   


 


 


REFERENCES/BIBLIOGRAPHY



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