Navigating pre-acquisition company valuation in the UAE

Amir Fardoun highlights the aspects involved in pre-acquisition company valuation in the United Arab Emirates - regulations, steps and valuation methods.

Published on The Oath , As businesses seek growth opportunities, mergers and acquisitions (M&A) have become a common strategy. However, before finalising any acquisition deal, it's crucial to accurately assess the value of the target company. In the United Arab Emirates, a dynamic and rapidly evolving business landscape, understanding the nuances of company valuation is essential for successful acquisitions. This article elucidates the key considerations and methodologies involved in valuing a company pre-acquisition in the UAE.

REGULATORY FRAMEWORK

Before diving into the valuation process, it's imperative to grasp the regulatory framework governing M&A activities in the UAE. Foreign investors should be mindful of local laws, regulations, and restrictions, particularly concerning valuation limits. The UAE Companies Law and various regulatory bodies provide guidance on valuation methodologies, reporting requirements, and compliance standards.

UAE Companies Law – The UAE's Federal Law No. 32 of 2021 Law outlines the legal framework for conducting business activities in the UAE, including provisions related to company valuation. It requires companies to adhere to internationally accepted valuation standards and principles. Additionally, freezones may have specific regulations governing company valuation within their jurisdiction.

As for the controlling the securities and commodities market in the UAE, the Securities and Commodities Authority (SCA) is responsible for overseeing granted securities which more or less affect the company valuation under one or many of the criterias exposed below. It provides guidelines on valuation for companies listed on the stock exchange, ensuring transparency and investor protection.

PRE-ACQUISITION VALUATION STEPS AND METHODS

Common practice in the UAE as well as the current applicable regulations leads to consider the following steps and methods when it comes to valuing a company prior to its contemplated acquisition:

1. Preliminary step: financial statements analysis

Conducting comprehensive financial due diligence is the cornerstone of pre-acquisition valuation. This involves analysing the target company's financial statements, cash flow projections, historical performance, and any potential liabilities. In the UAE, accounting standards may vary depending on the company's legal form and sector. Understanding the applicable accounting principles and ensuring compliance with International Financial Reporting Standards (IFRS) or other relevant standards is crucial for accurate financial analysis.

2. Selection of Valuation Methods

Various valuation methodologies can be employed to assess the target company's worth. Common approaches include earnings before interest, taxes, depreciation, and amortisation (EBITDA), comparable company analysis (CCA) and precedent transactions, discounted cash flow (DCF) and asset-based valuation. DCF analysis, which estimates the present value of future cash flows, is often favored for its ability to incorporate company-specific growth projections and risk factors. CCA and precedent transactions rely on market multiples to benchmark the target company against its peers. In the UAE's diverse business landscape, selecting the most appropriate valuation method requires careful consideration of industry dynamics, company size, growth prospects, and available data.

a. Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA): EBITDA is a widely used metric for assessing a company's operational performance. The target company's EBITDA is calculated to gauge its profitability, irrespective of financial structure and accounting decisions. This method provides a clearer picture of a company's ability to generate cash flow from its core operations.

b. Comparable Company Analysis (CCA): CCA involves comparing the target company's financial metrics with those of similar publicly traded companies. Identify comparable companies within the UAE market, considering factors such as size, industry, growth prospects, and risk profile. This method helps establish a valuation benchmark based on market multiples.

c. Discounted Cash Flow (DCF) Analysis: DCF analysis estimates the present value of a company's future cash flows, considering the time value of money. This method consists of projecting the target company's expected cash flows over a defined period and discounting them back to their present value using an appropriate discount rate. DCF provides a fair and credible valuation, focusing on the company's current ability to generate future cash flow.

d. Asset Approach: The asset approach focuses on valuing the company based on the value of its tangible and intangible assets. This includes methods such as the net asset value (NAV) method and the excess earnings method. However, using this method requires to take into account all existing and outstanding liabilities related to such assets and may present itself as inconvenient to the seller due to a decreased NAV and therefore a low sale price.

3. Considering market conditions

The UAE's market conditions can significantly impact company valuations. Factors such as economic stability, geopolitical risks, and industry-specific dynamics should be carefully assessed. Keep in mind that the UAE's economy is influenced by global oil prices, making it essential to consider the broader economic context. Evaluating the target company's industry position and market dynamics is essential for contextualising its financial performance. Factors such as market growth, competition, regulatory trends, and technological advancements can significantly impact valuation.

In the UAE, certain industries such as real estate, hospitality, and energy are key drivers of economic growth. Therefore, it is crucial to properly analyse industry-specific metrics and trends in order to receive valuable insights into the target company's growth potential and competitive positioning.

4. Legal and Regulatory Due Diligence

Given the complexities involved in company valuation and M&A transactions, engaging professional advisors with expertise in UAE's business environment is highly recommended. Experienced financial advisors, legal experts, and industry consultants can provide an important understanding of the company’s legal and financial situation, facilitate due diligence processes, negotiate deal terms, and navigate regulatory requirements, thereby enhancing the likelihood of a successful acquisition.

Beyond tangible assets and financial metrics, assessing intangible assets such as brand reputation, intellectual property, and human capital is essential for a detailed valuation. Moreover, identifying and mitigating risks associated with legal, regulatory, geopolitical, and macroeconomic factors is critical for accurately assessing the target company's value.

Valuing a company pre-acquisition in the UAE requires a rigorous approach that considers both financial and non-financial factors as well as combining financial statements analysis, industry benchmarks, and thorough due diligence in order to allow acquirers to take well informed decisions and to negotiate fair deals. It is important, along with considering all of the above valuation methods, to note that the introduction of corporate tax in the UAE since June 2023 has impacted the company valuation in several ways:

• Earnings reduction: corporate tax will directly reduce a company's earnings as a portion of its profits will now be allocated to tax payments. This will his reduction in earnings could lower the valuation multiples used in valuation models such as EBITDA.
• Cost of capital: the introduction of corporate tax may increase the cost of capital for companies operating in the UAE. Investors may perceive higher risks associated with investing in taxed entities compared to tax-free entities, leading to an increase in the required rate of return.
• Cash flow impact: corporate tax payments will reduce the cash flows available to the company for reinvestment or distribution to shareholders. Lower cash flows could lead to a decrease in the discounted cash flow (DCF) of the company.
• Competitive positioning: companies operating in the UAE may face increased competition from entities in jurisdictions with lower or no corporate tax. This competitive disadvantage could impact the company's growth prospects and, consequently, its valuation.

By adhering to accepted practices in the UAE and leveraging appropriate valuation techniques, businesses can ensure transparency, accuracy, and credibility in their valuation processes. As the UAE continues to evolve as a global business hub, adherence to valuation guidelines will remain essential for fostering investor confidence and driving sustainable growth in the economy.

Article by: Amir Fardoun , senior associate, CVML