|Theme||Visible||Selectable||Appearance||Zoom Range (now: 0)|
1962 Economic and Valution Symposium, Dallas, March 15-16, 1962
Debate over techniques of valuation of the going concern has been intensified in the recent wave of merger activity. It is the objective of this paper to analyse various methods of valuation within the con ceptual framework of present value theory. Initially, however, it is necessary to establish an unambiguous concept of investment value before turning to the challenging problems of determining suitable bases upon which bids and offers can be formulated.
THE CONCEPT OF INVESTMENT VALUE
Valuation of an integrated oil company is perhaps best approached by considering the process by which an individual capital expenditure proposal is appraised. Investment in a project is essentially made for the purpose of maximizing profit; i. e., obtaining the highest available rate of return on outstanding equity investment over the economic life of the venture. The process by which investors can most real istically estimate earning power and evaluate alternatives is through discounting future outlays and income receipts in such a manner as to permit comparison of cash outgo and income on a present value basis. Two widely utilized techniques are the trial and error solution for the "discounted rate of return" and the present value" method in which discounting is performed via an assumed minimum acceptable rate of return. In the following discussion, the "present value" method will be employed in view of the ease of its application and the implicit assumption of reinvestment at the project rate.
The present value concept of the measurement of economic worth was propounded in a highly developed form around the turn of the century by Friedrich Von Wieser, Eugen V. Bohm-Bawerk and H. J. Davenport. Davenport, for example, suggested that the process by which the present price of capital goods is fixed is one of capitalization and that "the present money worth of any future income or of any series of income constitutes "capital". More recently, economic innovators such as Irving Fisher, Lord Keynes, Kenneth Boulding, Eugene Grant, Friedrich and Vera Lutz, and Joel Dean have elaborated on the concepts of present value and the discounted rate of return.
Application of present value theory to project proposals and to going concerns fundamentally assumes that the purchase price or capital outlay is determined by the present value of future earnings available for dividend distribution, and further that these cash earnings can be estimated into the future with some reasonable degree of accuracy. The strength of the present value method is the required quantification of all known factors having a bearing on the relation between cash outlay and income in the stream of dime. The inescapable weakness of a discounting procedure, as in all measures of prospective profitability, is the requirement of predicting events which necessarily must remain in the nature of estimates, particularly as the forecasts extend into the more remote future.
The most critical element in appraising the present worth of an asset is a realistic projection of earnings prospects. Business ventures are, however, by their very nature surrounded by uncertainty. Entrepreneurial profit is in large measure derived from out. guessing competitors as to the outcome of events which are essentially unique. The drilling of a wildcat well, the introduction of a new product or process, the establishment of a new distribution outlet, the purchase of a share of stock or the decision to become liquid all require that the investor make an estimate of the outcome of these actions. Though varying in degree, each one of these decisions must be based ultimately on judgment and understanding since no precisely accurate numerical calculation applies to such singular and uncertain events.
Chan, S.A., First City Natl. Bank of Houston SPE Member
The independent producer is expected to be, knowledgeable on a wide range of subjects such as administration, geology, law, fund-raising, finance, engineering, negotiations, seismic interpretation, regulatory ruling,, tax matters, oil field equipment, etc. One of the more crucial aspects in the successful establishment, organization, and growth of an oil company rests in the development and maturation of a strong banking relationship which could open doors to other financial institutions and markets.
The banking industry has long been a backbone in meeting the financial requirements of the petroleum industry. Of the many services which financial institutions provide, the secured oil and gas reserve loan may be the most common type of financing sought by the serious oilman. To the extent that the independent producer successfully applies for and obtains a secured loan, he must understand the, rationale and reasoning of both the banker and the borrower. Reasonable expectations concerning the financial request, loan structures, appropriate security, legal aspects, tax implications, and other requirements or constraints must all be integrated into a negotiated agreement.
Such a loan agreement should allow the independent producer enough flexibility to benefit by participating producer enough flexibility to benefit by participating in drilling and developmental projects which fits his field of expertise. Concurrently, the lender must have sufficient assurance that the loan will be repaid on a timely, basis through proceeds from the anticipated development projects, cash flow from existing operations, sale of assets, and/or guarantees of financially sound individuals or entities. A more thorough understanding, of the expectations and requirements from the oilman and the lender will assist the independent producer in his financial negotiations.
The petroleum companies and commercial bank lending, institutions have jointly cooperated in developing one of the most vital segments of our modern day economy, that of the oil and gas development and production industry. The banking stalwarts of the energy industry have solidly supported the exploration and production companies for over half a century. Trough the years as opportunities present themselves and as talented individuals break present themselves and as talented individuals break from the structured organization of larger companies, a whole holst of smaller independent producers has emerged.
Quite often the founder or chairman of the independent producer has risen to his level of prominence by doing a job very well, whether it is in prominence by doing a job very well, whether it is in the area of seismic interpretation, engineering, land leasing, administration, law, accounting, or whatever. As the captain of his ship, he must guide his ship through the murky waters of deregulation, re-regulation, stiff competition, uncertain economic markets and changing, technology. This corporate leader, must rely upon the timely and accurate advice of his counselors, of which not the least important is his relationship banker, to avoid the pitfalls and catastrophes that have fallen many companies.
Originally banks were used to obtain financing for drilling and development. Through time, the trendsetters of the petroleum industry have learned to build their banking relationship to be an integral resource of their decision making process. As oil companies have sought to grow through acquisitions, banks have become a familiar intermediary in an increasing number of property sales due to the broad Customer Case of petroleum companies at the leading energy banks. As the independent producer grows, the contacts with appropriate public market financial intermediaries are often initiated through strong regional or money market banks. During periods of expanding growth or of a stagnant economy, banks have assisted their customers in attempting to determine the credit worthiness of the oil company's customers and creditors. Even though the banks responsibilities to the petroleum industry has expanded to that of a financial advisor and counselor, the most predominate role of leading energy banks is to lend additional capital necessary in developing oil and natural gas fields of low to moderate risk.