MBS 665 Business Valuation Report: Towngas China Case Study

This report presents a critique of an article concerning the business valuation of Towngas China Company Limited. It begins by identifying the key issue: whether the share price of HK$4.9 accurately reflects the company's intrinsic value. The report connects this issue to the broader topic of business valuation, specifically the use of discounted cash flow (DCF) analysis to determine intrinsic value. It evaluates the main issues, including the application of the Gordon Growth Model and the challenges in estimating free cash flows within the gas utilities sector. The report also explores the importance of assumptions in valuation and considers the role of beta in assessing stock volatility. Ultimately, the report concludes that while company valuation is important, it is not the only metric to consider, and the DCF model should be viewed as a guide rather than a definitive tool for stock valuation. The analysis emphasizes the need to consider financial health, future earnings, and other factors in evaluating Towngas China's performance.

Running Head: BUSINESS VALUATION
BUSINESS VALUATION
Name of the Student
Name of the University
Author Note

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Table of Contents
Introduction................................................................................................................................2
Discussion..................................................................................................................................2
Key Issues in Case.................................................................................................................2
Relation of Issues in Article with the Topic...........................................................................3
Evaluation of Main Issues in Case.........................................................................................3
Opinions relating to Case.......................................................................................................5
Conclusion..................................................................................................................................5
Reference....................................................................................................................................6

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Introduction
Business valuation is general process to determine economic value of the whole unit
of company or business. It is used for determining fair value of the business for various
reasons such as value of sales, establishing ownership of partner and even proceedings of
divorce. There are different valuation methods used by the practitioners of industry for
determining valuation of company (Trugman, 2016). Hence, this report aims to discuss key
issues in valuation of Towngas China Company Limited. Further, discussion will be on the
way issues in article relates to topic, evaluation of main issues of case and based on these
discussion, opinion will be given on case.
Discussion
Key Issues in Case
The key issues highlighted in the case provided is to find out whether share price of
the Towngas China Company Limited valued at HK$4.9 is based on its intrinsic value.
Towngas China Company Limited was known formerly as Panva Gas Holdings Limited,
which is one of the leading market player in businesses in the China. It is in the business of
gas utilities and is Hong Kind based company. This company has received lot of attention
from substantial movements of price on SEHK over last few months, decreasing lows of
HK$5.16 and increasing to high of HK$6.17 at one point of time. Some movements of share
price can give the investor better opportunity for entering into stock and buying potentially at
the lower price. Hence, the issue is whether current trading price HK$5.20 of Towngas China
is reflective of actual value of small cap or whether it is undervalued currently, providing
with opportunity for buying (St, 2020).

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Relation of Issues in Article with the Topic
The issues discussed in article is related with business valuation. It is because stock of
Towngas China is priced currently at HK$5.20 on market that is in comparison to its intrinsic
value of HK$3.61. It is based on the valuation method of discounted cash flow valuation. In
the article, intrinsic value of stock is estimated by the help of estimating future cash flows of
company and discounting them to its present value. The intrinsic value is referred to
perception of investor of inherent value of asset, for instance options, stock or real estate.
Hence, knowledge about intrinsic value is beneficial for the value investors, who is having
goal to buy stocks and the other investment at discount to this particular amount. There is
significant difference in between market value and intrinsic value of company’s share.
Intrinsic value is estimate of actual true value of the entity, regardless of the market value.
Further, the case in article believes that value of company is present value of all cash it will
be generating in future period. However, among many others, discounted cash flow model is
just metric of valuation, which is not having without having any flaws (Olbrich, Quill &
Rapp, 2015).
Evaluation of Main Issues in Case
Towngas China is operating in the sector of gas utilities, hence, calculation of
intrinsic value is done in slightly different manner. Dividends per share payments are used
rather than using free cash flows. It is because it is hard to estimate free cash flows and in the
industry of gas utilities sector, it is often not reported by analysts. This method will
underestimate stock’s value, unless entity pays out majority of FCF as dividend (Bancel &
Mittoo, 2014). Further, when Gordon Growth Model is applied, then the assumptions is taken
that payments of dividend will continue to rise forever at sustainable growth rate. It is
because of various reasons, the uses of very conservative growth rate is done, which cannot
be exceeded beyond the GDP of company (Carter, 2014). Hence, in this case, 1.6% of ten

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year government bond rate will be used. The expected DPS will be then discounted to the
value of today at cost of equity of 6.4%. In comparison to current price of share of HK$4.9, it
appears that company is expensive reasonably at writing time. In any calculation, assumption
plays vital role on valuation. Therefore, it is advantageous to view this as rough estimate
compared to précising down to last cent (Cong, 2017).
“Value of per share= Expected EPS/ (Discount rate-Perpetual Growth Rate)”
Chart 1: Intrinsic Value based on the Future Flows of Cash.
Chart 2: Growth Expectation by Analysts

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Moreover, beta is measure of the stock volatility of stock in comparison to market as
whole. The beta of company is found from industry average beta of the global comparable
entities. It is within imposed limit in between 0.8-2.0 that is reasonable range for stable
business (Sinh, 2018).
Opinions relating to Case
This article helps in understanding that there are various valuation methods used for
estimating intrinsic value of company, however, selection of the best valuation method differs
by the industry in which company is operating. The opinions have been gained that DCF does
not considers industry’s possible cyclicality or future capital requirements of company,
hence, it does not help in giving full picture of the potential performance of company rather
there are other methods to measure company’s performance. Further, when there is sharp
changes in risk-free rate or cost of equity or if growth of company is at different rate, output
looks very differently (Shapiro, Mackmin & Sams, 2019).
Conclusion
Therefore, this report concludes that although, company valuation is important for the
potential shareholders, however, it should not be only metric that can be looked, while doing
research of company. This article has found that DCF is not only the metric used as perfect
tool of stock valuation, rather it needs to be seen as only guide of the assumptions that needs
to be true for over and undervaluation of stock. Lastly, it can be said that for analyzing
performance of company, intrinsic value is not only the metric that matters rather, some of
the vital aspects to be considered for Towngas China includes analysis of financial health,
analysis of future earnings and finding or analysis of other higher quality alternatives.

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Reference
Bancel, F., & Mittoo, U. R. (2014). The gap between the theory and practice of corporate
valuation: Survey of European experts. Journal of Applied Corporate Finance, 26(4),
106-117.
Carter, M. M. (2014). U.S. Patent No. 8,799,040. Washington, DC: U.S. Patent and
Trademark Office.
Cong, L. W. (2017). Real options, business valuation, and dynamic decisions. Journal of
Management Policy and Practice, 18(3).
Olbrich, M., Quill, T., & Rapp, D. J. (2015). Business valuation inspired by the Austrian
school. Journal of Business Valuation and Economic Loss Analysis, 10(1), 1-43.
Shapiro, E., Mackmin, D., & Sams, G. (2019). Modern methods of valuation. Estates Gazette.
Sinh, H. A. Y. (2018). The suitability of proxy levered beta in business valuation: Evidence
from vietnam. Asian Economic and Financial Review, 8(2), 248-268.
St, S. (2020). Is Towngas China Company Limited (HKG:1083) Worth HK$4.9 Based On Its
Intrinsic Value?. Simply Wall St. Retrieved 24 February 2020, from
https://simplywall.st/stocks/hk/utilities/hkg-1083/towngas-china-shares/news/is-
towngas-china-company-limited-hkg1083-worth-hk4-9-based-on-its-intrinsic-value/
Trugman. (2016). Understanding business valuation: A practical guide to valuing small to
medium sized businesses. John Wiley & Sons.