Back-room valuation struggles

FAS 157 has created friction surrounding when exactly the value of an investment should be written up. American Capital's Jay Beam contributes to the discussion.

With FAS 157 coming into effect this year, plenty of private equity firms are finding themselves embroiled in healthy debates with their auditors over the application of fair value. But these lively discussions aren’t always over write-downs. At a recent roundtable discussion hosted by sister publication PEI Manager and appearing in the July edition of the magazine, several private equity finance professionals recounted instances where they had to argue with auditors on the topic of when to write up the value of an investment prematurely.

Marc Unger, chief financial officer of New York-based CCMP Capital, recalled a portfolio company that was performing very well. About a year after CCMP’s initial investment in the company, a valuation from an independent valuation firm showed a “healthy increase in value.”

“We sat down with the valuation team, and the auditor on our other engagement as well, and we said, ‘We’ve only owned this investment for a little over a year. It’s performing to plan, but right now it’s too early under our policy to determine if the true value of the company is any higher or lower than the price we paid,” Unger said.

In the current market, many GPs are instead focussed on trying to avoid fair-value write-downs.

American Capital is quite familiar with the potential downsides of fair value: the firm had to report a loss of $180 million in the first quarter, although the firm felt that value differed substantially from the “realisable value” of the assets in question. Jay Beam, the head of the firm’s finance team, said one of his most challenging valuations was also a premature write-up.

The firm, which has long used fair value as an accounting standard, several years ago invested in the construction of ethanol plants. In the six month gap between signing the deal and closing the deal, President Bush gave a speech on ethanol that caused ethanol stocks to “shoot through the roof.”

“We had a very healthy debate regarding the value, the first quarter we bought the asset, because there was a significant amount of time between when we priced the deal and when we invested,” Beam recalled. “In that instance, we took a write-up in the first quarter. Clearly significant events had occurred, and third party market data supported that. We went to the point of engaging a third party valuation firm to provide an independent valuation. We spent a significant amount of time with industry experts and investment bankers regarding valuations of a number of companies in the field that were planning to go public. I can’t tell you how many hours we spent on that one valuation.”

The rest of the discussion can be found in the July issue of PEI Manager