What’s the deal with disruption?
March 08, 2019
Disruption is affecting an increasing number of sectors, that are either experiencing or expecting disruption from technological, social and environmental change, with the current retail market softening being just one example. We’ve found that getting an early view of disruption is particularly important given human nature means we inherently underestimate the likelihood of extreme events but also overestimate our ability to cope with them as a result of optimism bias.
Bearing this in mind, targeting appropriate deals and determining the correct valuation is more important than ever. Our recent global M&A study suggests that 86% of value creating deals were part of a broader portfolio strategy, rather than opportunistic. This begs the question, of how investors or management should be anticipating and pricing in potential disruption to valuation decisions.
We have already had clients ask us how disruption might affect valuation for a business and our approach is to understand the key value drivers for a given business. We then apply our Horizon Disruption tool, which systematically maps disruptive trends and technologies across industries to quickly assess which of these disruptors are likely to have the greatest impact to valuation.
We recently performed this exercise for an air cargo handling business and looked at potential disruptors to the three key elements of its business:
- The number of passengers travelling via aeroplane
- The volume of cargo being transported
- The airports through which cargo is transported
The global trend of increasing economic power moving towards the East which may provide risk to some industries, for air travel this provides opportunity as there will be a growing middle class with increased spending power leading to greater demand for flights. This will in turn lead to a greater number of routes being flown and more capacity for freight. Current estimates suggest that the number of air passengers will nearly double by 2036, to 7.8 billion passengers annually, with most of this growth coming in emerging markets. This represents significant value opportunity, providing investment into infrastructure into developing markets.
Whilst the predictions of more flights is likely to be promising for airport handling companies, it is not all good news for all air freight. The commercialisation of 3D printing is likely to significantly reduce volume of air freight and affect the profitability of flights. Some current studies suggest that up to 41% or air cargo falls in the category of high volume bulk goods, which could be 3D printed in situ, removing a huge chunk of air cargo. Coupled with a growing public consciousness about waste and the environmental benefits of a more circular economy, assumptions about future growth of air freight mirroring passenger numbers should be heavily tempered.
We considered the increased frequency of extreme weather events, such as increased intensity of storms and frequency of storm surges. This was particularly relevant as 15% of the target’s revenue was generated through coastal airports with less than 5m sea elevation and therefore at major risk of disruption. In the most recent hurricane season, Japan’s Kansai airport was closed for an unprecedented 11 days, whilst only one of the many hurricanes to hit America’s coastline caused the cancellation of over 1,000 flights. We calculated that just the top 20 airports were at risk of losing €160k EBITDA for every unforecasted week of closure, which taking an estimated multiple of 12 x EBITDA, could have a €1.9 million impact on valuation.
All of these, already visible, disruptors will emerge to a greater degree over time and have an increasing impact on future cashflow assumptions and therefore valuations over time, with varying levels of mitigation available to investors. It is this systematic tying back of emerging technologies and trends and applying defined realistic financial values to them which PwC is best placed to consider and advise.
Would your business benefit from a disruptive lens applied to your valuation approach to avoid overpaying for an asset, correctly valuing management incentive schemes or to be able to outbid competitors in an auction environment through extra strategic insight?
Read our latest report which examines current European airport valuation trends and takes a deep dive into the broader airport deal space.