Consolidated Investments In Egyptian Financial Statements

In today's business environment,consolidated investments in subsidiaries, associates, joint ventures, and marketable investment portfolios form a large part of companies' investments and contribute to shaping the company's financial performance and value.

Companies with diversified holdings in other firms require optimal valuation that takes into account the specifics of the relationship between the two companies in terms of control, representation on boards of directors, the size of the stake, and their impact on the financial statements and valuation approaches.

Investment Classification under IFRS and Accounting Treatment Impact on Financial Statements

When a company holds some cash during periods of profit growth and aims to maintain strong liquidity management, investment portfolios are formed in financial assets at different proportions according to the strategy the company desires, the level of risk, and the diversification required. According to >IFRS 9, cash should be invested in multiple assets instead of remaining idle in the treasury.

The way these investments are handled in the financial statements; whether classified under FVPL or FVOCI or otherwise varies, and the valuation differs depending on the nature of the relationship with these securities.

According to standards, holdings of less than 20% are considered marketable securities portfolios and are recorded differently; either in the income statement, on the balance sheet, or with no effect if held to maturity. Companies also invest in stakes ranging between 20% and 50% of the voting rights in another company, which usually represents significant influence without full control.

These investments are recorded using the equity method, where the company's share of the associate's profits and losses is recognized in net income, adjusted for any dividends received.

In the Egyptian context, investments by major banks such as Commercial International Bank (CIB) and Banque Misr in fintech companies, emerging banks, or other stakes in unlisted companies across various industries are accounted for proportionally in revenues and net assets, according to IFRS 9 when applying the financial asset classification. On the other hand, when a company has control, usually at a level exceeding 50% of voting rights , the principles of full consolidation of financial statements are applied. In Egypt, large companies such as Orascom Construction and Ezz Steel adopt full consolidation to present the assets, liabilities, and revenues of their subsidiaries fully in the consolidated financial statements.

Consolidation provides a clearer picture of business size and assets, but it may also lead to higher apparent leverage ratios and make profitability analyses, such as Earnings Before Interest and Taxes (EBIT), appear stronger due to the aggregation of substantial subsidiary revenues.

Valuation Implications of Joint Ventures

Joint ventures represent a significant part of the business world and have specific impacts on the generated cash, which is allocated in the valuation. In Egypt, partnerships are currently emerging in sectors such as renewable energy and financial technology, and they are often owned equally between two parties, making the equity method the best approach to recognize investors' shares. This method ensures that risks and rewards are shared evenly and provides an accurate reflection of the parent company's financial performance without exaggerating results.

In Egypt when major Egyptian construction companies, such as Arab Contractors Company and Talaat Moustafa Group, invest in reconstruction and infrastructure projects; such as building smart cities with other contractors, they record only their share of the profits. They also take into account performance fluctuations related to client payments and regulatory changes, instead of fully consolidating all revenues and expenses, which could distort financial performance in the consolidated financial statement.

The Role of the Valuation Analyst in Determining a Company's Stake Fair Value

In the context of different forms of company investments and mergers and acquisitions, the shape of financial valuation varies depending on the type of control. If the stake is less than 50%, meaning it represents only significant influence, the revenues and assets transferred to the parent company are recognized proportionally according to the company's share. The opposite applies with the acquisition method, which involves full transfer.

Therefore, the valuation analyst must consider the extent of the company's influence over the subsidiary or associate to perform normalization when valuing a company that holds stakes without influence in sister companies, as well as estimate the control premium under the GCM methods when valuing the parent company's stake in the subsidiary at different levels depending on the degree of control, whether it is only significant influence or full control, as metrics such as P/S and others will differ.

Moreover, when valuing a bank or company stake representing a minority interest using DCF, which benefits the majority, the financial appraiser must consider whether the bank's stake represents significant influence or control in order to determine the appropriate lack-of-control or control discount, and the appraiser should take this into account. On another level, the risk profile will also change, leading to a different discount rate, as the company indirectly bears the risks of the industries it is involved in.

Investments in companies also cause variations in the treatment of the Goodwill item, which currently requires specific valuation techniques. Differences in accounting treatments between partial and full goodwill at the time of investment or acquisition affect how goodwill is calculated, and this goodwill will represent a component of the final valuation.

The second area the valuation analyst must examine is how accounting treatments affect two key inputs: discounted cash flow (DCF) and market multiples. Differences in revenues and shifts in leverage ratios which affect WACC and represent risk impact the cost of capital and the terminal value.

Conclusion

Ultimately, financial valuation is a tool that reflects intrinsic value, and it is a report that should also reflect the economic control relevant to the audience, rather than merely an accounting presentation of figures. The valuation analyst must isolate operating performance, and distinguish between companies in which there is a high degree of control, allowing their inclusion in terminal value calculations and those in which the ownership does not provide significant influence or only partial control, which does not allow for full forecasting of their cash flows in the terminal value.

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