Assessing the viability of a business.

wrote

The people who know what they are doing, will do a NPV calc, realise that the bonds are actually probably worth **less than** 30K to them, but buy them anyway because they don't mind losing a little interest each month for the chance of a bigger prize.

This is just like people buy lottery tickets, knowing that they're really only worth around half of the quid paid for them (only around half goes to the prize fund, the other half going to tax / "good causes" / etc). But they don't mind that the average value is much less than they pay, because they have a (tiny) chance of a big prize.

wrote

Can you *reliably* quantify the chances of guns remaining banned, or becoming legal?

wrote

Can you *reliably* quantify the risk of the congestion zone being extended to encompass that particular dry-cleaning business?

If you know **for sure** what is going to happen, then a future-looking valuation may be better than a past/present valuation. But any uncertainty will produce an inherently *un-*reliable valuation. Don't you agree?

yes. Where we disagree is that I would rather have an unreliable view of the future than a completely reliable view of the past. At least until the point where time reverses and the business starts to trade backwards along the historical path :-)

I would of course take the past into consideration in forumlating my wildly unreliable prediction of the future.

Phil

If he wants a controlling influence he is not sellling his business. Either you get more than 75% of shares or you don't (depending on Articles of association if ltd company).

He can get share of business profits by selling retaining a minority share.

Is he aware of how you feel? Tell him. If he still won't give you access to the information you need then maybe you need to reconsider. He may be hiding something he doesn't want you to know and may hope an outsider will overlook whatever he's hiding.

"John Redman" wrote

none of which relate to reality :)

A business is worth what somebody will pay for it. That will be more if the business fits in with what the buyer is doing, or planning to do. A lot less if bought for its cash flow, and usually less still if bought to be asset stripped.

Quite. You do your analysis and you form a view. Could be right, could be wrong, or somewhere in between. If you followed Tim's approach you'd either never bid at all on the grounds that the future is entirely opaque, or you'd overpay, on the basis that the past will repeat itself indefinitely.

I am currently valuing four factories for a client in eastern Europe who's thinking of buying them. The biggest imponderable is whether environmental legislation will force them to spend large amounts of capex just staying in business.

There are no other known ways.

Which the buyer arrives at on the basis of some or all of the above, unless he is profoundly stupid. Even Enron, when overpaying for power stations in Argentina and what not, used a formal valuation methodology; they just got their assumptions wrong.

That's right, you look at the company's curent cash flow projections and modify them according to your view of the business' true prospects including any potential liabilities and any synergies from merger with your own.

Nope.

and usually less still if

You can only asset strip a business if its assets are undervalued relative to their replacement cost, so targeting a business to do this to it requires you to value the assets while hoping that the target company's management does not understand what the true value is. This does indeed occasionally happen but it's not the everyday activity it used to be 20 or 30 years ago.

I agree. I hadn't looked at premium bonds for a long time and didn't realise they were tuning them to a target return. Bad example.

The problem with average outcomes is you don't see them, you only see one of the possible outcomes. So you don't see people with 1.97 eyes and you won't see 3.25% return on a premium bond you'll either see zero or a lot more.

Phil

"John Redman" wrote

Auction?

Good!

What makes you think that we disagree on that? ;-)

"John Redman" wrote

Exactly my point - the future isn't necessarily *reliable*, because it could easily be wrong!

"John Redman" wrote

How do you know what my "approach" is? I haven't given one! I've simply been saying that I don't believe looking to the future is always the most reliable method. And now you seem to have agreed!

"John Redman" wrote

Let me ask - do you have a *reliable* estimate for that risk?

"Phil Thompson" wrote

Agreed!

"Phil Thompson" wrote

Unlikely to be exactly 3.25%, yes...

"Phil Thompson" wrote

I don't agree. With enough PBs, it's very possible to see between 0% and

The phrase was '*most* reliable'. Backward-looking approaches are inherently less reliable than forward-looking ones because in the latter case you are least trying to consider what may happen to a business' revenues. Looking at what happened to them in the past doesn't tell you much that you can use.

Um, no, I've disagreed....if you can cite one example of historical performance being a better indicator of a business' value than the NPV of its reasonably foreseeable current earnings, the world of corporate finance awaits the book...:-)

We have an estimate at least. We look at what current and intended EU environmental legislation is doing, what the implications are for a manufacturing business of the type in question, and hence cost the capital plant - emissions reduction, for example - required to meet the specs.

We then look at whether the country in question is likely to join the EU any time soon. We also compare our estimates of the cost to the seller's. On that basis, you can work out the possible implications for enterprise value of compliance to the various environmental specs that may possibly apply. You deduct that cost from future cashflows, and this version becomes a sensitivity to the base value.

Yebbut the point is, you buy premium bonds because you think they're worth more than face value in that they offer the very, very remote prospect of a large gain. Since the overall prize payout is set at some percentage level, and some will get more than that because they win big prizes, clearly others will get less because they are funding the winners' gains by accepting less.

Which tells you that to people who buy premium bonds, the key valuation methodology is NPV; they hope they'll gain more than 3.25% or not too much less than 3.25%, and in any case, 3.25% is the limit of their opportunity loss.

If you have a small number of PBs, like #100, then given that the minimum prize is #50 the returns are different from those you'd expect if you had the maximum holding, but the underlying economics are the same.

Auction is a method of sale, not of valuation.

wrote

True. I'd like to suggest that, of your four quoted methods, you should be able to rely on: (1) the "stock market cap" (if available) being paid now, ... much more than... (2) any "net present value of future earnings" turning out to be 'correct'.

Similarly, I'd suggest that: (1) any value for "replacement cost of the assets" known now, ... is likely to be more reliable ("can be relied upon") than... (2) any "net present value of future earnings" turning out to be 'correct'.

wrote

No, you are looking at *one* future possibility. There are vast numbers of possible future outcomes. Why do you think the one you are considering must be more reliable?

wrote

I'm not talking about the "best" indicator, I'm talking about how "reliable" it is.

The problem is, that it either *will* join the EU (giving rise to one valuation, let's say X), or it *won't* (giving rise to another valuation, let's say Y). It can't "half-join".

If you value it at X, and the country doesn't join the EU, your valuation was demonstrably wrong. If you value it at Y, and the country does join the EU, your valuation was demonstrably wrong.

If you value the business somewhere between X & Y, then you *know* you are wrong!

wrote

Well, if you are asking *my* thoughts on the matter (you said " *you* buy ... because *you* think... "!) :-

I think that my premium bonds are worth *less* to me as PBs than their face-value would be in the bank (where I'd effectively get more than 3.25%, tax-free). The reason I still hold the PBs is the same reason that I might buy a lottery ticket - even though I'd value them at "less-than-face-value", there is still a remote chance that I might get a nice payout!

wrote

My NPV valuation of my PBs puts them at *less* than face-value (for reasons discussed above). I might *hope* for nice payouts, but I only *expect* around 3.25% (currently, on average).

wrote

Not necessarily. Put a large enough reserve on the sale, and it turns into a (market) valuation!

In message , john snipped-for-privacy@my-deja.com writes

This seems to be a discussion about whether history, or a forecast, is the best way of valuing a business. Surely a combination of the two is the most reliable.

Yes, there are other things to consider.

Let's say key personnel decide to bugger off (and this cannot possibly be prevented) - how will this affect the business?. All kinds of stuff like that. Especially for a small business, which is certainly what the OP was talking about.

Another thing is the vulnerability (of the product/service being offered) to competition which doesn't currently exist. This can be quite subtle. I've seen various business opportunities over the years which looked great, but didn't go for them because it would have been dead easy for someone else to do the same thing.

Lord White (that wise old boy who liked young girlies; don't we all...) once said something which every businessman should never forget: (paraphrasing) On any deal, don't worry about how much you can make because tomorrow is another day and you can always make the extra buck tomorrow. Always look at how much you can LOSE, because a bad failure is going to set you back years, possibly for ever.

The four items you give are all reasons to do the deal, and the last of them is particularly fickle. What matters more are reasons to NOT do the deal.

That is a detail that needs to be considered within the NPV. You are quite right to want it in the valuation, but it does not in itself produce a value.

So you did your due dilgence, and you found that the sales / growth projections were unrealistic, because the businesses faced competitive threat (eg because barriersto entry were low). This is probably why they were being sold. Again, this is exactly what a proper valuation will look at.

Well, if your priority is risk avoidance yes, hence the need for due diligence. You are, however, most likely to make money if you spot a business which has an undetected upside, or an upside only available to you.

The asset replacement angle essentially tells you if you would in fact be better off building your own copycat business, rather than buying someone else's. The market cap approach theoretically reflects the business' prospects, but is apt to reflect investor sentiment as much as value, as witness dotcom valuations pre-2000. The NPV approach lends itself to sensitivity analysis of the sorts you've described and the comparable transaction analysis route tells you - mutatis mutandis - what value the rest of the world thinks the previous three methods suggest.