Valuation may change the fate of your business
It is never easy to come to a client meeting where you, in the capacity of an advisor, are to present the first valuation of your client’s business.
Prior to the meeting, you’ve learned about the company business model, received the business’s historical PL & BS, some related operating data (e.g. number of units sold), and perhaps also received the company’s business plan.
In some instances, a friendly hint from your client might have indicated to you what the general in-house expectations of the business value are, especially as your role is to advise the company on disposing the entire business. Of course, just make sure that you provide an unbiased and independent view on the business value.
The business model is not what management believes it is
When you begin creating the financial and valuation model, you may notice that management’s perception of the business model is not necessarily reflected in the company’s financials. You know those management presentation statements, e.g.: “We are the leading producer of small aircraft engines”. Only that the financials show that for the last three years the company has produced and sold almost no new engines and that 85% of its revenues are actually coming from the repair and overhaul of an existing fleet.
Distorted expectations of the business value
The business plan, of course, is based on an increase in the sales of new engines and shows profitability that, however hard you try, you don’t see likely being achieved in the future. Working capital remains flat despite the increase in sales, and capex is not needed as management claims it has invested enough in the past.
Running your standard DCFs and comparable transaction multiple valuations leaves you flabbergasted as you cannot quite get where the general in-house expectations of the business value are coming from.
Non-operating assets decrease the value of your business
Bearing in mind current value expectations and that there is only one week left before giving your valuation presentation to the management, you begin with valuation alchemy. This is the most exciting and creative phase in financial modelling as far as I am concerned.
When you accept that a company might operate under a different business model, you open up a wealth of potential. You instantly begin spotting new revenues, costs, and assets that the company does not need to effectively maintain its future cash flows. You eliminate the “hockey stick” of planned revenue for the new engine sales and decrease the costs that common sense suggests are unproductive. In some cases, you can see entire business lines/processes that, if discontinued, would increase the value of the company.
Continuing with valuation, you calculate normalized Revenue and EBITDA, and eliminate unnecessary stock as the result of the decrease in planned new sales revenue and that current stock would cover the next ten years of production. As the result, you outline a plan to relocate operations to a smaller area to further cut into your fixed cost base.
After all these paper changes, the business displays different dynamics, different sales patterns, and much different profitability levels. The capital employed is down and return on capital employed is up, changes which result in a higher value for the business.
You finish your work excited over what a great company you’re about to sell.
Meeting the enemy on a client basis
Instantly, you realize that the changes which you’ve incorporated into the valuation model are massive. Not only do you need to explain at length to the management why have you taken such an unsolicited attack on the company business, you need to do it in such a manner that they do not look like a bunch of incompetents and you still maintain your advisory mandate.
You also need to suggest a process which will progressively lead to the desired outcome. And you have to be damn convincing.
Conventional wisdom can sell you short
Conventional wisdom suggests that at this point of time, you step back to reconsider the level of proposed changes and come back with a smart compromise.
But you know what? Sometimes it might be better to go and hit the wasp’s nest with a full blow. If there are changes in the company that you as the outsider can see, believe in, and rationally defend, then go ahead and suggest them. Suggest them in a smart way. By the time this process is successfully over, you may have experienced a moment of victory which will nurture your professional life for a long, long time.