March 26, 2008 FASB Statement No. 161
Last week, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.
February 29, 2008 Buy or Sell?
The concept of buying low and selling high could be the most clear-cut theory in finance and simultaneously the most difficult to execute. It is the goal of every investor to maximize their return on an investment by waiting for just the right time to buy and sell. With the volatility currently being displayed in the market and the possibility of a recession looming on the horizon, the question of timing is even more evident. So how can an investor decide if a stock is attractively priced in the current market? It is a question that will most likely never be answered with concrete certainty, but there are questions an investor can ask that can increase their success.
January 21, 2008 Shot in the arm.
Last Friday, January 18, President Bush announced a preliminary plan to offer Americans $150 billion in tax relief to prevent the economy from sliding into a recession. While economists seem be in consensus that a quick capital injection into the economy will increase spending and hold recession at bay, temporarily; the debate is focused on what form this capital injection should take. The choices include unemployment insurance benefit increases, increased food stamp funding, individual tax cuts, business tax breaks and increased federal housing subsidies. Of course all of these have the pitfalls. In my opinion, what's most important is that a large portion of the capital injection go to those who are having to choose between heating their home, or feeding their family; otherwise, we'll likely see a spike in plasma television sales, or maybe an increase in the savings rate?
January 21, 2008 The sky is falling...
From its high in October of last year the public market place has fallen by about 15% through last Friday. As the market takes a well deserved holiday after a tumultuous start to the year, I ask myself "what if any impact these last four months have on the price of option grants?" And more importantly, "what if we see a continued correction through the first quarter?" Consider that many emerging companies last valued their grants right about the market peak and are now faced with setting a price as of 12/31/07. With a slew of annual updates on the way, how do we know factor in the changing sentiment in not only the public market but the economy in general? Recession/inflation talk is the new buzz while the housing market collapse remains a well versed threat. Yes, we base the value of most emerging biotech and tech companies on some future exit which may or may not be in this economic cycle. And, of course, we have already begun to hear the refrains, well we are actually "recession proof" and even some "new economy" talk sparks up from time to time much like 10 years ago. By no means, am I implying that we are on the edge of a similar bubble, but we are cognizant that despite the fact that most of our clients had great years in 2007, values must be tempered by the changing landscape. That means multiples might tick down slightly, we are going to more cognizant of company specific risk factors (e.g. how susceptible are you to the over all economy), and most importantly are the management teams we talk about in tune with the change in values around them.
January 07, 2008 Welcome to the Recession
With anticipation and a touch of fear, many were hanging their hats on the December jobs data and the official start of the recession. The disappointing numbers were the lowest in more than four years and further signal the economic slowdown. For what is worth, an economic recession conjures up many assumptions with respect to valuation. Aside from the migration to consumer cyclical stocks such as Proctor and Gamble, Johnson and Johnson, and possibly the fight to treasuries, we also may expect to see more write-downs on corporate balance sheets. As we move into the 2008 audit season auditors will have the nagging benefit of hindsight relative to year-end financials. The question is how will this clouded perspective impact the results of goodwill impairment tests (FAS 142), fair value calculations of investments under the anticipated FAS 157 or the fair value of various embedded derivatives under FAS 133. With less optimism than late last year, will auditors view companies' projections with an even greater deal of skepticism? Only time will tell, but management will be under pressure to defend the assumptions used in the valuation of the assets on carried on their balance sheets.
December 02, 2007 Convergence of Financial Reporting Standards
The standardization of financial statements on an global level is an important agenda item for the FASB, IASB and all users of financial statements. In a recent conference held by the FEI ( Financial Executive International) regarding Financial Reporting Issues, FASB Chairman Robert H. Herz and IASB Vice Chairman Thomas E. Jones presented some general issues and thoughts regarding the alignment of US GAAP and IASB. Ironically, Mr. Herz pointed out that while over 100 countries have adopted IFRS, many of them have added to or modified the IFRS standards they adopted, defeating the purpose of a standardized system. Other items discussed included the the level of detail included in IFRS as compared to highly detailed US GAAP standards, and the likelihood of the US eventually moving to IFRS. According to Mr. Herz, the benefits of a global implementation of IFRS include decreased cost of capital, increased worldwide investment and reduced reporting costs for domestic firms with international operations. While updated guidance regarding statements 133 and 140 is expected in 2008, the timing regarding a transition plan for US Companies to move to IFRS is still very uncertain.
October 10, 2007 The Housing Crisis - In it for the long haul?
The recent Business Week cover on the housing crisis is definitely a tough pill for all of us homeowners that bought a new home in the past five years. If you haven't listened to the podcast and/or read the article this week, it is a must. It highlights the crisis in one of America's hottest markets - Las Vegas - and pushes all of us to hope that "what happens in Vegas stays in Vegas". Yet, it's creeping into a neighborhood near you with little relief in sight. As I listened to the podcast this morning, a thought continued to befuddle me about the utility of real estate appraisers in the cyclical housing market. Consider that homes that were once appraised at $800k are now selling for $480k (an example given for the Phoenix market) yet in both instances loans were approved based on values given by real estate appraisers. Their defense is that other homes were selling at the same price - so the home must be worth $800k. A little bit of the "greater fools theory," if you ask me. It seems that in turbulent times, whether it be the boom/bust of the housing market or the boom/bust of tech in the late 90s, investments always come back to real returns. "If there were no buyers, I would be willing to pay X to live in this house," instead of "I know that the value is going to go up so I want to participate in the appreciation." In the long-run, there are no greater fools then when you analyze returns from a return on investment lens versus through rose colored glasses "my neighbors were dumb enough to buy at that price, so it must be worth it." All said, I think it's time to finish the basement, because we may be in for a long haul.
October 01, 2007 Fueling Foreign Investment
Whenever the average consumer hears of rising oil prices, the first thing that comes to mind is the fear of high gas prices and the impact on their wallet. Yet, while high oil prices do have a large impact on the economy as a whole, they also serve to fuel foreign investment in the markets and can help drive the economy. For instance, the recent credit situation has constrained many investors. However, investors with large cash reserves, such as oil rich nations possess the necessary liquidity to be risk averse to the credit markets. Thus, allowing them to invest when an opportunity presents itself and capitalize on a poorly performing mergers and acquisitions market.
September 19, 2007 Delaying the Inevitable?
For anyone following the mortgage meltdown and subsequent market turmoil that has followed, it has not been a question of if the Federal Reserve would get involved, but rather when. And on September 18, we got our answer, as the Fed cut the federal funds rate by 50 basis points in an effort to lessen the impact of a poor housing market on the rest of the economy. So, like a good parent the Fed stepped in to bail out the hedge funds and sub-prime lenders largely to blame for the current situation in the first place.
September 16, 2007 Land of Opportunity
With the winding down of the global mergers and acquisition boom, which began in 2003, many investors are wondering where the new market opportunities may lie. The recent credit crunch has choked off the easy credit that had been fueling the buyouts for years. In fact, through June 2007, M&A activity, as measured by total transactions volume, had been at an all time high. However, the recent liquidity issues have already begun to slow the number of acquisitions and even thwart some deals that were previously in the works. According to the market research from Dealogic, in August there were about $222 billion worth of deals around the globe, the lowest monthly total since July 2005 and considerably lower than the $695 billion figure struck in April and the $579 billion in July. While it is unlikely that there will be a quick rebound in the credit markets, it is even more unlikely the deals will dry up altogether. So, who will benefit from the tighter credit markets and lower deal prices?
September 08, 2007 I just completed a deal - now what?
Over the past six months we have had several emerging companies complete acquisitions in this heated M&A market. In most instances it's not just one deal, but successive deals of a similar nature in a short amount of time. As a result, these clients are terribly busy with the integration of new facilities, assets, employees etc. Accounting and taxes are not always the top priority and usually the accounting team starts to fall behind. Why? Well, often companies underestimate the financial integration issues, including the work that needs to be done by their current audit teams on the new assets. Secondly, acquisitions are rarely scheduled. In other words, the auditors, bankers, valuation professionals etc., don't have the acquisition built into their capacity and may have to "fit it in" with normal recurring projects. Which means, that acquisitive companies can fall behind on reporting. The good news from the valuation front is that the two most common post deal requirements that companies generally face do have synergies if managed appropriately.
August 26, 2007 Sub-prime Lending Fallout
As everyone has been reading about for weeks now, the effects of sub-prime loan defaults have begun to trickle down throughout the US Economy. On Thursday, August 23rd Home Depot felt the effects first hand. The Company has been in negotiations to sell its wholesale distribution business to a trio of private equity firms for $10.3 billion. However, given the significant write-downs lenders are facing as a result of sub-prime defaults, the deal has been stalled. The stall has been a result of lenders becoming more risk averse, given the significant portfolio risk that has surfaced. This of course is magnified by the Home Depot wholesale division's direct link to the real estate markets, which are greatly stressed by foreclosures.
August 23, 2007 The Value of Perception
We have all heard the phrase "image is everything," and in fact have seen the concept ring true. Over the years, advances in technology coupled with the increasing number of media outlets have seemed to make the world a much smaller place, making perception more important than ever. In today's market the mere mention of scandal can throw a company's stock in a downward spiral. While it is easy to see the impact negative perception can have on a financially sound company, it is much more difficult to measure the value of a positive public image.
August 10, 2007 LBOs Gone Bad
The most recent issue of Business Week focuses on the well publicized problems of the housing market, which is definitely fascinating. Yet, there is a short article on page 40 on the plight of Spectrum Brands, which is a must read. The article highlights the 12 year history of Spectrum and the growth through leverage acquisitions that has left the company with a mountain of debt. Spectrum followed the lure of acquisition and added new brands to build itself into a consumer brand powerhouse. As the article reveals on page 42, "...Spectrum might have been able to handle the ups and downs relatively well if it didn't also have to deal with so much debt." Its easy to wonder what might well happen to the `Spectrum's' of today's private equity market over the next decade. Carrying debt of 9 times operating profit is "unmanageable" for most companies and is a lot like living pay check to pay check. Everything is alright until your car breaks down.
July 17, 2007 Isn't it Ironic?
Will the collapse of the sub-prime market affect the Dow? I find it ironic that the day after the Dow breaks 14,000 is the day the Bear Stearns reports that "one of its funds was worth nothing and another worth less than a 10th of its value. According to the Wall Street Journal this morning, "the pain experienced by Bear...is being felt by investors around the world. History has shown that relatively illiquid securities, based on an uncertain value of their underlying holdings (e.g. declining home values) are subject to a rapid collapse (e.g. the S&L crisis). Fear plays an important role in value as the uncertainty can very much feed upon itself and create a lopsided market (too many bears - more irony). So might there be parallels to other markets that are highly dependent on relatively illiquid investments in private entities (e.g. private equity)?
July 16, 2007 Make Mine An Apple
The story is quite simple. Five years ago today Microsoft's stock was trading at $22.675 per share and has climbed all the way to $29.97. Apple closed at $7.17 on June 22, 2002 and finished Friday at $132.30. iPhones, iPods and MacBook Pros vs. Vista - not really even a fair fight. Steve Jobs has demonstrated an amazing ability to build value in his organization over the past five years and unless you are a five year shareholder of Microsoft stock or an equity analyst you probably don't realize how marginal the returns have been. However, as we all know value is based on future expectancy, which stock would you buy today?
July 05, 2007 A Venture Backed Economy?
Recently, there has been a slew of blogs and articles examining the unprecedented success of private equity firms. While the success of these firms is very apparent, it is more difficult to quantify the impact they are having on the economy as a whole. Could their success have a direct impact on the average American or is it simply a lucky few reaping the rewards?
June 19, 2007 The Beginning of the End of the Private Equity Run?
For years private equity firms have enjoyed cheap money and low interest rates, which they have used for countless deals and unprecedented success. However, concerns about rising rates in the Treasury bond market are raising worries. Could this be the beginning of the end of the cheap money cycle so imperative to their success?
On June 12 the yield on the benchmark 10-year Treasury note reached 5.25 percent, its
highest in the last twelve months, up from 4.67 percent the previous month. This increase in bond yields has fueled worries that it will be more difficult to borrow money going forward. Large investors, such as pension funds have invested billions in private equity in search of high yields. But now some of these investors may reevaluate where the opportunities really are and in turn slow the amount of money flowing through private equity. Rising borrowing costs could also put pressure on private equity at a time when there is already concern over the high prices being paid for deals. However, notwithstanding the possible slowdown, most analysts agree that while credit may start to tighten, it will take much more than a gradual increase in interest rates to derail private equity.
June 13, 2007 Time for the Private Equity Groups to IPO?
Why does an IPO make sense for a private equity firm, but not for the
portfolio companies they own? This question continues to nag at me, as I
wonder how long until a private equity firm takes a private equity firm
private, so they can avoid those nasty quarterly earnings calls and take a
more long-term investment view. Should we, the individual investors, play in
this game? Part of me says, if Steve Schwarzman is selling I am not buying.
Yet, owning an interest in Blackstone has proven to be a tremendous
investment and having access to some of the strongest best performing funds
in the world could be a phenomenal opportunity to further diversify your
portfolio with a quality proven financial investor. Is now the time to
purchase an investment in private equity as multiples, returns and premiums
all have trended upwards significantly in the past four years? Is the buyout
world just beginning or is it about to crack? Will the public markets crack or
fuel private equity groups? Will they now begin to face the same pressures
that crippled their portfolio companies: 1) quarterly earnings pressures; 2)
the high cost of public compliance; and maybe worst of all 3) be forced to
dissect the value of their investment portfolio and reveal the inner
workings of their powerful investment process? A new paradigm may well be
upon us...wait, as someone once told there "are no new paradigms". What goes
up must...
May 22, 2007 The Power of a Strong M&A Market
As the strength of the current M&A market continues, many may be wondering what kind of impact will be felt on the market as a whole. While it is impossible to predict how the markets will react to specific M&A transactions, they do appear have a general impact. For example, the recent announcement that Bausch and Lomb will be taken private in the coming year means there is a wave of cash that will be looking for a new home. And while Bausch and Lomb may be the most recent announcement, according to Justin Lahart of the Wall Street Journal (Taking Stock: How Buyouts Alter the S&P, 5/17/07) there are a total of 12 companies in the S&P 500 index set to go private this year alone. Standard & Poor's analyst Howard Silverbratt estimates the total price tag for these 12 companies weighs in at an incredible $179 billion. So where does this cash go and how does it impact the market?
May 20, 2007 Cheap At Twice The Price?
Microsoft Chief Financial Officer Chris Liddell acknowledged on a conference call Friday that like the DoubleClick scenario, Microsoft was also in a competitive bidding war for the aQuantive deal. This is one reason the company is paying a significantly higher price per share for the company than its current market value. With Google's recent purchase of DoubleClick, Yahoo buying Right Media, and WPP Group buying 24/7 Read Media, the real question is with whom were they in a competitive bidding war? Did Microsoft pay an 85% premium to avoid paying twice that much later from a private equity group? Considering that DoubleClick was taken private at $1.1 billion by a financial investor two years ago and returned to the market at $3.1 billion, an 85% premium seems to make sense. This also explains Microsoft's `urging' of regulators to review the Google/DoubleClick deal. And, by the way, Murdoch's bid for the Wall Street Journal looks cheap compared to Google and Microsoft.
May 18, 2007 Creative Lending
The buyout frenzy continues- the latest example being Microsoft's acquisition of aQuantive Inc. for approximately $6 billion- an offer that was 29 times aQuantive's projected 2008 earnings (before special items). At least Microsoft was merely deploying a portion of its $28 billion cash balance held at the end of its fiscal year 2006. Even more baffling is the leverage multiples put up by some of the recent LBO's in the marketplace. Banks and private lenders have loaned a significant portion of the debt in these buyouts- often loaning debt up to 10 times EBITDA- a direct result of the surplus of available funds in the marketplace allowing for "creative" terms for the borrower. Relaxed loan restrictions are allowing companies to be more leveraged than ever before. Sound familiar?
May 18, 2007 What is Liquidity?
There are several types of liquidity. In general phrasing, liquidity usually alludes to cash, the money or capital that fuels the wheels of commerce. In the financial world, definitions are more complex. There is market liquidity, the ability to buy and sell securities without greatly affecting the price. And there is funding liquidity, referring to the availability of credit and the ease with which institutions can borrow money. These definitions seem relatively straightforward, but do they really capture the concept of liquidity in the market? A recent article in The Deal entitled "Hooked On A Feeling" alludes to a more conceptual definition.
May 08, 2007 67% - the magic number?
Speculation is running rampant on the Murdoch - Dow Jones deal. Will the family reject the offer? Can they reject the offer and not get sued? Why would anyone in their right mind offer such a premium?Interestingly enough, when we think about the buying power of the private equity world, the old adage "step up to the plate" frankly may be the only way to close this deal for Murdoch. A bidding war with a few powerful private equity firms with access to excessive debt appears to be pre-empted with a 67% premium. That's one way to win a bidding war. Is that really what it's going to take for a strategic buyer to guarantee a win in today's market?
May 04, 2007 Control Premium or a Minority Discount
If you are a minority shareholder in Dow Jones & Co. you may want to give strong consideration to selling your shares soon, instead of waiting for the Murdock offer to close. Fortunately for minority shareholders, the stock is publicly traded and liquidity exists. They can sell at $55 per share today. Otherwise, if the company were privately held, the 66% control premium offered by News Corp would
possibly never be realized. The stock hasn't traded at this level since 2000 and fundamentals have steadily deteriorated since. The fact that the controlling shareholders are not willing to even consider a 66% control premium clearly indicates that maximizing shareholder return is not a priority. What's sad it that WSJ writers are painting the papers with how terrible the deal is. Sure it is, for them. Though they won't say it, they know if the deal goes through, they will be victims of change or possible pounding the pavement. The real issue here is shareholder prudence, not job security. If this deal falls through, it will be a long time before we see DJ in the 60's. Well the good new is, I guess we can now justify a minority discount of 50% . Or maybe it's not justified.....
April 29, 2007 Where were the appraisers?
House-flipping in Vegas! Seemed like a great idea at the time. As I have read several of the articles on the problems in Clark County I am amazed at the stories. "We had seen real evidence of what was possible in this crazy, inflated market, and we just wanted to get a piece of the investment equity" said an investment buyer (Denver Post - April 29, 2007). Once again we all sit back and ask ourselves how in the world could anyone think that after home prices had soared $200,000 in 18 months, that now was a great buying opportunity. We wonder, what they were thinking, when they still would buy the home knowing that the sales staff increased the price $20,000 after every fifth buyer or when they slept over night in the parking lot with 100 other people just to simply have an opportunity to make an incredibly speculative investment. And most importantly how making a down payment of $5,000 on a $540,000 investment home was a 'great opportunity'.
April 26, 2007 Patty Dunn Speaks
I had the opportunity to listen to Patty Dunn speak at the Western M&A forum yesterday in San Francisco. With her attorneys at her side, she gracefully dodged any questions pertaining to the HP drama and addressed the crowd of investment bankers, transaction attorneys and private equity firms with a perplexing observation on the recent buyout activity. Her point focused on the fact that many public companies feel the need to go private (or "go dark") in an attempt to move away from public company scrutiny. Instead of worrying about back dated options, (or leaky board members) the executives can focus on running the company. Although Ms. Dunn failed to consider the factor of leverage, the greatest returns are generated in the dark stage, and it is the reason that so many public pension funds are allocating substantial amounts of resources to this alternative investment category. The irony she points out is that it is these funds that are often leading the charge on greater regulation and visibility in the public markets, but increasing investments in limited partnership interests, where visibility is even worse.
So let's see. This sounds a bit like 2000 all over again. Higher returns, public funds follow, someone screws up, public funds point finger, and heavy regulation followed. For what it's worth, I hope nobody screws up......
April 09, 2007 That's Life!
What is the life of an asset? Is it something that the SEC and FASB says it is for the preparation of financial statements? Is it something the IRS says it is for the preparation of a corporate tax return? Or is it the amount of time before an asset actually has no remaining value (i.e., reality)? While each of these definitions has their place, investors, the users of financial statements, should be most interested in reality. And that is where the divergence begins.
April 04, 2007 That's not your deal! It's mine!
The much-discussed drama of the EGL, Inc. private equity transaction has everyone questioning the "new" rules of engagement. It seems that if a higher bid comes in after the documents are signed, the board has to consider the higher offer. As the EGL board was accepting the management led buyout at $38 per share, Apollo Management LP was submitting an offer for $2 more (and have since increased it to $41). At first the Apollo law suit seemed to have little validity, but a recent court decision has delayed the close. And guess what? The market thinks the lawsuit holds and the deal gets done higher than the original offer. EAGL closed today at $39.69!
April 03, 2007 Chasing Alpha
The asset management industry is currently in the midst of a paradigm shift. In early March of this year, I discussed the benefits of performance fee refunds to compensate investors for sub par returns. However, while many investors and asset managers laud the alignment of interests (of investors and asset manager) through charging for alpha, as opposed to beta, criticisms have inevitably come to the forefront.
March 21, 2007 Always question the source!
This is a pathetic example of journalism! This "article" sites the likes of anitwar.com, kitco.com and (my favorite) goldenjackass.com. The last two are brokerage houses for gold, the perceived "hedge" against any market bubbles. (note: the total return on gold has been about 75% - over the last 20 years, consistent with the rate of inflation). The article bashes mortgage brokers with which I can understand. Their ethics in the past few years are most certainly circumspect. However, I have even less respect for commodity brokers. They are the used car salesmen of the financial industry (no disrespect to used car salesmen) and are in the business of sensationalizing the impending bear market, even in the most prosperous times. And regarding Jimmy Rodgers, I have heard him speak. As a global investor in third world countries, he is a strong proponent of commodity investing. Yes, he is a smart guy, but he too is in the business of raising capital for his fund. The impartial journalist takes us to his true feelings with;"Bernanke--could care less about the public welfare. All their energy is devoted to building a lifeboat for themselves and their fat-cat buddies. Once, they've robbed the last farthing from the public till they'll be gone, and we'll still be marching along the path to national calamity."
March 20, 2007 Six Degrees of Separation
The concept that all people are connected by six degrees of separation seems like something of Hollywood fiction. However, in the business world the theory seems to ring true. In a recent Wall Street Journal article discussing the ramifications of a former Silicon Valley company, it seems clear that the business world may be smaller than we think. A firm called myCFO was founded in 1999 by some of the biggest names in Silicon Valley, who also sat on the board, with the sole purpose of providing wealthy individuals a wide variety of financial services, from wealth management to estate planning. An idea that seemed simple enough, especially at a time when the technology boom resulted in a number of new millionaires looking to minimize taxes. myCFO's main tax shelter was a Custom Adjustable Rate Debt Structure ("Cards"). Each involved an ostensible 30-year bank loan to a foreign party for $50.0 million to $100.0 million. myCFO's client then assumed the loan and after some complex swapping of collateral, claimed a loss for tax purposes of almost the entire amount of the loan. At the time, myCFO was not the only firm to offer such a product, and a product such as Cards was not deemed inappropriate.
March 12, 2007 Bottle of Red - What's In A Label?
Recently, the US Department of Justice and the FBI launched an inquiry into the sale of counterfeit wines at prominent auction houses in New York and London. According to the Wall Street Journal, the investigation is focusing on whether auction houses and importers knowingly sold counterfeit high-end wines despite doubts of authenticity. The high-end wine industry, $1,000 or more per bottle, as a whole has boomed recently. In fact, several auction houses have reported double and triple digit year-over-year revenue growth related to wine sales. However, Wine Spectator magazine recently reported that as high as 5.0 percent of rare vintages sold at auction may be frauds.
March 07, 2007 Do you know what your future holds?
Understanding your company's future capital requirements is crucial in determining shareholder value. Quist has done numerous 409A valuations for emerging companies that are in need of additional equity financing. When going into a valuation there are several questions you should ask yourself to better understand the future financial needs of your business.
When will additional financing be needed? How much cash should be raised? What significant milestones is my company looking to achieve in the short and long-term? Will we need additional cash to support these milestones and growth?
Most companies receive several rounds of equity financing before an exit is realized. Each additional round of financing is accounted for in the valuation, which ultimately reduces existing shareholder ownership and the value of the company's common shares through dilution. To determine the impact of additional funding to existing shareholders a pre-money and post-money valuation of the company is completed.
The pre-money valuation is simply the estimated value of the company as it stands prior to any investment. Determining the pre-money valuation of the company, combined with the amount of capital secured, determines the amount of equity ownership sold in exchange for capital. The resulting valuation after the investment is called "post-money" valuation. From this, the impact of the funding to existing shareholders is determined.
March 07, 2007 A touch of Grey?
What does it mean to be independent? Independent of what? The lines of
independence appear to be getting real blurry in the world of
valuation. While the major audit firms have drawn some hard lines, we
still find grey in the rest of the market. Recently, we heard of a
west coast investment bank including a 409A valuation as part of a
debt financing. In other words, they threw in the valuation for
"free". Well, at least they positioned it that way. The mortgage
industry does something similar, "no money down, no closing costs, the
biggest no brainer in the history of earth", of course no one really
talks about how the rate might compare. Sounds like a new floor in
valuation. Yet, maybe the valuation is really worth the explicit price
being paid. Claiming to be an "independent" third party valuation
provider and actually being one are two different things. Of course,
the first and obvious test of independence is whether you actually own
an interest in the company you are valuing. Beyond that a simple
litmus test seems to work quite well, I put myself on the stand in
U.S. Tax court with my client's financial position on the line. Will I
be discredited? Do I have the credentials to defend both my position
and my independence? Could my valuation be colored by other interests
I have in the company? I think we are only beginning to uncover and
define what "independence" really means in the world of finance. Stock
recommendations dependent on investment banking relationships,
auditors dependent on consulting services, valuations dependent on ___?
Might there be a shakeout??? Only time will tell...
March 04, 2007 Going With The Flow
In the business of asset management services, the name of the game is flows. That is of course, the amount of money coming in the door and conversely the amount going out. This is important because, asset management firms generate revenues primarily through fees on assets currently under management and to a lesser extent, fees on gains earned by the company's investments.
February 27, 2007 The Use of Forward Looking Multiples In Valuation
Accounting-based market multiples are the most common technique in equity valuation. These multiples are present in analysts' reports and investment bankers' fairness opinions. They also appear in valuations associated with corporate transactions. However, it is difficult to know which multiple to apply to the subject company and most multiples used for valuation are trailing multiples, which are based on historical data. If the value driver of a multiple refers to a forecast instead of a historical number, it is termed "forward-looking". Valuation theory tells us that the value of a firm equals its discounted stream of expected future payoffs. Following this principle, forward-looking multiples are more appropriate for valuation purposes.
February 26, 2007 The Value of Key Players
These past two months have been a sad time for Denver Bronco fans and for all of us following the tragic deaths of two young promising Bronco players. Both players were considered to be key components of the growth and future success of the Denver franchise and will be missed. This weekend, as I opened the paper and reflected on this latest tragedy I couldn't help but wonder what was in store long-term for the Bronco franchise. How will they regroup as a team? Will they fight harder, struggle, or never miss a beat? Can they fill the shoes of Darrent Williams at corner or Damien Nash in the backfield?
While I recognize that the tragic death of an elite athlete is not the same as losing a key employee, we often find management teams with huge talent and age gaps in their organization. This is especially true in professional services, in which entire generations of employees are lost for a variety of reasons (e.g. a downturn can cause an organization to stop recruiting or be faced with layoffs). In certain cases it reflects management's inability to motivate and retain employees, while in others it may well be external factors. When analyzing the breadth and depth of management teams and their long-term impact on value, we have to consider the expected tenure and skill sets of the organization and its competitors. In a weird way, we look at the future and value in the same way a professional sports franchise may when they are forced to wonder who is going to fill whose shoes and when. All organizations need to plan for change and development of team members, just like the Broncos have to now.
February 19, 2007 Buy and Hold vs. Fix and Flip
The phenomenon of RLBOs (or Reverse Leverage Buyouts) has met with intense
public scrutiny of late. The public's attention became fixated on a few
landmark cases such as Refco, which was bought through private equity for
$500 million and subsequently taken public a year later for more than double the price. Not
long thereafter Refco collapsed, its current market cap is $50MM, and the
inevitable lawsuits ensued. Overall, the recent controversy regarding
RLBOs has focused on the use of leverage to provide large divided payouts
to select shareholders (private-equity firms), who then push the
overleveraged firms too quickly into public markets. Detractors cry unjust
enrichment to the detriment of shareholders. So the logical question to
ask is: do RLBOs create or destroy value? As with most questions, the
answer depends.
A recent study, "The Performance of Reverse Leverage Buyouts", by Cao and
Lerner reviewed the post-IPO performance of 496 corporations that were
initiated by private equity firms between 1980 and 2002. The study
specifically focused attention on RLBOs.
The study demonstrates that RLBO firms generally outperform both the
overall market and shares issued in other IPOs that were not backed by
private equity. Bigger IPOs backed by private equity did better than
smaller ones. In many cases, it appears that private-equity firms generally
have a vested interest in maximizing long-term value, and asset stripping
rarely proves prudent. Even after private-equity firms sell - at least in
subsequent IPOs - they often retain significant holdings for years to come.
However, this study is only a partial refutation of the criticism leveled
at RLBOs. Cao/Lerner also assert that firms that were held for less than a
year by private equity performed poorly, indicating that 'fix and flip'
appears to destroy value while 'buy and hold' creates value.
