I was recently asked whether there was any value in a loss-making business that had had a good reputation for 30 years.
Put very simply, and almost as a philosophical maxim, the sum of the value of an enterprise is equal to the sum of the NPVs of its projects (including as one project the liquidating of its assets, if that’s what it has to do). If it has no projects, it has no value. If it has only or overwhelmingly negative NPV projects, then it has negative value. Even the case of Woolworths shows you that a name that we all grew up with cannot prop up negative NPV projects for long. Therefore the way to assess value is to make a business plan for all the projects based on assumptions analysed down to the smallest level logically appropriate, with values ascribed to those assumptions which are objective and as researched as possible, and then to run PV calculations on the business plan.
Sure, someone will come along and say “Hey, that’s too complex. What something is worth is what someone else would be willing to pay for it. This I know, for the IFRS tells me so” – but in the final analysis what that other person is willing to pay will only be based on what he thinks he can make from it in the terms stated above, less his margin for risk of buying it. No business person actually buys at the value in use, they want to make a profit on buying it at less than that, but their perception of the ultimate value should be based on the sum of the NPVs of the projects.
Needless to say, I regard the frequently drummed out maxim “it doesn’t matter what a business is valued at if nobody is buying it at that rate” as singularly unintelligent, because it simplifies the case and takes all the finesse out of negotiating over a business. It overlooks the fact that if we have ascertained a balanced argument that the NPV of the sum of a company’s projects is, say four million, and there’s no-one to be found willing to pay more than three million, it doesn’t mean that the valuation is necessarily wrong. It may well indicate that you need to check it again, but if you do and come up always with the same answer, then all it means is that now is not yet the time to sell the business. If you can’t wait, then you have to sell at undervalue, just as if a buyer can’t wait, he or she will probably buy at overvalue.
David J. James
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