Assessing Value: To a 100% acquirer of the business!


(Donald Francis) #1

Mr D while congratulating ValuePickr on where it has in the last 4 years, was quick to point out that there is more to come. In his words

"The best is yet to come…estimating the value of a business to a 100% owner/takeover valuation. This exercise will be useful to hold on to extraordinary, seemingly richly valued businesses …KNOWING THESE CAN BE UP FOR SALE.

Even if they are NOT FOR SALE, their intangible assets need to be valued properly. We might not be accurate but we can certainly estimate how desperate a new owner would be to acquire.

Concepts of Intellectual Property, Brand and Pricing Power, Network Effect - as barriers to entry and thus building blocks for disproportionate future growth - HAVE to be incorporated in Valuation.

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I have been trying to get my feet wet on the subject for months now. I feel totally inadequate to tackle the subject, let alone put an introductory/influencing piece up, for discussion.

However given the confusion I have witnessed (especially in the last 6 months) in several stellar minds, I make bold to push through some of my yet unformed thoughts to kick-start this very important discussion piece.

Its important to bring everyone on the same page - if we are to have more & more insightful discussion, so here goes.

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What makes for the most valuable business?

Most folks I have seen are confusing huge SIZE OF OPPORTUNITY, coupled with Integrity of Management and Efficiency of Management - as THE defining factors.

While these are no doubt important, and if you can find a business with these characteristics early on, it will sure make for great returns, perhaps even extra-ordinary returns, if you hold on to the business for a number of years.

However, the moment we put on the shoes of a 100% acquirer of the business, a shift in perspective is bound to occur.If you have some ~6000 Crs and want to buy the most valuable of the VP Portfolio businesses, which one are you likely to go after??

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IT’s obviously NOT in the NUMBERS/RATIOS - else Mayur Uniquoters would have been the most valuable

IT’s my case that its NOT even in the SIZE OF OPPORTUNITY - else Astral Poly Technik would have been the most valuable

IT’s also NOT the best Economic Profit Added or FUTURE VALUE CREATION - else Ajanta Pharma might have been the most valuable

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Its my case that financial factors and the above more tangible aspects of the business provide only a part of the Value Estimateto the 100% Buyer of the business. It is the **Intangible Assets **in the business(in addition to above) that determine the Real Value to the Buyers.

Most times it is an evaluation of how much would it cost to re-create an existing intangible asset based on the original cost of creating it - that plays a decisive role.

Intangible Assets could include Brands and Pricing Power, Intellectual Property, Proprietary products, Customer loyalty and concentration, Trade secrets and Process know-how, skilled employees and skilled management team, strong distribution network. Intangible Assets could also include strategic benefits to a specific buyer and the cost of doing it alone!

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That’s as far as my thoughts go on the subject :slight_smile:

Looking for help from seniors and fellow-learners to take this important discussion forward. And more specifically to applying these to current and future VP Portfolio candidates - and estimate their value to a 100% buyer of the business - as Mr D would want us to.


(Ananth) #2

If business is superior (higher intangible assets), would that not reflect in superior return on capital ? Isn’t ROE/ROCE single most important metric of the business we should be focusing on.


(Vinod MS) #3

Hi, this is a challenging task as a buyer of a company would have a totally different perspective.

Though M&As also involve buying a company think of a buyer as an individual too, not necessarily a company. As Donald told which company would you buy out if you had 6-10k Cr today? We would then think in terms of real “value” in terms of future potential and in terms of how “difficult” it would be to build a company like that today.

A Kaveri Seed Com took 3 decades to build its germiplasm, research, distribution, farmer awareness etc. How much would you pay for 10-15 years of your valuable time if you get the same on a platter today? This “time” has value?

How much would a foreign buyer pay for not handling “red-tape” and other local issues when he gets a company up and running and all he needs to do is bring in his "technology"other expertise, access to foreign markets - the company’s future business would look completely different if he were to run the business henceforth. This value cannot be captured in ROE and ROCE of past data.

ITCs distribution strength is legendary, a buyer with great set of products can push many products through that channel.

A big pharma giant might want to lap-up Shilpa as he can realize even greater value than what the current promoters are currently achieving.

Cheers

Vinod


(Donald Francis) #4

Ananth,

There we go again!

While RoE/RoCE are important - they are not the end all. That is exactly the case I am making that it isn’t. If it were, Mayur Uniquoters with ~47-56% RoCE range would have been the most valuable business compared toAstral (28-32% RoCE range). However Mr Market has consistently valued Astral higher than Mayur right from the start - we believe, for a reason!

If you look at Business Quality - what is Mayur’s business - simply processing Fabric with PU or PVC - not much of value-addition or scope of differentiation from others, except in the process and quality standards. You can certainly see many more variables affecting Mayur’s business than you can see in Astral for example.

Try seeing it from the Competitive Forces at play for Mayur. Big Customers or their Tier II suppliers like Lear. We know how it is in the extremely competitive auto OEM Business or Footwear business. Margin squeeze/pressure every year is the norm. If Mayur decides not to agree to Tier II supplier, the Tier II supplier has options ton prop up a 5th or a 6th supplier to him at the cost of Mayur. You will come up with many more, as you think of it from Porter’s 5 forces model of competitive pressures - bargaining power of Customers & Suppliers; Threat of Established Rivals (competitive intensity) and New Entrants, and Product Substitutes.

And now try seeing it for Astral - what are the variables in its business and what is the degree of vulnerability to these competitive forces. You will probably come to the conclusion - given huge opportunity size in front of both Mayur and Astral - scaling up for Astral is much easier - it has just to continue to execute - set up capacities and invest in the distribution network, while making sure to Keep Lubrizol happy. It has to deal with lesser number of variables - just by virtue of its business/business model.

So Business Quality is more important than the numbers - once you operate over a basic threshold. As long as you have a good spread (Return on Capital is greater than Cost of Capital) and you can continue to scale up i.e. continue to Invest larger sums of Capital at this spread - there are other factors - that will lead you to differentiate one business from the other.

We have tried to cover all of that in this ART of Valuation thread, so I don’t find it necessary to labour over this point any more.

The point I am trying to make, even after the above argument, is that Astral is not the best business to own - even in VP Portfolio. End of the day, it is still a processor business - its unlikely to have any enduring pricing power (without which the “branding” doesn’t count for much), it probably does not add much by way of intellectual capital (new IP or new process know-how), or for that matter much by way of intangible assets - except the strong distribution network.

Whereas there are quite a few who have similar good numbers/ratios, are investing more in the business every year and thus generating higher Economic Profits every year, have the potential to grow as fast or better in next 5 years, and have considerably higher intangible assets to count (over Astral).

Return on Capital is important. Size of Opportunity and ability to scale up (Management Efficiency and Integrity) is more important no doubt about that. With these as essentials in the business, there are other things - Intangible Assets - which ultimately weigh more to the 100% buyer of the business - and establish the REAL VALUE of that business.

Time to get beyond the Numbers and Size of Opportunity!

Time to separate the Men from the Boys - separate the wheat from the Chaff - for every business in your Portfolio. Every new addition must challenge and dislodge atleast one incumbent - a key tenet in the ART of Valuation.

It may be difficult to do, not always possible - but that does not mean we will not strive for it.

Time to focus on the INTANGIBLE ASSETS! and put a Value to them?


(Punit) #5

Since you are offering only 6000 cr, it will miss by a tag bit to acquire Gruh Finance. If we ignore the numbers (especially the speculative bit from Mr.Market), the business have every aspect and quality of a great business.


(Supratik) #6

Hi Donald,

What was running at TCS, it grew faster than many competitors. Agree on Brand value, but competitors were never behind in value terms.

Pricing power is almost Nil since there is no specialized niche skill that it works on. There is stringent bidding in the projects outsourced.

~Supratik


(Donald Francis) #7

I haven’t studied IT companies so I am not the best person to comment.

I think the big 4 or 5 TCS, Infosys, Wipro, Tech Mahindra and Cognizant have reached a size that tilts the scale in their favour. Outsourcing as an Industry and especially Outsourcing out of India has reached a competitive cluster effect - that is impossible to ignore. Leading to a situation - that anywhere in the world if there is a outsourcing deal of any size - these guys are in the reckoning in addition to the IBMs and Accentures of the world. And especially for very large transactional deals involving lots of people - the pre-qualification norms ensure that only the top 10-15 companies qualify.

I don’t think we can belittle the domain and process knowledge that each of the Practices within Retail or Manufacturing or BFSI or Telecom that these companies/professionals today possess.

Having said that - I see no connection of your question with our quest at establishing superior business value - and putting up a measure of Value for the Intangible Assets. There are many examples of very well run businesses like Mayur and Astral with superior management (Integrity, Efficiency and ability to Scale) looking at addressing huge opportunities before them but not much of intangible assets, perhaps.

Do we ignore them - surely not. Do we fall in love with them - again surely not. We can be unemotional about each business and have a rational basis to place them in their SLOT. As per the ART of Valuation discourse, Mayur and Astral are A Category business. TCS is also a A Category business. Certainly not A+ or A++ Category.

The quest is to latch on to a A+ Category business from the early stages. and Intangible Assets have their role cut out!!


(Administrator) #8

Hi Guys,

Its apparent that many folks (probably new to ValuePickr) are having a hard time coming to terms with the hierarchy of Valuation Concepts that are being laid out.

Before cluttering an important thread with too many counter-questions, it is recommended that anyone participating in this thread, please familiarise yourselves(do some thinking)with following important reading pieces (in that order):

1). Capital Allocation Framework

2). Business Value Drivers

3). ART of Valuation

These are “distilled wisdom” pieces from our Seniors (may not stand the highest academic rigour) but are at the heart of ValuePickr process. And we believe, at the heart of its performance skill and success (apart from the big chunk of Luck that is necessary).

We hope all participants going through above - will substantially improve discussion quality again - because it will help bring everyone on the same page!


(Hitesh Patel) #9

100% acquirer of a business would not be looking at the return ratios. It will be the job of his managers to sweat the assets or improve efficiencies and thereby improve these things if they are not acceptable in the first place.

What the guys acquiring the company would be interested in would be something that would give an edge to the company in terms of brand power, patents, distribution reach, technological advantage, some other kind of moats like customer lock in and so on and so forth.

Among all our valuepickr businesses I feel that most attractive businesses would be ones like Kaveri Seeds where the intangible asset in form of germplasm (which is achieved after years of toil) and its distribution might would be difficult to replicate easily. Astral might come in close to Kaveri in terms of its distribution might as well as raw material sourcing from Lubrizol, (although with other CPVC raw material manufacturers coming up that might no longer be an extra ordinary advantage), its product range (though here too the lag period could be only around 1-2 years after launching a product), and its brand strength. (brand strength is not as strong as other franchises like Page, Colgate or such other businesses)

Among the stocks I own, I think businesses like Page Inds, Hawkins, Symphony would be the preferred acquisition targets for any one with loads of money.

Essentially I think it boils down to companies with some or other kind of moat described by Pat Dorsey. These moats have to be of an enduring quality so that they cant be breached easily by competitors.


(Rohit Chauhan) #10

I think the following comment from buffett summarizes our discussion well. when asked about what businesses are the best to own - following was his comment (as i remember)

“Leaving the question of price aside, the best business to own is the one which can deploy the most amount of incremental capital at high rates of return (above cost of capital) for the long period of time”

This comment bring up multiple points we need to focus

)- Moat or competitive advantage : As hitesh just pointed out - does the company have some moat which enable it to re-invest capital at high rates of return. This moat can be brand, distribution network, production advantage etc.

)- depth of the moat : larger the better …allows the company to re-invest at higher rates of return. ofcourse deep moats are difficult to sustain

)- durability of moat : This is the most important and least appreciated concept. Doesnt matter if the moat is deep, but if vanishes after a few years, then the business is in trouble. think bharti airtel, MTNL etc. The moat has to be structural and not just because the business is in the right place at right time (enjoying the tailwind of the market)

)- lenght of the moat : this is related to the opportunity size. Value is created if the company can invest incremental capital for a long period of time. Lets say a company earns 30% ROC. A PE of 30+ requires that the company be able to deploy its current profits at similar rates of returns 10 years from now.

So if you take the above statement, and think through the depth (difference between ROC and cost of capital ), durability (intangible assets, structural advantages, management etc) and duration (opportunity size, ability of the company to capture it, competive intensity, entry barriers etc), you will get an idea on the sustainability of the business.

An HDFC bank or Nestle has very durable moats and hence have created so much wealth


(Mallikarjun) #11

Hi Supratik/Donald

Skilled workforce and labor arbitrage were the factors for Indian I.T , i think…

Given a choice, will go with Polymedicure ( though they are competing on the price font by being a low cost manufacturer ) they can reach higher on the valuechain…

Regards

mallikarjun


(P Sharma) #12

A lot of good stuff has been covered in this thread already. I agree with Vinod that we need to look atthis from the eyes of the acquirer and what the motivations are.

One kind of acquirer is the likes of Warren Buffet. He insists that the deal bring a good management teamalong with it as in his words, Berkshire Hathaway(BH) cannot supply this. Here he is only interested incompanies as Rohit pointed out with durable moats that can earn a high ROC for a period of time. BH’scontribution could be some possible synergies with the other group companies but a major contributionof Warren Buffet and Charlie munger is in capital allocation. The acquired company continues to do whatit was doing earlier almost independently but under the BH umbrella.

The second group of acquirers is companies acquiring businesses where they see a lot of synergies eitherin terms of brands, distribution, operations or IP. These target companies will have all the attributesthat we have already discussed in other threads like size of opportunity,ROC etc . However there isalso hidden value in terms of the business and the opportunity being under leveraged till this point.

The acquirer identifies that the right ingredients are present in the business and given the acquirers IP,management strength and past experience, the acquired company can be made to run much faster.

If i were looking to acquire a company, i would be looking at a target where the basic building blocksare there but the extra something is missing which i as an acquirer bring to the table.I would be quite confident of affecting that change and would be willing to pay extra for nothaving to start from scratch.

Let us look at the Blue Dart acquisition by DHL. Blue Dart was the leader in the Indian market and had thedistribution network in place. It was a leading brand and had all the regulatory approvals, including slots atcongested airports. What did DHL bring to the table? Access to superior technology and processes given their globalexperience but more importantly an international gateway and network that Blue Dart was lacking.The acquisition has been a success.

The recent case is the UB Spirits acquisition by Diageo. UBS brings strong brandsand a strong distribution to the table. Diageo has better brand management skillsand global expertise in managing the spirits business. Can Diageo leverage UBS’s strengths to take it to thenext level?

One intangible here in my opinion was the mediocre management of UBS and that provides Diageo with a lot ofheadroom to make improvements in the existing operation.

Which companies in the VP portfolio qualify for the first and the second category? In my opinion Kaveri Seeds andPoly medicure qualify for the second category having created assets that can be dis-proportionately leveraged if in the case of Kaveri the acquirer is a global seedcompany with block buster portfolio in rice hybrids for example. The Kaveri distibution network, the contract farming agreements, germplasm can be leveraged.

A global medical devices manufacturer can similarly leverage Polymed’s manufacturing and design capabilities and provide it a global sales network. Shilpa can alsobe a candidate on the same logic.

In the case of Astral and Mayur, what is that an acquirer can provide? The manufacturing and design is not very complex. The distribution in case of bothalready exists in India. Mayur might benefit from a global sales network but will i be willing to pay a premium for their manufacturing? Astral is more of an executiongame and the current management is doing a good job. Will Lubrizol be willing to pay a premium to forward integrate by acquiring Astral? I have my doubts.

Therefore the key in my opinion is to identify companies which are at the cusp of making it big but are waiting for the fillip to take it to the next league.


(Ravjit Singh Bagga) #13

2 examples of stocks i own that have been acquired…

  1. Accelya kale

Accelya was in BPO and Kale in to software. Accelya had their reach with global airlines and kale had niche software skills which could be leveraged. So what accelya did was bring in both their reach with clients, better management and combination of both BPO and Software domain and leverage on the Indian labor skills and rates…It was on Accelya’s part that they could vision to buy Kale and create a strong business which standalone Kale could not do.

As we are discussing here, the acquirer Accelya kale saw the opportunity to add new domain of niche software to their BPO, use their distribution and leverage the Indian labor cost.

  1. Thinksoft

SQS which is the largest Software testing company acquired indian company thinksoft…

Thinksoft is primary in domain of BFSI testing and had good presence in American markets while SQS lacked both…

So by acquiring Thinksoft they again got the domain of BFSI domain and the American markets, moreover Thinksoft on its own could not go for big ticket deals but now with SQS piggy backing they could go for more big and marquee deals. Also SQS benefits from outsourcing work to India…


(Vimal) #14

Very interesting thread. I am still a wet behind my ears on financial concepts, so I apologize if my questions are a little naive:

  • Is an intangible asset a special type of moat? Or are they different things…
  • What are good examples for intangible assets? For instance, is Coca-Cola/ThumsUp an example?
  • If it is intangible, then how can you value it in the first place?

(Vimal) #15

Maybe my questions were not fully fleshed out…

I understand that Kaveri’s germplasm is a moat, and it would take another company a long time to duplicate something like that. But it is doable, and you might say that if I invest so much time and money I can do the same thing.

A brand-name on the other hand is something embedded emotionally in the minds of consumers, almost into the local culture. That is much more than x years of advertising budgets. Or have an innovative leader like Steve Jobs. How much value did Apple lose when Steve Jobs died?

It is not obvious to me that brand-name, talent are the same type of enduring moats. Reputations/trust are easily lost, talented people can leave (Infosys is a recent example - even Steve Jobs was booted out of Apple).


#16

What makes for the most valuable business?

A business which takes away the customers pain with reliability, costs a small amount as compared to the overall cost for the customer and in case the business stops operating, customer’s world would come to standstill due to lack of reliable alternatives.

For example, if CRISIL and ICRA stop operating, the bond and debt market would come to a standstill. Among VP stocks, Shipa Medicare does posses the potential to be one.


(Donald Francis) #17

Random Walker and other Fellow-Learners,

Thanks for continuing the dailog.

While many find it easy to hide behind the “Moat” word I have always struggled (and continue to strive) to first understand for myself (and then communicate) why some firms continue to add more value than their rivals/peers and are likely to continue to do so over long periods of time.

Came across a recent Report from Ambit - Ambit Strategy: Cusp of Greatness - that describes the same things from the work of John Kay: Foundations of Corporate Success - I thought in a more interesting and understandable way - especially on the (value of) Intangibles.

Think it will be useful for all.

Excerpts from the Ambit Report

Sustainable competitive advantages allow firms to add more value than their rivalsand to continue doing so over long periods of time. But where do these competitiveadvantages come from? And why is it that certain firms seem to have more of theseadvantages than others?

In his 1993 book, âFoundations of Corporate Successâ, John Kay, the British economistand Financial Times columnist, wrote more comprehensibly and clearly about thisthan any other business guru. John states that âsustainable competitive advantage iswhat helps a firm ensure that the value that it adds cannot be competed away by itsrivalsâ. He goes on to state that sustainable competitive advantages can come fromtwo sources: Distinctive Capabilities or Strategic Assets.

Whilst strategic assets can bein the form of intellectual property (patents and proprietary know-how), legal rights(licenses and concessions) or a natural monopoly, the distinctive capabilities are moreintangible in nature.

Distinctive capabilities, says Kay, are those relationships that a firm has with itscustomers, suppliers or employees, which cannot be replicated by other competingfirms and which allow the firm to generate more value additions than its competitors.He further divides distinctive capabilities into three categories:

ï Brands and Reputation

ï Architecture

ï Innovation


(Donald Francis) #18

While “Brands and Reputation” and “Innovation” is something all of us would appreciate, I find the way Kay coins Architecture - very very interesting, to take note of:

Architecture

âA dream you dream alone is only a dream. A dream you dream together is reality.â

â John Lennon

âArchitectureâ is introduced as the first of the three primary sources of distinctive capabilities and it refers to a network of relationship contracts within, or around, the firm. It can be subdivided into internal architecture (relationships with employees), external architecture (relationships with their suppliers and customers) and networks (relationships among a group of firms engaged in related activities). It adds value by helping create organizational knowledge and routines that enable the company to respond flexibly to changing circumstances and allows easy exchange of information. Note that such capabilities can only add value in a longâterm context, which penalizes opportunistic behaviour.

I can’t help wondering that ValuePickr Community has something to do with this kind of an architecture as one of its distinctive capabilities :slight_smile:

Ambit Report elaborates further

At the core of successful architecture is co-operation (within teams, across variousteams in a firm and between a firm and its suppliers) and sharing (of ideas,information, customer insights and, ultimately, rewards). Built properly, architectureallows a firm with ordinary people to produce extraordinary results.

Perhaps the most striking demonstration of architecture in India is the unlisted nonprofitagricultural co-operative, Gujarat Cooperative Milk Marketing Federation Ltd(GCMMF), better known to millions of Indians as âAmulâ.


(Donald Francis) #19

The Ambit Report-Ambit Strategy: Cusp of Greatness may be of topical interest to all fellow-learners as Ambit applies these principles in what they call the STAR framework - to Marico, Page, BKT, Astral, V Guard, E-Clerx and Mayur Uniquoters (These qualify to be on the cusp of greatness as per Ambit).

Appreciating and Valuing the Intangibles may become a little more clearer?

You may like to write to the author for a copy of the report

Saurabh Mukherjea, CFA

[email protected]

Tel: +91 99877 85848


Business Quality: Refining our thinking on "Great Businesses"
(Arjun Chandrappa) #20

Thanks Donald, Great insights.