The Concept of Value and Other Whimsical Things – Part 3
Continuing our voyage to value, don’t ever forget that purchasing anything in a market economy is basically participating in an auction… whether you are aware of it or not. This is true whether you are buying or selling a distributorship. Even the employment market is basically an auction… you desire a certain skill set and the market (the auction) tells you what the price of this skill set is as of today in your specific geographic territory. It might change tomorrow but as of today this is what it is. And just like an auction, you can always overpay but other than those few times when you are lucky and can find a deal, you can seldom underpay. And when do you find a deal? Generally when there are few, if any who want to purchase what you are bidding on at that time. Just like buying or selling a distributorship.
Although this is a rather crass example, it is a great illustration of this real-world economics in action. I had a friend who was in the Army stationed in San Diego in the late ‘60s. All the Army guys hated it when the Navy made port since it drove up the price of… well let’s say it drove up the price of certain commodities… and even after they left town it would take some time before these prices decreased back to more “normal” market prices. Economics always works, whether we like it or not – unless of course that thing we call government intervenes but that’s a rant for another day ;-)
This factor (no, not the Navy… the reduction in potential purchasers) is one of the concerns of the recent MillerCoors contract… it certainly seems to shrink the pool of potential purchasers substantially… thus potentially lowering values by a significant amount. Whether this truly comes to fruition is another matter entirely. There still are A LOT more buyers than sellers and this always puts upward pressure on price (see the Navy above). Distributorships are fairly unique entities and there really aren’t that many around – i.e. limited supply. Throw in all the other non-financial considerations I’ve talked about in the beginning of this article and it is difficult to truly decide which directions values might go. If you are considering selling or buying, my attitude is just get the deal done. Waiting to see what the future may or may not hold is generally a poor strategy.
In fact it seems that in many situations, the ultimate determinate of value is becoming can you get the deal financed? Even though the buyer and seller might agree to the value, if the deal requires debt, the bankers might hold the cards. In theory the value of any financial asset is not determined by the means used to purchase it. An asset doesn’t have value A if it is purchased with no debt, and value B if it is purchased with debt. A crusty old MBA finance professor used to call this attempting to measure with a rubber yardstick. But unfortunately the real-world occasionally raises its ugly head and slaps what is “right” about the head and face. Maybe availability of debt financing doesn’t have anything to do with value, but it certainly does have a lot to do with ability to pay… and if it impacts everyone’s ability to pay, then it must impact ultimate value.
Since few folks have ten’s of millions of cash laying around just waiting to be used to purchase a distributorship… and government subsidizes debt… i.e. you can deduct your interest payments, this leverage makes purchasing any significant asset with some degree of debt a wise financial choice. Therefore the banker does come into the picture… both from a willingness to lend perspective and from a cash-flow perspective. The banker could give a hoot about whether you overpay for an asset, but they very much want to ensure the cash flow is sufficient to cover the debt payments and not strangle the company it the process… at least until they get all of their money back ;-)
In summary, what have we discovered about value? That it is a very fluid and flexible concept which is impacted by a great many factors… some are hard facts and some (many?) are very soft and emotional. This isn’t to say that getting a valuation done for your company is a bad idea - come on! I do them so of course they are a great idea! ;-)… in fact the valuation is often the first step in many transactions… it’s just that as a “consumer” of this product, a valuation, you should be aware of the nature of the concept of value so as to maximize the value it brings to you.
As a completely off the wall side note… I had a crazy finance professor in my MBA studies who taught a class on investments. And he began the class with asking what seems to be a very simple question… what is the difference between gambling and investing? Or is there one? It’s not as clear as one first might think… his belief was that they are a continuum. Most would agree placing a bet on a complete game of chance is gambling. But what about a person who studies dog racing and places bets based on the “superior” knowledge. The prof liked dog racing over horse racing since those pesky jockeys can easily influence a race.
One could make the case that because of this superior knowledge, this is closer to investing than gambling. Just think, instead of telling your wife you’re off to the track or betting on your favorite football team… perhaps perceived as a bad thing, you should be telling her that you are investing… of course a good thing! ;-) Reading the sports pages? … Investment prep work. Weekly poker games? … investment in action! What does this have to do with value and buying and selling distributorships? I’ll leave that for you to decide ;-)