More on Valuations and Mergers
OK, OK, OK… the messenger really does get shot at. The conflicts between market price and real value to the holder of the asset… and forced (not market driven) consolidation are why mergers are making more and more sense. Don’t blame me because the actual concept of economic value doesn’t fit into your personal desires. Here are a few points straight from finance 301 - it is a little more advanced than 101 ;-)
· The economic market value of a financial asset is set by the marketplace. This does not mean that this value is the same for every individual on the planet. If your personal economic value for this asset is below that set by the marketplace, you won’t move on the asset… i.e. it is a “bad” deal. On the other hand if your personal economic value for this asset is above that set by the marketplace, you just might move on the asset… i.e. it is a “good” deal.
· What in statistics are called outliers, do not determine the market value of an asset, the marketplace does that. The value of an asset does not skyrocket just because for one person on the entire planet that financial asset is worth far more than the market price. Think about this one again. Today, far to many values placed on distributorship rights are based on the value to some statistical outlier, not on some general market value.
· Ability to pay is not the same as market value. These are mistakenly being combined in many people’s thinking. As an example, think about getting your home appraised (valued). If the market value is $500K but because of some unique situation for one individual in the entire country, your house can have an economic value of $2M to him, what is the appraised value of your home? It is $500K.
· Let us use the stock market for publicly traded companies as an example. Millions of shares of stock may be traded on any single day… some are buyers, some are sellers (it takes two to tango). In this dynamic process a general value is determined. For privately held businesses arriving at a value is a much more difficult task since there aren’t all these market-determining transactions. And of course in this industry, the suppliers retain tremendous power in determining who gets the opportunity to operate a distributorship. But still, for any proposed sale I can find 50 willing qualified buyers… these buyers will have different visions of the future, different comfort levels regarding risk, and various other variables, but their offer prices will in general be grouped in a certain range… this sets the true market value. Now if some adjacent or overlapping wholesaler can pay far more than this market value and still make the deal work, this has no influence on the market value of this asset. These people are statistical outliers who do not set the market price… like the home buyer above. One person’s situation does not set the market value. The seller might attempt to sell to this person and set their price accordingly, but this again has no influence on market value. In fact there is really no financial reason for the prospective purchaser to pay more than market value plus $1… you can make a strong case that there is no need to share ANY potential savings based on synergies to the seller… none. Of course this assumes a willing seller, something that might not be the case.
· Obviously if the economic market value of a financial asset is BELOW the financial value that the present holder of that asset (the owner) receives, then the owner won’t sell the asset. Right? The marketplace says it’s worth $20 but the present owner gets $30 worth of value from it… then why would the owner sell? This is the crux of the issue facing many beer wholesalers. For MANY wholesalers, this market value is not enough to justify the sale of the asset. After paying taxes, the remaining dollars simply cannot produce enough economic value to equal what the original asset produced. Therefore market value is thrown out the window and instead the selling price is attempted to be set by these statistical outliers for who the asset has much more value. But from the buyer’s perspective, why should they pay many times the market value for the asset just because they can? And in many situations, the seller is attempting to take ALL of the operating synergies, leaving the buyer with the worst of all worlds… paying far more than the market value but in the end receiving none of these outlier benefits… plus sitting on a pile of debt and having all the financial and operational risk on their shoulders. But our friendly suppliers want to shrink the number of their wholesalers but market realities aren’t driving this. That one issue is causing a lot of these problems. Get wholesaler gross margins to an average 18% and then you’ll see market realities driving these sales and consolidations. Just kidding guys… put down the gun!
· Intersection – Remember your old geometry class where you learned about unions and intersections of sets? Hold on, this is a good concept… no reason to doze off ;-) The intersection of 2 sets is the set of elements which are in BOTH sets. In a venn diagram, imagine 2 circles that overlap each other to some degree… this area of overlap is the intersection of these circles… Now think of these two circles as a buyer and a seller. Within the buyer’s circle are all those prices which they are willing to pay. Within the seller’s circle are all those prices which they are willing to sell for. If these circles don’t overlap, then no deal will get done… there is no intersection of these sets. But if these circles do overlap, there is potential for a deal to get done… and it is defined by the amount of this overlap. Now the seller will want to pull the price towards one end of this intersection and the buyer will want to pull the price towards the other end of this intersection, but all successful negotiations MUST by definition occur within this area of overlap. Once one side leaves this area, a deal cannot be accomplished. That’s just a mathematical reality. Far too many brokers seem to have no grasp of this concept.
· Since many of these consolidations are not market driven, merging is making more and more sense. Obviously a merger changes the nature of the financial asset but other than that, there is only upside. Some compelling reasons to consider a merger include:
o You “invest” pre-tax money versus after-tax money.
o Your primary financial asset remains in the beer business, and for at least the foreseeable future, there are few business with the financial rewards and security of this industry.
o You share in the synergies of these operations, increasing the profitability for everyone involved. Let me repeat, everyone makes more money.
o You don’t end up sitting on a pile of debt where only your heirs will see the financial benefits of a purchase… until then it is only the bank that rakes in the additional money (IF you find some one to finance the deal). Or if you are the seller, you pay a pile of taxes and then try to find another investment with the upside potential of the beer business… good luck.
o The surviving entity is much larger and thus has more power in pricing, purchasing, negotiations with suppliers and retailers, desirability to suppliers, etc.. In addition, this larger entity will offer your employees much more potential career advancement and can attract higher-caliber employees across the board. It becomes a virtuous circle where good things only drive even more good things.
o Your family can still participate fully in the business even though it will no longer be a single “family” business.
o Since very few want to leave this industry (it does not make market-driven sense), it is a wonderful compromise for all involved. You might not have 100% of what you want, but you end up with 80% of what you want and that 80% is most likely FAR GREATER than the non-merged 100%.
o Fighting produces winners and losers, and generally both end up bloodied and battered (and often the “loser” ends up being the “winner” in the long-haul). Joining hands and coming together only produces winners. Something to think about over the holiday season.