We wanted to have a look at a topic that always present in our industry but even more so in light of the current world crisis. Recently there has been an increased focus on more inclusive valuation methods, with an increasing opinion that traditional ways of determining business value are insufficient to deal with fast moving businesses in the modern era.
Different methods result in different valuations. This is ever important given the lack of an open market for private assets to be traded, and thus be assigned an instant market value. The traditional methods in use in private markets such as discounted cash flow, price-earnings and market value use or at least justify forecasts based on historic financial performance. The complaint typically says that traditional valuation methods are not completely suitable for modern businesses which may be growth-oriented companies albeit with negative cash flows.
More inclusive methods such as customer-based corporate valuation (CBCV) have been used to great publicity for some high profile cases, the main proponents being Theta Equity Partners, who have successfully demonstrated that the IPO valuations of certain companies were mispriced – simply by incorporating a measure for customer behaviour. In one highly publicised case, Theta performed a valuation on a home-goods e-commerce retailer, and concluded the stock price was less than 16 of the going market price – again highlighting the inadequacies of current frameworks, especially the perfect market assumption.
In addition, other more modern drivers of valuation and customer behaviour such as ESG, can influence the risk adjusted valuation of any business – even where the historical fundamentals of that business are good. ESG is an interesting field of study, as a lot of the data needing to be collected, audited and benchmarked, are not financial data. Rather, they are measures of improvement in certain societal outcomes, for example, carbon abatement, water usage, or employee diversity.
All of these measures call for an improvement to the way that private markets participants handle and aggregate their data. It’s not enough to consider systems on their own – systems that don’t have the right processes designed around them, can easily fail to do their jobs. The ideal scenario we would see, is where participants from investors to fund managers, to operators of portfolio companies, are able to transmit data and transact business, in the same ecosystem. This is a theme to which we will return from time to time, as it is something we truly believe in.
Discussions around these topics frequently turn to AI and robotics. But the key issue with these discussions in the context of private markets and alternative assets is the lack of uniformity in fund formation and then in deal construction. AI and robotics depend on repeatability – and without it, we can end up with just expensive toys. We believe that as the investment markets converge, AI will eventually become a reality for alternative assets – but it certainly will take longer than what some people would have us believe.
If there is a common theme, it is that the pace of change is so rapid that the utility of historic data can rapidly be depreciated because the situation can change in the blink of an eye.
Covid-19 (Coronavirus) and impact on valuations
The IFRS accounting standards mandates the use of fair value for valuing investments (IFRS 13) as does the FASB (ASC Topic 820). As leading valuation experts Duff & Phelps held on a recent webinar, it’s important to note that Fair Value does not equate to a fire sale price – healthy to remember this when most of the press is bleak. As anyone involved in valuing a company can tell you, of course we would need to take the effect of Covid-19 into account when assessing factors on enterprise value (EV) such as revenue, supply chain, operations and liquidity.
In addition, for quarter end March 31 valuations, we must bear in mind that a lot of companies simply are not open – therefore it can be difficult to assess the full impact of shutdowns around the world.
The key takeaway is that one should remain pragmatic and calm during the valuation process, taking into account all available information, and indeed, using the last known valuation as a guideline and starting point. It behoves us to leave the more sensational reporting in the news media alone wherever possible.
Author: Redmond Lee