Valuation of Companies : Story telling or just number Crunching ?

Every company just like humans, it is  born , it grows ,it matures and like everyone declines, and just like human who don’t like to age , companies don’t like to get old. The focus of a company needs to change  as it moves across the life cycle , from start-up , to growth to decline . More value is destroyed around the world by companies not acting their age, young companies try to act old and old try to act young .

There are entities like plastic surgeons who help people look young, investment bankers & consultants try to mask the age of companies . For most people when they think about valuation of companies they think about excel sheets , tons and tons of numeric data , however valuation can never just be about numbers , a good valuation always has a story embedded in it . How does the balance between the story and numbers change as the company  grows from start-up to a mature company is more important to know.

Before beginning , lets first understand what a financial balance sheet looks like because most of the things mentioned above will be derived from the balance sheet only .

At one it looks very similar to accounting balance sheet , but instead of breaking down the assets in liquidity terms , the assets are derived as assets in place and growth assets. For instance Microsoft can put windows , and office in the assets in place category and the what the analyst thinks the assets will  be in the future that will be in the growth assets  category .

And other side of balance sheet is how will you fund the company , using the borrowed money called as debt and using your money called as equity.

Corporate Life cycle

To understand this more, in the  launch phase can have companies like Rapido , Ola Electric  ,in the growth phase there can be Ola cabs  and Paytm , in the shakeout you can have the Jio , and the maturity can have the ITC and HULs and decline can have the GEs and the Nokia.

Now, think where is the place where you can put your company in the graph. It can be depressing but it is what it is.

For instance , in the launch section we can also have AI based companies , these are young companies just coming up, most of these companies will not make it . If they make it they become young growth companies like teenagers.  You know what teenagers do? . Stupid things.

So, companies like Tesla and Ola behave weird you can understand why . These Teenage companies don’t think through before doing , for instance groceries delivery firms like Dunzo, Blink it  didn’t think through when they came up with instant delivery models and now have to pivot to new one, blink it is now going to do what urban company is doing .

Then you got young growth companies , this when you can sleep at 3 am in the morning and wake up at 6 am and still function , this phase of life is full of potential . Remember you B school days?.

 Then companies become mature like Facebook and googles of world , you are enjoying life.

In the middle age, companies where you don’t like your life much , you get into mid-life crisis . Finally , there is decline . So , all this is a nature of the process. Understanding where the company is in the stage , you can find out how the company should be run and how should it be valued.

Some business are easy to enter and scale , they don’t require huge investments you can grow quickly , some take longer to grow . That determines how quickly you can grow from start up to mature company .

So, what causes the company to grow quickly is the ease  of scaling up , ease of entry and how little capital you need to grow and what causes  the company to decline is same set of factors.

Life cycle of the companies is getting depressed, for instance the tech companies get aged in dog years , the grow from nothing to something very quickly , the don’t stay mature for very long time .

For Instance , GE had a long history of more than 100 years, but now the situation is more or more less hopeless now. In contrast , take yahoo or Hotmail , Yahoo was founded in 90s , the became quickly a 100 B dollars in matter of 7 years  . It stayed as mature company for about 7 years before it went to decline. It has mail program and search engine which no body uses.

If you look at the great companies that started in 70s in tech space , the life cycle is now compressed.

Corporate Finance :

There are 3 basic decisions that you need to take as a company

1. What assets to invest

2. How will you fund those assets.

3. if you can’t find the investments  , how much cash to returned to the shareholders( dividends)  .

So, how the focus of the business changes , depending on where you are in the stage of the company life cycle.

When you are in start-up phase, the only decision  you should think is about investments ,

Because you can’t borrow only equity works , in case of debt you have to pay interest payment and those payment can’t be made with “potential “. The company has no cash flow to pay the debt and how much can you pay dividends is not in the question because there is no bottom line.

As company mature they can think about financing , like what mix of debt and equity should they have  , and in the decline phase the focus shifts to the dividends principle.

The problems arise when the company refuses to act their age, like 50 year men wearing ripped jeans trying to look cool. Many companies try to act age that there is not right for them . A young companies that borrows out to get money are not acting their age, why? if you are young company you will put you entire future at risk. Few years back , when tesla borrowed 5 Billion dollars and it was bizarre decision , when it was losing money and with a  focus on scaling with a uncertain future was just pure gambling .

Mature companies that issue a lot equity is same as above , bizarre. In  this process they destroy value because they try to be something that they can’t be. For instance , Walmart a company in the decline business bought flip kart , which is a money loosing machine , paid 21 billion dollars. It was most expensive facelift in the history. So, when  companies refuse to act their age, their investors pay a price .

Cash flows-

In the start-up stage , the cash flow is zero, instead there is a cash burn , it is a feature for young companies

You don’t have to make from start but eventually you have to make money , so one way to find where the business is in the life cycle is to look at their cash flows. So, as the company matures there will be cash flows to be reinvestments , and in the decline there will be dividends or even buy backs.

Most government want the companies to not to buy back and instead re invest money to generate jobs , but if you are General motors you won’t want them to reinvest your money because there is not much to do as far as fuel based cars is concern in the future .

So , most of large companies investing your money is almost guaranteeing that your money us going to burn later.

Connecting stories to numbers :

People think that valuation is all about the numbers, although it is not just about the numbers. Good valuation Is bridge between stories and numbers. When  someone asks a valuation analyst that why the revenues are up 25 % every year for 5 years and then 5% thereafter , the answer will never be that “ Oh ! I am used to that number “. It will always be a story behind it. Every number  has story behind it , and every story needs to have number behind it . With young companies it all about story , when you value Uber , it is a young company losing money , the valuation being built around a story that uber being a car service company .

Now, if you change the story from car service to a logistics company , the whole set of valuation will be changed . Now , the size of business has been tripled , if you add networking benefits globally the valuation will be changed by billions of dollars.

If you are founder , the words you use to describe the business can mean the difference . With mature it is the numbers that drive your valuation , it is like being on the chapter 34 of the 35 chapter book , you can’t re-invent the company now.

Now , coming to the CEO of the company , if you are young start-up company you need a visionary CEO like Elon musk or Steve Jobs . You want a story teller .

When you are a  growth company you need builder, the right CEO for company is different in different stages . Because the life cycles have become depressed , the management turnover has increased across the globe, because the stages of the company change quickly and need of the leader with it too.

Written By: Ankur Kushwaha, Sr. Consultant, Invest Punjab | Govt. of Punjab.

DISCLAIMER: Views expressed are personal.

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