Business valuation-Myths and facts.
The Edutech company, Byju’s, has been valued at $5 billion, much higher from the previous $3.6 billion, when it raised $540 million in a funding round led by South African conglomerate Naspers. Flipkart was valued at $21 billion in 2015 when the Walmart had acquired 77% of its stake. While Toyota recently invested about $500 million in the ride hailing company, Uber, at a valuation of $76 billion, bankers have indicated that the said company could be valued at as much as $ 120 billion. All the figures are dream high which can make any investor drooled over, easily.
Whereas despite of this eye-popping valuations, all the above companies are at operational losses and it may take years to reverse the situation. Think & Learn, which runs online learning platform Byju’s, doubled its revenue to Rs 500.2 crore in 2017-18 from the previous financial year while its losses fell around 40% to Rs 37.1 crore during the period, according to the company’s consolidated financial statement. Similarly, E-commerce major Flipkart has trimmed its consolidated losses to Rs 11.606 billion for the financial year ended March 2018, as per regulatory documents. The company had registered a total loss of Rs 16.402 billion in the previous fiscal, according to the documents filed with the Corporate Affairs. Ahead of its initial public offering, Uber reported a net loss of $865 million in the fourth quarter. Meanwhile, Uber's adjusted EBIDTA losses came in at $842 million, an increase of 88 percent year over year, and an increase of 60 percent from the third quarter.
There is something atypical with the above statements. The valuation of these companies are sky-rocketing so as the losses. After reading the above passages, which are very incongruous to each other, a natural question will come to the mind of a common man, often perplexed and astonished, on the authenticity of the said valuations. Are these valuations bogus?
Value and price
Everything has a value and a price. Though we use the said terms interchangeably, both are quite different. Value is on the beholders eyes. It will differ from person to person even for same goods or article. A Morris Minor car may have only scrap value in the eyes of a scrap dealer but the same car shall have much more value in the eyes of an antiquarian. The price is the consideration one shall have to pay to acquire the ownership of something which is having a value.
Valuation
Anything, tangible assets, intangible assets, liabilities, equity or business can be valued based on certain principles and practices. There are internationally accepted valuation standards to evaluate the value of an asset, liability or business. The methodology for valuation shall vary depending of several internal and external factors. The valuation of a business at the time of liquidation shall be totally different from the valuation of the business for investment purpose. Valuation for insurance purpose shall be different from valuation for the purpose of the sale. Valuation of a start-up shall be totally different from the valuation of a proven business model. Depending on the methodologies adopted for the valuation, the value shall also vary.
The ultimate number game.
There are many approaches and methodologies for valuation. The most prominent among those is Discounted Free Cash Flow (DCF) Approach. Under this approach , the valuation of a business is arrived at on the basis of projected cash flows from a particular business. In many cases, the projected figures may be purely based on assumptions and presumptions, present market conditions, market share, potential of the product, credibility of the promoters, competition etc. The present value of the future cash flows shall be arrived at by the valuer, after discounting the risk factors, to arrive at the estimates. If the value arrived at through the DCF analysis is higher than the current cost of the investment, the opportunity may be a good one. In the case of Byju’s, Uber, Flipkart etc the potential and bandwidth of the product to reach the maximum customers across the markets may have been considered while projecting their cash flows and that may result in huge valuation of those companies. As all these are niche sectors, there is no bench mark or comparable business model or active competitors to gauge the growth potential. So the valuation may have been arrived at depending on the growth potential of the market and resultant cash flows. For example, India is having a gigantic student population of 315 Million, which is second largest in the World. The number of internet users is estimated to be 566 million as of December 2018, registering annual growth of 18%. Of this, 293 million active internet users reside in urban India, while there are 200 million active users in rural India. The boom of internet in India and the thriving student population shall project a student orientated technological product as a lucrative one. An educational product which is aimed at the student population is having a very vast and huge un tapped market to explore. If the technology is having the bandwidth to reach the maximum student population then the same will positively influence the projected cash flows and improve the valuation of the business.
There are valuation methodologies such as Income approach, market approach, cost approach to arrive at the value of a business or company. Under the Income approach the Profit After Tax (PAT) or Profit Before Tax (PBT) or Earnings Before Interest and Tax(EBIT) or other cash flow measures are considered as Income for the purpose of the valuation. The market approach adopts the transactional data to help determine a company’s value. Under the cost approach, also known as asset based approach, a company’s value is determined by analysing the market value of the company’s assets. This valuation approach does not give actual picture of the value of the business as it is not giving weightage for the going concern aspect of a business. Apart from the above the macro and micro economic factors shall also positively or negatively influence the valuation.
So it can be understood that the valuation is more or less a number game, presumptions and assumptions based on forecasted cash flow or income, which can vary depending on the purpose. A valuer, who is having an insight and vision, can add more quality to the valuation by adopting right kind of methodologies and approaches, at right time and right place.
Foot note.
Nine months after the much hyped IPO, Uber is worth just about half the projected $120 billion mark. The ride-hailing firm went public at $45 a share and has since dropped to around $41 within a week, still struggling at $40, pegging Uber’s market capitalization at $69 billion and crowned as the stock market debut that lost more in dollar terms than any other American initial public offering since 1975.
Going as per the above, one can see that, the valuation of the companies referred in this articles are based on certain assumptions and presumptions and the said figures are only indicative in nature. It can be solid as a rock or fragile as a bubble, depending on several external factors.
Bijoy P Pulipra