📈Corporate Strategy and Valuation Unit 14 – Asset-Based Valuation & Liquidation Value

Key Concepts and Definitions

• Asset-based valuation determines a company's value by assessing the fair market value of its assets minus liabilities
• Liquidation value represents the estimated proceeds from selling a company's assets and settling its liabilities
• Going concern value assumes a company will continue operating and generating cash flows in the future
• Tangible assets include physical assets such as real estate, equipment, and inventory
• Intangible assets consist of non-physical assets like intellectual property, goodwill, and brand value
  • Intellectual property includes patents, trademarks, and copyrights
  • Goodwill arises from the excess purchase price over the fair value of net assets acquired in a business combination
• Book value is the value of an asset recorded on the balance sheet, which may differ from its fair market value
• Fair market value is the price at which an asset would change hands between a willing buyer and seller in an arm's length transaction

Asset-Based Valuation Approaches

• Cost approach estimates the value of an asset based on the cost to replace or reproduce it, considering factors such as depreciation and obsolescence
• Market approach determines an asset's value by comparing it to similar assets that have recently been sold or are currently available for sale
  • Comparable transactions method analyzes recent sales of similar assets to derive a value estimate
  • Comparable public company method uses valuation multiples of publicly traded companies in the same industry to estimate value
• Income approach calculates an asset's value based on its expected future economic benefits, such as cash flows or earnings
  • Discounted cash flow (DCF) method estimates the present value of an asset's future cash flows using a discount rate that reflects the risk of those cash flows
• Replacement cost method calculates the cost to replace an asset with a similar one of equivalent utility, considering factors such as current market prices and technological advancements
• Reproduction cost method estimates the cost to recreate an exact replica of an asset, including any obsolescence or depreciation

Liquidation Value: Basics and Applications

• Liquidation value is relevant when a company is expected to cease operations and sell its assets
• Orderly liquidation assumes a reasonable time frame to sell assets and settle liabilities, typically resulting in higher proceeds than a forced liquidation
• Forced liquidation occurs when assets must be sold quickly, often at a significant discount to fair market value
• Liquidation value is used in various contexts, such as bankruptcy proceedings, restructuring, or when a company's going concern value falls below its liquidation value
• Liquidation value can serve as a "floor" value for a company, representing the minimum value that shareholders could expect to receive in a liquidation scenario
  • If a company's going concern value is lower than its liquidation value, it may be more beneficial for shareholders to liquidate the company
• Liquidation value is typically lower than going concern value due to factors such as time constraints, market conditions, and the piecemeal sale of assets

Valuation Techniques and Methodologies

• Net asset value (NAV) is calculated by subtracting total liabilities from the fair market value of total assets
  • NAV per share is determined by dividing NAV by the number of outstanding shares
• Adjusted book value modifies the book value of assets and liabilities to reflect their current fair market values
  • This approach considers factors such as depreciation, amortization, and market conditions
• Excess earnings method allocates a portion of a company's earnings to its tangible assets and attributes the remaining earnings to goodwill or other intangible assets
• Breakup value estimates the value of a company by summing the fair market values of its individual assets and subtracting liabilities, assuming the company will be broken up and its assets sold separately
• Liquidation value method calculates the expected proceeds from selling a company's assets and settling its liabilities in a liquidation scenario
  • This method considers factors such as liquidation costs, taxes, and the time frame for liquidation
• Replacement cost method estimates the cost to replace a company's assets with similar ones of equivalent utility, considering factors such as current market prices and technological advancements

Real-World Case Studies

• Sears Holdings Corporation: In 2018, Sears filed for Chapter 11 bankruptcy protection, and its liquidation value was estimated to be higher than its going concern value due to its extensive real estate holdings
  • The company's assets, including real estate, inventory, and intellectual property, were sold to pay off creditors
• Toys "R" Us: The iconic toy retailer filed for bankruptcy in 2017 and ultimately liquidated its assets in 2018
  • The liquidation value of Toys "R" Us was estimated to be lower than its going concern value due to factors such as declining sales, intense competition, and the need for a quick liquidation
• Blockbuster: The video rental giant failed to adapt to the rise of streaming services and filed for bankruptcy in 2010
  • Blockbuster's liquidation value was estimated to be significantly lower than its going concern value due to the declining value of its physical assets (DVDs) and the rapid shift in consumer preferences
• Nortel Networks: The Canadian telecommunications company filed for bankruptcy in 2009 and subsequently liquidated its assets
  • Nortel's valuable patent portfolio was sold for $4.5 billion, demonstrating the potential value of intangible assets in a liquidation scenario
• Chrysler: During the 2008-2009 financial crisis, Chrysler filed for bankruptcy and underwent a restructuring process
  • The company's liquidation value was estimated to be lower than its going concern value, prompting the U.S. government to provide financial support and facilitate a merger with Fiat

Challenges and Limitations

• Subjectivity in asset valuation: Estimating the fair market value of assets can be subjective and may require professional appraisals or specialized knowledge
• Rapidly changing market conditions: Asset values can fluctuate based on market conditions, making it challenging to obtain accurate and timely valuations
• Intangible assets: Valuing intangible assets, such as intellectual property and goodwill, can be complex and may require specialized valuation techniques
• Liquidation discounts: In a liquidation scenario, assets may need to be sold at a discount due to time constraints or market conditions, resulting in lower realized values
• Lack of marketability: Some assets, particularly those that are specialized or industry-specific, may have limited marketability, making it difficult to find buyers and realize fair market value
• Interdependence of assets: The value of some assets may be dependent on the presence of other assets or the company's overall operations, making it challenging to value them independently
• Legal and regulatory considerations: Liquidation and asset sales may be subject to legal and regulatory requirements, which can impact the timing and proceeds of the liquidation process

Industry-Specific Considerations

• Real estate: Asset-based valuation is commonly used in the real estate industry, where the value of properties is a key driver of company value
  • Factors such as location, property condition, and market trends can significantly impact real estate valuations
• Natural resources: Companies in the oil, gas, and mining industries often have significant tangible assets, such as reserves and equipment
  • Valuing these assets requires specialized knowledge and consideration of factors such as commodity prices, extraction costs, and regulatory environment
• Financial services: Asset-based valuation is relevant for financial institutions, such as banks and insurance companies, where the value of financial assets (loans, investments) is a key determinant of company value
  • Valuing financial assets requires consideration of factors such as credit risk, interest rates, and market liquidity
• Technology: Technology companies often have significant intangible assets, such as intellectual property and proprietary software
  • Valuing these assets can be challenging and may require specialized valuation techniques, such as the relief-from-royalty method or the multi-period excess earnings method
• Healthcare: Healthcare companies, such as pharmaceutical and medical device manufacturers, may have valuable intangible assets, including patents and research and development (R&D) pipelines
  • Valuing these assets requires consideration of factors such as patent expiration, regulatory approval, and market potential

Practical Applications in Corporate Strategy

• Mergers and acquisitions (M&A): Asset-based valuation can be used to assess the value of a target company and determine an appropriate purchase price
  • Acquirers may use asset-based valuation to identify undervalued companies or to estimate the potential synergies from combining assets
• Restructuring and divestments: Companies may use asset-based valuation to assess the value of individual business units or assets when considering restructuring or divestment strategies
  • This can help companies make informed decisions about which assets to retain, sell, or spin off
• Financing and capital allocation: Asset-based valuation can inform decisions related to financing and capital allocation, such as determining the appropriate level of debt or equity financing based on the value of a company's assets
  • Lenders may use asset-based valuation to assess the collateral value of a company's assets when extending credit
• Performance measurement and incentives: Asset-based valuation can be used to measure the performance of individual business units or assets and to align management incentives with the creation of shareholder value
  • For example, a company may tie management compensation to the increase in the value of specific assets or business units
• Strategic planning and scenario analysis: Asset-based valuation can be incorporated into strategic planning and scenario analysis to assess the potential impact of different strategies on a company's value
  • This can help companies make informed decisions about investments, divestitures, and other strategic initiatives based on their potential impact on asset values and overall company value