Session 19: Asset Based Valuation

Introduction to Asset-Based Valuation

In this section, the speaker introduces asset-based valuation as a third approach to valuation and explains how it differs from intrinsic and relative valuation.

What is Asset-Based Valuation?

• Asset-based valuation involves valuing a company based on the assets on its balance sheet by attaching a value to each asset and adding up those values.

• There are three scenarios where asset-based valuation might be used: liquidation valuation, accounting valuation, or sum of the parts valuation.

• To value individual assets in an asset-based valuation, you can use intrinsic or relative valuation methods or rely on accounting book value.

When to Use Asset-Based Valuation

• Liquidation, accounting, and sum of the parts valuations are all scenarios where individual assets may need to be valued.

• Asset-based valuations are easiest for businesses with separable assets that have standalone cash flows and trade in their own marketplace.

Challenges of Asset-Based Valuation

• Most asset-based valuations are heavily dependent on accounting book value.

• It can be difficult to separate and value assets that are linked together or have collective cash flows.

Liquidation, Accounting & Sum-of-the-parts Valuations

In this section, the speaker discusses how asset-based valuation can be adapted for different types of valuations: liquidation, accounting, and sum-of-the-parts.

Liquidation Valuation

• In liquidation valuations, companies are valued based on their individual assets because they will be sold off separately.

Accounting Valuation

• Accounting valuations require breaking down the value of a company by assets and estimating fair value for each asset.

Sum-of-the-parts Valuation

• In sum-of-the-parts valuations, individual assets are valued separately and added up to determine if the total exceeds the value of the company as a whole.

Conclusion

In this section, the speaker concludes by summarizing the key points about asset-based valuation and its uses in different scenarios.

Key Takeaways

• Asset-based valuation is a third approach to valuation that involves valuing a company based on its individual assets.

• Asset-based valuation can be used in liquidation, accounting, or sum-of-the-parts valuations.

• Separable assets with standalone cash flows that trade in their own marketplace are easiest to value using asset-based valuation.

Asset-Based Valuation

In this section, the speaker discusses asset-based valuation and its three main uses.

Liquidation Valuation

• Liquidation valuation is a special case of asset-based valuation.

• A liquidation discount may need to be applied to assets when liquidating a company quickly.

• The amount of the discount depends on the assets being liquidated.

Accounting Valuation

• Accounting fair value can be based on intrinsic or relative value.

• Most accounting rules are still written in terms of intrinsic value, but accounting standards talk about value through the eyes of a market participant.

• Accounting needs to make up its mind soon about whether fair value means intrinsic or relative value.

Sum of the Parts Valuation

• A sum of the parts valuation involves valuing each business separately and adding them up to get a total company value.

• If a company is trading at less than its sum of parts value, it could be undervalued and eventually increase in price.

• Investors with deeper pockets could buy the company and break it up into individual pieces for profit.

United Technologies Example

In this section, the speaker provides an example of how to perform a sum-of-the-parts valuation using United Technologies as an example.

Simple Sum-of-the-Parts Valuation

• The simplest way to perform a sum-of-the-parts valuation is by using one variable (such as beta) that is available for all businesses within a company.

• Comparable companies within each business are found, and their median EV/EBITDA multiple is used to estimate each business's value.

• These values are added together for a total company value.

Sophisticated Sum-of-the-Parts Valuation

• A more sophisticated sum-of-the-parts valuation involves using different scaling variables for each business, such as EBITDA or invested capital.

• The best variable is chosen for each business by looking at publicly traded companies in that business and running regressions.

• This method provides a more accurate valuation but requires more work.

Three Ways to Value a Business

In this section, the speaker discusses three ways to value a business: discounted cash flow valuation, relative valuation, and sum of the parts valuation.

Discounted Cash Flow Valuation

• To do a discounted cash flow valuation, you need to calculate the cost of capital for each business.

• You also need to determine the return on capital by business, which requires information from the company about investment in capital growth rates and margins.

• The speaker was able to do an intrinsic valuation of each business for United Technologies by allowing for different growth periods and attaching different characteristics for different businesses.

Relative Valuation

• The speaker uses relative valuation by getting a predicted value for each business and adding them all up based on differences between United Technologies and other companies within each business.

Sum of the Parts Valuation

• To do a sum of the parts valuation, you need to get an intrinsic value for each business. This requires doing your homework and calculating caustic capital by business.

• Once you have calculated the intrinsic value for each business, add them all up to come up with a total value. However, there is one more loose end to tie up - corporate expenses that were not allocated or any of the businesses.

• Take present value of those expenses over time assuming no constant growing perpetuity and subtract it from the total value of businesses. This gives you a sum-of-the-parts intrinsic valuation for United Technologies.

• All three approaches yield consistently higher values than the enterprise value for United Technologies at 52 billion dollars.

Conclusion

• Despite having different numbers across approaches, they all share one thing in common: they are consistently higher than the enterprise value for United Technologies.

• The speaker would still buy United Technologies and hope that either the price drifts up towards 70 billion or that somebody takes over United Technologies and breaks it up.