Understanding Valuation

There is a simple aspect of valuation which many of us find pretty difficult to grasp. Lets say you think your company is worth Rs 100. If you want to give somebody a 10% stake, he should pay you Rs 10 right? Nope, not necessarily. It depends on whether you are considering a pre-money (pre-funding) or post-money (post-funding) valuation.

The idea is best explained through shares. Lets say you have 100 shares in your company each worth Rs 10. So you are worth Rs 1000. Now, you require a funding of 100, so you issue 5 new shares at Rs 20 to an investor. So the investor has put in Rs 100. Your shareholding is 100/105% and the investors shareholding is 5/105%.

On a valuation basis, the pre-money basis the value of the business is 1000, money going in is 100 and post money value is 1100. If you were thinking of giving someone a stake in the company, you would do so on the funding being bought in, i.e. on the post money valuation.

So how does that work:
1) Project: Lets say NPV of a project is 100 (equity value). The equity funding required is 50. Post money valuation is 150. You want to give a 20% stake to an investor. So 20% works out to 20%*150=30. So he pays 30 for a 20% stake, and you pay 20 for a 80% stake. Obviously he is coming at a premium. Lets say par value is 1. So your shares = 20/1=20 shares, total number of shares = 20/0.8=25. investor’s no of shares = 5.. His share price= 30/5=6 or he has come in at 500% premium.
2) P/E in case there is capex is post-money.
3) Todays post money is t’rows (for the next cycle of investment) pre-money.
4) IPO valuation is post money. The IPO valuation assumes the proceeds of the IPO have been factored into the business plan.
5) A company X has a subsidiary Y. An investor has valued company A at 100 and will put in 49 for a 49% stake. 10 of it will remain in the company for funding. The value of Y for X s valuation is 90 (because the 10 will give rise to the cash flows which give the valuation 90).

As a closure, let me explain the idea in terms of selling of the company. In case you are selling the company, since the entire money needs to be put in by the new entity, the firm is sold at the pre-money valuation.

Can the Indian state be undermined by power blocks?

The Indian state as with anything Indian is an unique animal. At once bursting at its seams with a population explosion, scores of gods languages a climates, secessionist movements et all. We are unique and we could also become potentially powerful. But can the Indian state be undermined by a few particular power centers: Can the industry, interest groups or military ever provide a substitute (or a strong influence) in the current system. I would think not:

1) Structural stability: The seemingly arbitrary democracy by its vagaries ensures that the power is never concentrated at any given center for any particular period of time. This is applicable more in the national framework, with the regional parties constantly seeking attention. Many of the states have become inherently 2 party systems with no viable alternatives emerging (there is no strong reason for/against their going the coalition way), and these 2 parties tend to have a varying amount of influence on the centers.

2) Innovation is scarce: Indian innovation is confined to few centers of excellence in the public sector & a the rest lies in the adventurism of the Indian entrepreneur. He is likely to fight for his survival through manhandling the political machinery, but will he be more powerful than the state? Unlikely

3) Lack of expansionist tendencies: We historically have rarely invaded other countries (good/bad is out of scope). An influencing power center is formed when there is inherent feeling of superiority/inferiority among the populace. A group is convinced about what is right and sets out the mend the world in its world view. Our world view is based on inclusion, we would expand our physical presence & ideas, but area? Not for us.

hr consultants

One of my room mates is a HR consultant (yeah i see the grimace on your face). Oh c'mon, consultants as a breed itself are prone to globe & 'i told you so' syndrome and most HR guys do nothing during the 2 yrs of bschool ( most of us dont btw, but thats beside the point and to good hr guys (mathematical impossibility) you guys are like gods, so you should not take offense) and then are made to change organizational processes to match business needs. Phew!!! Sounds difficult.

With our man RR its almost mind boggling: The rest of us mortals, "hey dude how was your day?"

RR "Dude, did you know that telecom companies use something called spectrum?", 2 of my roomies are telecom engineers

RR: "Hey dude, how does a life insurance sales work". Life insurance sales bd roomie : "Its pretty difficult man, the training & retention of good sales people depends on a strong incentive package and its very competitive" RR, thoughtfully "Yeah man i see what you mean, its like foreign currency vs local currency" (dont even ask me explain that)

RR (to me the banker) : "Dude did you know why the market crashed today?", "no mate, lemme know i could pass on the info usefully" "There is this sub prime thingie in the us, highly credit worthy people were given free loans and they disappeared wiht the money", i almost decided to quit banking that day.

If my man is putting together organizational policy, god help the organization.

Travails of a banker out ot lose weight - 1

Yes, 6 months (err could be more than that, it sure atleast must be that much) into my new job and i have that sinking (yeah literally) that i could soon visualize an exponential increase in waistline with no visible sign in contraction.

So my roomie and i (yes, he is of the rule defying variety, jesus would be proud of him not to mention all his flames), 2 south indians decide to join an 'in' gym Euphoria in Juhu. Between the two of us we have set the treadmills alight ( he manages abt half a km a day and me about 1 ) and have gone through a grand total of 13 days and have lost about 4.2 calories.

"Dude, look at that guy, why the fuck does he need to come here?"

"He doesnt have a life man, so he is out to get chicks here" - between a banker and a consultant

"He comes here, thats why he looks like that" - the rational consultant

"You mean we will look like that" - the banker

"Quite possibly" the consultant doing his job

The banker having already sold the idea to himself, at the end of the 3/4th session "dude can you see the outline of the six pack"?

consultant, " sure dude, i even noticed that chick checking you out"

banker "gyming rocks man", consultant - " sure does"

I am the banker, my roomie is the consultant. Between the 2 of us we weigh 180 kgs around and consider ourselves super fit ( yeah we overtook salman on his trip to karjat)

I love my country

Can blogs have legitimacy?

Old topic actually, but after the recent barkha dutt (yeah i too read the compulsive confessor blog) debate, I was rethinking about the role of information dissemination. With the advent of blogs et all you would have figured that the traditional news forms would have begun to lose credibility. In fact its easily the reverse, during the normal course of browsing through the web you come across so much information, you tend to look at the magazines/newspapers/periodicals to make sense of the information. The speed at which blogs can spread information truly cannot be debated (both when under restriction or about about products china,ipod/paris hilton as examples), but what you can and should debate if it really makes sense to read a lot of blogs or read the comments of a few select group of informed individuals (time is of the essence) along the lines of gigaom (yeah i am a real big fan of om malik, get well soon om) or the blogs of columnists and presenters.

What I generally look for from a blog ( i am not the most well read here, but relying on regular readers of blogs as well), is something personal. An insight which might not not be the worlds best informed piece of writing/or the most insightful but simply something that open up new vistas of thinking for me. If there are mainstream blogs (lot of people rely on them for information), the net automatically imposes a penalty on them for misrepresenting information (yeah, even valleywag needs to clarify its posts sometimes), the lack of correction would make the blog irrelevant.

Blogs are essentially anarchist forms of dissemination of information. You would more likely need an reader driven form of checking the veracity of content and I believe that that process is natural for groups of regular readers.

Valuation - what to do?

Valuation is an intrinsic part of any negotiation. Even though we possibly look at in terms of financial transactions, every transaction has the inherent question "What is the value of the service/product" that is being offered.

Valuation is subjective, yes very much. The logic for that is pretty simple, ice to an eskimo is not very valuable. So what is being sold?

First the cash flows:

1) For a BOT, PPA or license, the essential valuation metric is the good old discounted cash flow. The DCF is one of the elegant logical construct that can be used, t'rows cash flows are less than today's cash flows, so once the cash flows are determined, there is nothing much to determine other than the discount rate. Cost of Debt currently is 11.75%(before the PLR cut), even if you assume the impact of leverage ot be minimal then the cost of equity would be > 11.75% ( assuming the firm is not out to destroy value to the shareholders - a fair assumption). So depending on the assumed levarage and the model of cash flows to firm or equity and wacc or cost of equity you are there.

2) The problem of valuation of an going concern is unique:
-The first PE question, what multiple? How do the ratio's compare to that of the industry. As a rule, higher the ROE higher the P/E, higher the earnings growth expected higher the P/E , higher the ROCE, higher the P/E. The question is simply, if firm getting superior returns out of the capital? The key issue becomes interpretation - getting the ratio's right will come in the advanced stage of the business, but during its initial build out phase the ratios will be skewed, both because of the lack of focus there or more likely management disdain/discomfort.

-Industry Analysis: OOh la la, all those consultants cannot help you take a decision here. As my boss loves to say, India it is all about getting the asset up. Once the asset is up you cannot stop it. But if somone where to look at the landscape in terms of a framework: cats dogs & what not - you will most likely come across the same. More importanly, the lack of availability of data (and incorrect data to be precise) kills the end purpose of an analysis

-holy grail: promoter premium. The uniquely indian animal called a promoter. He runs the company (sometimes strategy sometimes everything) and believes he needs a premium. ( the investor would want a discount for precisely the same reasons). Depending on the market most of the deals swing on this aspect quite significantly.

These three simple constructs actually muddle the concept of p/e that its almost imposible to decide on the right metric for everyone, so there is endless negotiation on this. All in all choose your methodology and its implementation carefully.