The Increasingly Arbitrary Process of Company Valuations
The conventional criteria for valuing commercial companies was typically to audit their current assets and then add a multiple of circa 4-10 based on their achieved EBITDA – Earnings Before Interest, Tax, Depreciation and Amortisation – generated via their past audited accounts, and future financial projections.
These sound rational valuing principles started to materially erode and became fundamentally undermined during the initial ‘Dot Com’ bubble of the late 1990’s and early 2000’s when website and digital companies started being valued according to their prospective future earnings and their customer’s ‘lifetime value’ – every aspect of these business valuations were based primarily on conjecture.
Many private and institutional Investors were very badly burned by many of these digital companies who listed on major stock exchanges only to see their stock pricing and market capitalisations plummeting when reality set in post their Initial Public Offering (IPO).
In recent years, however, we have observed another increasing divergence of valuation principles between physical versus online companies in terms of determining their net worth. For online businesses the basic principle of generating an EBITDA profit does not provide the foundation of valuation either in the private nor public markets. Digital monoliths in the shape of Uber, and latterly WeWork, both continue to generate enormous annual net financial losses with no imminent signs of profitability in the foreseeable future. In the case of Uber it is increasingly unclear whether they will ever reach profitability.
Uber having lost $1.6billion in the last calendar year, launched their IPO with a market capitalisation value of $72billion – or the combined value of Ford and General Motors. WeWork, who last week pulled their IPO due to a lack of market appetite and continuing concerns about their corporate governance, had previously been valued by its biggest investor SoftBank at $47billion – WeWork lost $2.00 for every $1.00 of revenue generated for the previous year and has claimed to be a digital business at heart when most would classify it as a Landlord.
Whilst future earning potential is always a significant valuation driver for any Investor, it would appear that there is now a wide acceptance that profitability is much more of a long game in relation to the digital space in both the global retail and media sectors.
On the valuation flipside there are a range of established companies, especially in the retail sector, who despite having delivered years of solid EBITDA results even in declining markets, have been recently valued as being worth ‘zero’ despite maintaining a positive Balance Sheet. Most recently Sir Philip Green’s Arcadia Empire has published accounts showing a £2.8billion net worth in their Balance Sheet post considering the trading losses on their business in 2018 yet market commentators have expressed the opinion that the company now has no worth whatsoever. Many other traditional retailers and brands in this rapidly changing dynamic epoch are suffering similar negatively obtuse summaries of their company valuations, which in turn are adding to the myriad of other financial challenges they now face.
In reality valuing a company is to a large degree arbitrary and in the eye of the beholder and Investor. It would seem that whilst digital and physical companies reside on the same stock exchanges, the measures applied to them are quite different in terms of establishing their share price and ultimately financial value.
The aims of the influx of digital Unicorns – companies with a perceived £1billion plus valuation whether in profit or not, including the likes of Deliveroo and Funding Circle – must be ultimately to try and replicate the commercial success of Amazon. Amazon launched in 1994, took nine years to generate a profit during which time it was virtually impossible to value and in 1999 made a loss of $719million on a turnover of $1.6billion, but has now gone on to be the most valuable company in the World by market capitalisation.