CENAK Consulting - News and Views

From Today's WSJ: Law Sans Sex Appeal

My vote is on the last suggestion:

Law Sans Sex Appeal

What's in a name? The financial-overhaul bill signed by President Obama Wednesday is widely known as the Dodd-Frank Act. But the statute still lacks a sexy acronym. The Sarbanes-Oxley Act, passed after a wave of corporate scandals, is widely known as "SarbOx.'' Some ideas floating around so far: DFA and DODFRA. And for those who think that the bill is going to cause enough regulatory headaches that it will drive them to hard liquor: DRANK.

Potential Risks of Buying Companies on Borrowed Money Examined

PBS on Friday aired this piece about Private Equity and the companies they invest in:

Potential Risks of Buying Companies on Borrowed Money Examined

A few observations:

1. Private Equity companies clearly have a PR problem.  They have to come to grips with the fact that they will have to change and be more open about what they are doing. 
2. The companies presented here would probably not be around any more had it not been for Private Equity investors taking a risk and trying to turn the ship around.  The only way you can do this is with drastic changes since, obviously, continuing the old path will eventually lead to bankruptcy.  Yes, that may feel like Predator drones coming in, but without them, you'd have nuclear wasteland, to stick with the metaphor.
3. Deals in the past were overleveraged and leverage will play a much smaller role in the future.  That is bad for returns but good for the quality of deals.  A lot of deals got done in the past that should not have gotten done. 

It is a shame that none of the Private Equity houses was willing to comment.  It may have not yet settled in with them that times are changing and that they have to change, too.  But saying that Private Equity destroys jobs and pensions is simply not correct.  The opposite is true.

If you have any questions or comments please contact me directly.  We help companies in all stages from young, growing companies with breakthrough technologies, to established companies that are looking to expand through fundraising, M&A and financial advisory. 

TARP, Stimulus and the Economy

It has been a long time since the last post. The reasons are lots of work and too many changes in the economy and in politics that made our heads spin here at CENAK Consulting.

We are in the lucky position to do well in this environment. Valuation of assets seems to be at the center of the current problems in the US and elsewhere. As asset values decline, banks are less and less willing to lend because they risk that the collateral goes down in value. The bottom line is that the US economy needs to de-leverage. That is a long process and will not be done over night.

The government, in the meantime, stepped in to randomly save some firms (AIG) while letting others go under (Lehman). The TARP was born, While we do not think that the TARP itself can save the economy, it prevented a total collaps. We think it had more to do with psychology than anything else as people saw that the government was willing to step in for banks and firms that it considered too big to let them go under.

Along came the stimulus plan to get people jobs and to get the economy going again. In our view, the stimulus plan is flawed in a big way and driven by politics rather than what needs to be done to provide stimulus. The US infrastructure is the worst infrastructure of any developed country. We have on average 3-4 power outages a year at our house. That is ridiculous. Driving becomes an exercise of avoiding potholes and Internet connections are slow. Yet only a fraction of the money goes into infrastructure, where jobs would be immediately created and future competitiveness of the country improved.

Washington has proven once more that it is not capable of doing the right things at the right time. That's concerning as it now also is trying to control what banks in the TARP can and cannot do. That can only end up in disaster. If you put a cap on compensation for executives, be aware of unintended consequences. Talented people will leave the affected firms and they may simply outsource the functions that require them to (still) pay competitive bonuses.

The economy will get better but it will take time. De-leveraging of companies, banks and individuals needs to continue. A new culture of saving will have to replace the old "buy today and pay in five years" attitude. All that will be a painful transition but one that is necessary and will lead to a healthier, and eventually less volatile economy. That is little comfort for people that are unemployed and looking for work.  Don't rely on our politicians to do the right thing.

Valuation - Art and Science

If we needed more evidence that valuation is as much an art as it is a science, we only need to look at the acquisition of Bear Stearns by JP Morgan.  The initial share price was set at USD2 per share.  A few days later, JP had to sweeten the offer to USD10 per share, a fivefold increase!  How can a company be valued five times as much within such a short period of time?  That's where the art factor comes into play.  This particular deal had many underlying forces, including some parties that really should stay out of the M&A business such as the Fed.  Bear Stearns had to agree to the USD2 offer that weekend if it didn't want to file for bankruptcy on Monday morning.  It also would have sent the financial markets into chaos.  So Bear Stearns' management agreed to the low offer because they had no other chance.  When in subsequent days the stock traded well above the USD2 mark, it send a clear signal that investors believed the offer to be too low, forcing JP to increase it significantly.  I am sure that if we had a chance to take a look at the cash flow models, that JP still predicts a very healthy return even at this price.  We do not know where the "make-or-break" value for JP is based on the cash flow models, but what we do know is that in this case, the science part of valuation clearly took a backseat to the art part.

Business Valuation Using Comparable Company Analysis - Part 2

Part 1 of our valuation series was an introduction to the multiple or comparable company analysis.  The first step to a meaningful analysis is to find a basket of publicly listed companies that can serve as comparable companies to the target company.  In this second part of our valuation series we'd like to talk about where the information and data for a comparable company analysis can be found.

In selecting sources for information, it is important to always favor the primary source over the secondary source.  For example, financial statements should always be taken directly from the company's SEC filings and not from secondary sources such as FactSet or Bloomberg.  These secondary sources often try to standardize their reporting system and it may not always be clear how certain financial items are being treated by these information providers.  However, it is always a good idea to double-check data with one or two of these service providers.

The following sources are most commonly used in the investment banking community for a comparable company analysis:

1. 10-K and 10-Q for financial data and footnotes.  These annual and quarterly reports can be found on the Edgar Archives of the SEC.
2. Real-time stock price data from services such as a Bloomberg terminal or FactSet.  These services are expensive, and other free online sources may provide a cheaper alternative.  However, Bloomberg and FactSet are excellent tools to double-check an analysis and should be preferred sources for stock price data.
3. Equity research reports from investment banks for financial forecasts.  These reports can be bought from services such as Thomson Financial's Investext.  They can cost up to USD30 or more per page to download, however they are important as forward-looking multiples are more significant than historic multiples.  Unlimited subscriptions can cost USD12,000 or more annually.  It is important to get recent reports that are not older than 6 months.  Equity research reports  typically get updated shortly after the companies report their quarterly data.

These are the most important sources to find financial information for companies.  International companies that do not report in the US typically publish their financial data on their websites.  Note that not all countries and exchanges require companies to report quarterly.  We will explain at a later time how to deal with inconsistent data and reporting.

Once the above information has been collected for the basket of comparable companies, the analyst can begin the calculation of the multiples.  In our next segment of the valuation series, we will talk about which multiples are typically used.  We will also talk about industry differences and specifics.

If you have any questions regarding the comparable company analysis, please do not hesitate to contact us at any time.

Happy New Year

A Happy New year to all of our readers, friends and clients.  There are a lot of exciting developments currently at our firm and we look forward to a very successful year 2008.  Current projects we are working on are several biofuel facilities in the US, sulphur fertilizer facilities in India and Dubai, a carbon offset project as well as an advisory project where CENAK advises a European company in the introduction of a new product on the North American market.

For all of these projects we have developed detailed financial valuation models and business plans.  As these projects develop further we will keep you informed about any progress here on our blog.

Have a successful new year and remember that the professionals at CENAK Consulting are there for you at any time to help you and your company with analytical, financial and business advisory services.  We look forward to working with you.

Business Plans - Part 1

The following quote from an article in the Wall Street Journal on 9 September 2003 pretty much sums up our thoughts on why every business should have a business plan:

"Years ago I was talking with a mentor about a start-up I was running. He asked to see my business plan  and I proudly told him that I didn't have one. Full of youthful arrogance I said, "I'm doing fine just by the seat of my pants." He replied, "If you think you're doing well using your bottom, imagine what you can do using your brain"

There are countless places on the web where business owners can get free advise on how to structure a business plan and what to write.  Where most business plans lack is when it comes to the financial implications of executing the business model that is presented in the business plan.  That is where we at CENAK Consulting come in and develop, together with the company and owner, a multi-year financial forecast based on the presented business plan and model.  These financial models can be used to test the business model under various conditions, which gives the business owner a much better understanding of the what-ifs of certain business decisions.  It frequently also results in changes to the underlying business model.  In this series about business plans we will write about experiences we've had with business plans that illustrate why it is so important to have one.

Rate Freeze

So government decided to step in and announce a program to help homeowners that entered into ARMs with a rate freeze.  This move has to be seen as a purely political maneuver considering the upcoming elections.  In our view, it is the wrong signal and it might prolong the workout process for the housing market.  Further, for all those people that made sure they understood what they signed and that they could actually pay their mortgages, this is a slap in the face.  If anything, the government should take an active role in educating people early on in school so that they understand how this market works.  21 year old college kids who never saved a dime are buying houses these days.  Most of them have no clue about how to manage personal finances.  Start there and tackle the problem at its roots, the lack of financial education. Don't intervene in the market.  That sends the wrong signal to the markets and the people who might get the idea that the government will bail them out again in the future. 

25 or 50 basis points?

After todays ADP employment data and other indicators the jury is still out if te Fed next week is going to lower the Fed rate by 25 or 50 basis points.  As of today, my prediction is 25 bps.  But then again, we are waiting for important employment data on Friday.  If there is a weakness in the data, 50 bps might be more likely.  We shall see, for now my money is on 25 bps. 

Black Friday and Cyber Monday - How to Really Save Money

The marketing departments of the retail industry have to be considered the masters of how to (mis-)use language to put a positive spin on what is really a negative event.  Consider this typical message that you see everywhere these days in some form or fashion:   

"LCD TV for only USD1,999.  Pay USD1,899 and save an additional USD100 if you buy this TV today".

What's wrong with this message, it looks awfully positive, you think?  Let's take a closer look.

Let's assume you buy this item today.  What really happens? 

First and foremost, you spend 1,899 bucks of your hard earned money!  But is that the message they want you to remember?  No.  The message they want you to remember is that you "saved" 100 bucks, not that you spend 1,899.

But, do you really "save"?  Only, if you actually go ahead and put what you "save" into savings!  That can be an interest-bearing savings account, your retirement account (which I hope you have), invest it in mutual funds or stock, etc.  Now, who really does that?  If my unscientific observations are any indication, pretty much no one. 

The next time you hear someone tell you that you save by buying an item, turn around and tell them that first and foremost you are spending a significant amount of money and not technically saving anything, unless you take that discount amount and stash it away somewhere where it earns you interest or capital gains.

It's the retail industry's positive spin that you save money, when in reality you are spending money.  Think a little bit about that before you hand the credit card over or press the "buy" button this Christmas season.