The Illusion of Value

Everything is Changing (Part I of II)

In this two-part article, the authors present some illustrations that indicate the illusion of value of many businesses.

Business appraisers have many tools to determine the value of a closely held business. So many so, that many “official” conclusions of value for the same business generate significant differences. This borne out by the normal expectation of rebuttal reports in marital and shareholder disputes, tax litigation over estate, gift and charity values of family businesses, and fair value situations. In some instances, there are multiple valuations.

Many valuations are prepared to fulfill a purpose such as for gift planning or estate tax purposes, employee compensation, or to present a value in a business break up or marital conflict. But none of the values are real—the real values are determined by an actual sale and then that value is valid only for that seller and that buyer at that time, for the terms negotiated, and because of the purposes, motives and pressures causing the sale. Perhaps a death compelled the family to sell a business quickly; or a business is sold so the owner could escape bankruptcy; or a buyer wants to get access to certain customers; or the key people working for a company offer to buy the business threatening to quit and start their own company if it is not sold to them.

Occasionally valuations are clearly agreed to by conflicting parties only to have an unanticipated subsequent event greatly change that valuation amount. Some intangibles such as a brand or individual reputation can create great value when viewed by a different lens.

In many cases, cash flow is a driving factor, but whether it is trailing, current, projected, or sustainable is subject to conjecture, and even when the cash flow is agreed to, capitalization rates can be seriously contested.

Because of the many varying opinions and frequency of differences, the authors are presenting some illustrations that indicate the illusion of value of many businesses.

The NY Yankees and NY Mets

Both teams opened new stadiums the same week in 2009. The stadium the Mets play in is called Citifield and the Yankees field is called Yankee Stadium. The Mets are being paid $20 million a year for 20 years by CitiBank for the naming privilege. That is $400 million not considering the present value of the payments. Obviously, both parties thought the value of the stadium’s brand is worth that much. It seems to us that the Yankees could have gotten more than that from Bank of America to brand its stadium Bank of America Stadium, but for some reason passed up on that. Question: Why? Well, the Yankees felt the value of its brand was worth more than $25 [our guess at the amount] million a year. We do not know the reasoning, but the Yankees as a business has a value of over four billion dollars. Twenty-five million dollars a year is not even one percent of that value. If the NY Yankees’ brand contributed just one percent a year to its value, they are ahead.

We also noticed something else—every time a news story shows children either in the United States or anywhere else in the world, the Yankee hats outnumber all other hats with logos combined. Check it out; merchandise sales to fans bring in significant revenue. The Yankees have among the largest major league attendance year after year, so the profits generated by the logo merchandise is also significant as is revenue from its licensees and company stores. As business appraisers, we could probably determine the extra cash flow from the sale of logo merchandise and license fees and whatever else; however, the Yankees made a decision as to the brand’s value—it is more than $25 million a year.

Car Dealerships 

Many dealerships lose money. Many go broke. Yet, there are a surplus of ready buyers. The value is evidenced occasionally by unique value drivers. Many occupy real estate owned by the dealer or with a long-term lease and they have a franchise that needs to adhere to the manufacturer’s standards including regular reporting. They have multifaceted businesses—they sell new and used cars retail and wholesale, perform repairs, and sell parts. They need to borrow large amounts to finance the inventory they are required to maintain and employ over a dozen types of skilled personnel. Advertising is a very large expense and often the manufacturer places conflicting ads. And margins are low, making high volume a necessity.

There are various aspects to valuing a dealership. When the industry is in its “up cycle,” dealerships often sell at numbers that make the rates of return difficult to justify in a traditional Income Approach. Often, buyers pay a hefty price for a good franchise even though the dealer is underperforming or losing money. It is difficult to explain that by using profits or cash flow. Historic cash flow may be out of the question, so other value drives need to be considered. Some of these are franchise and real estate value, value to a synergistic buyer, or value to the manufacturer to reacquire the franchise. However, except for a synergistic buyer that has motives other than cash flow, traditional methods may fail to come up with values that the owners deem reasonable. This creates a problem.

The franchise is the most important driver of value for auto dealerships, followed by real estate and facilities. Luxury imports are still the most desirable auto franchise, but they are losing steam to other imports and domestics. The value of an automobile dealership is dramatically affected by the brand that is generating those earnings. But limited positive cash flow will drive down the value of the real estate and the franchise. An illustration of how earnings drive value with real estate are empty or abandoned buildings that did not generate sufficient cash flow.

The fact that an auto dealership does not show any net earnings to capitalize to obtain a value does not mean there is no franchise value. The franchise should have some minimal value even if it is not generating cash flow. This minimum value is based on the history of the franchisor, the location and condition of the dealership, and the expected earnings under perceived conventional business circumstances. This “expected earnings” may include a discounted cash flow of future anticipated earnings or a percentage of net sales based on industry metrics. It is important to use discretion in applying these methods.

Restaurants

The famous Elaine’s in NYC, and the restaurant of choice for “Stone Barrington” closed. We are sure that most every customer of Elaine’s thought it was a gold mine wishing they could have a piece of it. The Stuart Woods character, Stone Barrington, certainly thought it was a gold mine—until it closed. However, he lamented that without Elaine, the value was not there. And it was not. It was closed and furnishings went by the auctioneer’s hammer.

Recently, some restaurant owners accused of inappropriate sexual advances had to close restaurants in high profile public venues because of the tarnished reputation. This caused huge loss of values almost instantly.

Skype

In 2011, Microsoft acquired Skype for $8.5 billion, six billion dollars more than the seller paid for it 18 months earlier. And that seller bought it from eBay who took a $600 million loss having purchased it from its founders in 2005 for $3.1 billion. The company was formed in 2003.

Here is a good example of the illusion of value. eBay thought Skype was a “steal” at $3.1 billion and two years later were glad when they were able to unload it for $2.5 billion. (Note that eBay retained a minority interest, so they recouped their loss.) The “killing” was made by the venture capital group that sold it for $8.5 billion to Microsoft who believed they got a great deal in buying it.

Stock Market Values

Public company values are likewise illusory—solid companies miss earnings by a few pennies, or announce a bad year coming up and billions vanish overnight. A new CEO or a fired CEO similarly can cause wide swings in values. Staid established companies with well-known brands have likewise seen their values dissipate due to outmoded business models, backward or myopic managers, or an inability to understand or adapt to how business has changed.

Stephen Bollenbach

When it was reported that Stephen Bollenbach was to be named CEO of Hilton after the market closed on a Friday, the stock opened on Monday up 15 points. There were 50 million Hilton shares outstanding so, on the announcement of Bollenbach being named CEO, Hilton’s market cap increased $750 million. This was in 1996.

Steve Bollenbach was a very impressive person with a varied and renowned career. Prior to joining Disney, he engineered the plan that kept Donald Trump from having to file for personal bankruptcy; was Treasurer and CFO for Marriott; and CFO for Holiday Inn, among other positions. When he left Disney to join Hilton, he became the first nonfamily member to hold their CEO position. He retired when Hilton was acquired by the Blackstone Group in 2007. Bollenbach was a master of corporate finance, debt structuring and planned bankruptcy, and he was involved in some of the biggest deals of his time.

We consult with a lot of businesses about their value and the trigger points that create and add value. Here was a $750 million increase in value just on the announcement! We hope he locked up his stock options beforehand!

Los Angeles Dodgers

In 2012, the Dodgers were sold for $2.15 billion…then that is what they must be worth. A few months earlier, they were valued somewhere from $900 million to $1.3 billion and the owner’s wife used that valuation as the basis for her divorce settlement. She also believed that this was the “real” value.

So what happened?

A strategic buyer emerged, not an investor looking for an above-average return on their investment. Not a pure ego player. Not someone that wanted to operate a baseball team. And, not someone who would want to own it for a few years to resell at a profit.

The buyer was someone that figured the value to them would be much greater than the value by any other measure because the value was not determined with anything within the Dodgers, but from the value to the buyer. Take Guggenheim Partners—this catapulted them to the top of the high-profile investment managers for the superrich, and some people just below that level. They became the go-to firm. Jackie Robinson’s widow’s and Magic Johnson’s money could not have made a difference in the deal, but they bring history, pizzazz, community involvement, star power, and cachet to the deal while raising their own brand value. Several rich people acquired bragging rights and great seats to all the games. And then some smart media people got involved and figured the value of a network the Dodgers could start like what the Yankees did (or get a humongous payoff for the TV rights).

Guggenheim Partners must be commended for how they put the package together. A huge value was created.

Fox Network

Before Guggenheim Partners acquired the Dodgers, Rupert Murdock did even better when Fox was the clear high bidder for the NFL rights to Sunday Football in 1993. His winning bid was so much higher than the CBS bid that the conventional wisdom was that he was off his rocker. What happened was that his winning bid established Fox as a legitimate fourth network—worth billions to him. His “overpayment” created unimaginable wealth for him. He saw it from the value created for him, not what it was worth in the market to the array of traditional buyers.

Whether buying or selling a business…an astute assessment of the price in terms of real value creation, called strategic value, will provide the advantage. It should always be approached that way.

World Wrestling Entertainment

In April 2019 World Wrestling Entertainment (WWE) reported a quarterly loss as compared to a substantial profit for the same quarter in the prior year. One of the reasons provided was superstar absences. They also said the engagement metrics will improve as their talent returns. This indicates that the revenue and profit drivers are superstars. This corresponds with the level of  fan interest making this an important value driver. However, the direct impact was on profits and cash flow causing reduced stock valuations with the immediate fall of WWE stock prices.

In the second and concluding article, the authors provide additional illustrations to underscore the illusion of value and limits of financial modelling in an economy that is undergoing through rapid change driven by evolving technology, innovation, and consumer preferences.

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Edward Mendlowitz, CPA, PFS, ABV, CFF, is partner with WithumSmith+Brown, PC, in East Brunswick, New Jersey. He has over 40 years of public accounting experience, is a licensed Certified Public Accountant in the states of New Jersey and New York, and is one of Accounting Today’s 100 Most Influential People. The author of 27 books, Mr. Mendlowitz has written hundreds of articles for business and professional journals and newsletters and presented over 300 CPE programs. He writes a twice a week blog at www.partners-network.com.

Mr. Mendlowitz can be contacted at (732) 743-4582 or by e-mail to emendlowitz@withum.com.

Louis Young, CVA, is with WithumSmith+Brown, PC, in East Brunswick, New Jersey. He has been engaged to perform valuations primarily of closely held companies and family limited partnerships. These valuations have been performed for estate and gift tax purposes as well as purchasing and selling businesses. Mr. Young has extensive experience in finance, with emphasis on the automotive industry. He has performed corporate financial planning, automotive factory financial statement analysis and departmental internal control analysis, been involved with mergers and consolidations, and cash flow planning.

Mr. Young can be contacted at (732) 379-5218 or by e-mail to lyoung@withum.com.