Sean Iddings Resident guitarist and aspiring intelligent fanatic.

What Is This Company Worth?

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This is a real world example. How much would you pay for the following company?

*Trailing twelve month (TTM), quarter-over-quarter (QoQ), year-over-year (YoY)*

Here is the current balance sheet and here is the cash flow statement.

Let me give you more information. The company started seeing one of their business operations explode. They didn’t have a first mover advantage. The world’s largest player in this niche, with a near monopoly, entered the U.S. market 7 years prior in 1998. This company started around the same time, but failed many times before they created their successful offering in 2002.

The CEO recalled:

“One of the most important things is knowing that you’re going to make mistakes and you may have to change. You have to be prepared to change the product and sometimes walk away from a product. You’ve got to be able to do that quickly without excessive costs sunk into the project. If you can do that, you will continue to innovate and develop different product until you hit upon a success.”

By 2004, there are numerous competitors in the space now, included were some corporate behemoths with plenty of resources and established distribution. Additionally, the total sales of all in this market is estimated at approximately $1 billion, up from $142 million in 1999. Market penetration was estimated to be low.

At the time, there looked to be a large runway ahead. Yet, having a runway for growth doesn’t equate to sales and income. It takes proper execution, especially if there are well established, better funded competitors. Which in this case there was.

Imagine yourself in 2004 doing due diligence on this company. During your due diligence you find that this company’s go to market strategy is unique and an almost better version of the world leader’s.

For example, the company had announced a unique marketing initiative where it would advertise on a monorail train. Imagine that you had the chance to talk with management and other sources. You find out how unique the set-up is. The cost to market on the monorail was set at $1 million per year for three years. That was a pretty huge price. The company had been paying a marketing firm $850,000 per year to display their advertisements. The return was phenomenal. So this is what the marketing director tells you:

“Ah, a million dollars is nothing. I’ll cut a deal with our marketing firm to sell them the visibility for commercials on the train. It just happens to be I’m gonna give them an $850,000 tab on that.”

Simply, the company reduced their previous advertising payment to $150,000, and got the monorail advertisement for free. Genius, right?

You also come away from talking to management feeling that they have integrity. They’ve done exactly what they said they’ll do. You learn that management was instrumental in turning around the business 12 years earlier from bankruptcy into what it is today. They essentially took the company from no money and $22 million in debt to a profitable growing company with nearly $0 in debt.

In addition, you find out that the management team paid off the debt in creative ways. For example, during the turnaround they wanted to sell off their manufacturing plant for $22.5 million. A potential buyer wanted it but could only afford $13 million. The company’s management decided that since they wouldn’t have a production plant after selling, they could have the new buyer produce for them at a 20% discount.

The deal was struck. It was a win-win. The buyer won because they got an asset at a huge discount and a large customer. The above company won by saving 20% over many years. In total, the seller (our company) ended up making $0.5 million more than the original asking price.

Wait, while you’ve been reading the above another quarter went by.

Here are the results:

Q2 2004 sales grew 65% year-over-year. Net income grew 252% year-over-year. Following the same metrics as above, here are the company’s trailing results.

Are you too late?

Here is the current balance sheet and here is the cash flow statement.

During the conference call you note the following:

Management has been investing in marketing headcount significantly “to make sure we’re getting attention; we’re in the face of our distributors.” The CEO says, “I think that we are probably introducing (hiring) another 50% next year, if the program continues to show the sort of results we feel.”

Results after the quarter sound stellar. The CEO says, “I can tell you that sales for July have continued to trend very strong for the company.”

The company has zero investment analyst coverage. There is only one institutional fund invested in the company. You can’t help but love how management reacts to question asking why the company doesn’t give guidance:

“I think that we simply expose ourselves unnecessarily and it just doesn’t do us any good because we’ll never be right. The company is growing, it’s growing in different directions. It’s not an old and mature business that you can predict with any real certainty. So with the best information in the world, we will make predictions, and they may or may not come out, or may come out too conservative. I know that you guys would like it, but I think at the moment it’s not practical for us. But certainly we will review it from time to time.”

Also note that the two largest shareholders, the CEO and COO, have sold ~26% of their stake from Q1 2004 to Q2 2004.

What do you think is the price of admission? And where do you think this roller coaster is going?

Follow along and find out in our case study.

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