In my long finance career, I was involved in numerous ‘transactions’ that involved valuation – not just valuing companies and businesses but also valuing intangibles like Intellectual Property or Wireless Spectrum. The value of assets that I valued varied from single-digit millions to a few billion dollars. And one striking conclusion that I have reached after multitudes of transaction is this – today’s valuation theories are meant to explain valuation after the deal is done or at best to define the value boundaries for the deal participants but not to actually arrive at the valuation number at which the deal will be done.
Most of the valuation modern theories such as DCF look at the future earning potential of the business or the asset and arrive at what is called a “present value” using the valuer’s cost of capital or expected returns as the discounting rate. What these valuation models try to do is to mirror the deal-makers’ mind-set in financial terms.
But these theoretical methods have two inherent shortfalls.
- They require some big assumptions – regarding long term cost of capital or the hurdle rate at which to discount future earnings to the present value and the long term growth rates … to name a few.
- More importantly, these methods present purely one-sided perspective and completely ignore the deal dynamics between the dealing parties, i.e. The seller and the buyer.
These shortcomings have plagued the valuation industry for decades and have pushed the deal makers/ arrangers to depend on generic data-driven dubious market multiples to strike deals! These dubious market multiples, which become circular self-fulfilling prophecies have, in fact, unwittingly led to many market hysteria & crashes fed by unreal frenzies & fears.
Perhaps, emerging game theory could help us come to a better valuation theory that can actually be used to arrive at the valuation by using the dynamics between the “players”. Till such time, the theorist will be religated to the role of being the coroners of the deal industry conducting the value postmortems!