District 9 Movie: Brilliant!

I enjoy going to the movies as much as the next person, but unfortunately I must say that most of the time over the last few years I've been sorely disappointed with most of the new releases I've seen.

One of the worst movies I've ever seen was the recent release of 'GI Joe'. I could tolerate most of the stereotypical and poorly thought out plot, right up until the point where a piece of Antartica was blown up and then pieces of iceberg started sinking and piercing the stereotypical 'evil under water lair of the bad guys'. They probably spent about $2M on that CGI scene, and they couldn't think to get someone with a brain to work out that if a BIG piece of ice is floating above an underwater city, and you blow it up, the SMALL pieces aren't going to start sinking. Ice floats no matter what. Duh. Sooo painful.

So I was delighted and surprised when I went to see 'District 9' produced by NZ's own Peter Jackson (and directed by Neill Blomkamp). This was a movie where you could easily initially assume that the plot would fall into the same "I've seen this movie 100 times before" category, with aliens, bombs etc, but Peter did a MASTERFUL job of getting on board with a movie that ACTUALLY made you believe it could be real - Filmed in a kind of 'CNN documentary' fashion, I don't think I've ever seen another movie quite like it. And I actually enjoyed the movie significantly MORE because there was no big name actor like Brad Pitt or Tom Cruise in the action scenes. Made it so much more believable. Peter must be starting to become very popular with film backers, because not only does he make great movies that I personally want to go and watch, but he must save at least $20M by not hiring big name actors. The small time lead actor in District 9 I think did JUST as good a job of acting the part as any 'big namer' I've seen recently.

I wonder if there is a bit of a sea change happening in the movie industry at the moment - all the pressures of Piracy, DVDs, Home Theatres and YouTube toward non-star based films must be having some effect. If more films like District 9 start being made, and less of the Hollywood junk films that look the same as 100 other films, and you can't remember which film is which, because they all start the same people, then it's got to be a good thing...

How to value a company

I was recently asked by a friend of mine how to accurately value a company. I guess my answer is that 'There is NO such thing as being able to ACCURATELY value a company!' However, there ARE standard methods by which to get an IDEA of value. The value of a company can really only ever be accurately obtained by what someone is willing to pay for it.

In my time I have purchased around 40 small Internet companies, a bar, a Barter company, and various small other companies. I have also then sold a large internet company (the aggregation of all the small ones), and the other companies off again.

When I am looking to purchase companies, I generally use a variety of valuation methods in combination, as one by itself is often not reliable. The valuation methods I most commonly use are:
- Assets minus liabilities (net position)
- Price / Earnings multiple
- Seeby's patented 'heads and eyeballs method of valuing an Internet company'
- Discounted Cashflows

ASSETS MINUS LIABILITIES METHOD
This valuation method is very simply explained as: add up all of the things the company owns (assets), subtract what it owes (liabilities), and then you can come up with a figure. Say for example there was a company that owned $4M of residential properties, and had $1M of mortgages. It would be pretty fair to say that the value of the company was about $3M. However - this valuation method can break down or be incorrect at times. For example - say you had a property company that owned $100M of commercial property, and had $100M of debt. If the property was returning $10M a year in rents (a yeild of 10%), and had costs on the debt of 5% ($5M a year), then this company would be making $5M per year. Clearly the company has a zero net asset position, but is not worth 'zero', as a $5M per year cashflow would be very nice! (The fact that the company is highly geared and may fall over because the bank decides to withdraw funding is another matter again which should be taken into account)

PRICE EARNINGS MULTIPLE
This valuation method is explained as: Take the money that the company makes each year, and then multiply that by some factor in order to work out the value of the company. If you had a company that was making $5M per year (as in the example above), you would expect that it was at least worth $5M (unless under risk of imminent closure), because you could buy the company, and then you'd have your money back in a year, after which you get money for jam. Personally, I like to buy companies at multiples of around 3x earnings, and sell them at multiples around 5x earnings, but companies are bought and sold on earnings multiples all the way from 1 to 100 or sometimes even more depending on all sorts of other factors. This valuation method might fall down or be incorrect where you had a company that had lots of assets and no debt, but didn't make much money. Think of a company that owns $100M of residential property with no debt, but none of the houses is rented out, so there is no income. Clearly it's not a great business from an income perspective, and close to zero from the p/e multiple valuation, but it's probably worth close to $100M.

It's worth noting that a comon way that people such as Eric Watson, Graham Heart and other corporate raiders and leveraged buyout guys make huge amounts of money, is by buying companies that are valued in traditional ways such as described, but then they either break them up and sell off the pieces, or re-package them in such a way that a different valuation method can apply, that allows previously hidden value to be unlocked, and then retained.

I myself have been researching a public company that has a net asset position of $20M, and solid earnings, and yet it's 'market cap' or net worth on the share market has dipped to just $10M because investors are scared of even good businesses right now. This means that if I was able to successfully buy the whole business for $10m, I could sell off the assets and I'd get $20M back (and $6M of their $20M of assets is just cash in the bank, so that would come back instantly). Companies like this are said to have a higher 'asset backing' than market cap - which is rare, but is definitely a good thing, because it means that if the company went out of business, the value of the assets sitting there is more than what you could purchase the company for. It's like buying a company for $500,000 that happens to own a $2M house with $1M of debt, and is therefore worth $1M, but no-body has picked it up - perhaps because the business isn't 'sexy'.

SEEBY'S 'HEADS AND EYEBALLS VALUATION METHOD'
This method I developed myself after 5 years of doing deals to buy Internet companies. It is useful when the other two methods above break down, and can be used to find or justify hidden value. Most often it applies to Internet and tech companies, but doesn't need to. If you think of a company such as Netscape back in the Dot Com Bubble days, they didn't really have many assets other than a bunch of computers and desks (so wouldn't have been worth much on an 'assets' basis), they didn't have much revenue because they gave their product away (so they weren't worth much on a p/e basis), in fact all they did was lose buckets and buckets of money, and yet the sharemarket at various times valued them at hundreds of millions of dollars. The reason for this huge valuation was because of all the 'eyeballs' that they could control, which is an opportunity for future sales. Instinctively you would know that if you had a company that could advertise to almost anyone on the planet, and yet didn't have any assets, and didn't make any money, that it would still be worth a lot because of the potential to up-sell, move into different markets, evolve the business model etc. This is what Netscape was, but ultimately they didn't evolve - if they had evolved into Google in time, then their investors would have been very rich instead of losing their shirts. Using my own more complex inputs and this valuation method, I was able to accurately identify Internet companies that had hidden value that I could sell for a higher price, but that could be purchased for a low price based on traditional valuation methods.

DISCOUNTED CASHFLOW
The discounted cashflow method of valuing a business basically takes into account the time value of money, and works out what future income streams are worth today. The discounted cashflow model might be usefull for valuing a company that has no income, no assets, but has a business plan that is likely to succeed and shows considerable growth in the future. Wikipedia probably does a better job than me explaining this, so have a look at their article on the subject