In 2002 a program at Cranfield University suggested that business valuation was flawed as most value came from intangible assets. Since then it has emerged traditional means of company balance sheet valuations based on assets and historical profit trends are flawed, and Icebreaker argue has given rise to the hangover and real quandary we are in today.
Value creation comes about through three primary business elements, business process, employee knowledge, and the use of tangible assets. The ability to extract value is mainly therefore through developing people to develop the business process to extract the value from knowledge and assets. Measuring this “intangible value” comes from a balanced approach – captured by a summary of customer, financial, business process and people development initiatives.
Yet financial skills are often stated main skill requirement of a turnaround professional. This finacial focus is counterintuitive; as financial performance is a lag indicator. Financial performance only emerges only as a consequence of getting the balance of the rest of the scorecard right, not the other way around. This is purely in an effort to create “certainty” and communicate with the investment community in a language they understand.
It is only when you visit overseas business that one realises, whilst much Western business could be better, the way we engage work together is a whole lot more productive and when outsourced is often just replicated in lower cost economies overseas with many more people (on a cheaper day rate) producing the same result. It is this intangible value that takes time to replicate, and building it – leads to long term advantage.
Maintaining the business asset is therefore about Motivation. Motivation is about creating a clear corporate direction, improving working relationships and developing people.
There is no doubt that there is significant global uncertainty and a shift occurring with a significant fall out. The real shift is in fact: The so called “emerging economies” have become the leading growing economies, leaving the “traditional Western economies” reeling with debt and complacency, materialising through unaffordable public sectors, red tape, and a hollow hope that things will simply get better, leaving the fundamentals unchanged. As the fundamentals have changed – without change it won’t get better, to coin the phase – if you do what you do you won’t even get what you have got.
The growing home grown market in these emerging successful economies is fuelled by a positive balance of payments and retains their cash within their own regions. This drys the flow of capital back to Western centres, and creates a rich choice of investment options for Asian investors.
Western asset overvaluation and unpayable levels e debt remains a real challenge. A lack of regional central support of the intangible assets in our industry destroys historical value built up over many years. This value might have taken 100s of years to create and even now could take many years to replicate. Product quality too is a good indicator of intangible asset realisation from emerging markets.
There is a lag in the financial community to get to grips with these fundamental shifts. Many institutional investors now have portfolios typified with utilities, regarded as safe long term sources of revenue, and are steering away from businesses that have been significantly restructured to meet the emerging climate. This is catch 22.
Certainty is an imperative for human decision making, without it we cannot process what we are told. This leaves traditional investors caught like rabbits in the headlights; out of their depth with limited knowledge of comparable reference companies, or those they know well. Growth projections coming out of this crisis makes it difficult to convince investor’s of projections and its unclear how long snap back to certainty will take. With further strength in the stock market, trade sales for VCs and private equity firms have dried up, and replaced by owner realisation of a much smaller % of valuation on sale, (to mitigate revenue / crystal ball risks), with a high risk owner earn out period of up to 5 years to realise the rest.
Historically private equity firms have avoided flotations, preferring the control, certainty and buzz of selling to trade buyers or buy out firms. Stock market increases are giving rise to an increase in flotation, which should free up the pressure on bank funding, freeing up the market. The difficulty is that IPO will have to be priced to sell.
The Aug 09 stock market valuation increases of 25% seems to be currently driven through low trading volumes. London Stock Exchange state transactions are 30% down on July of last year, thought to be fuelling the price increase, rather than fundamental change. Commodity prices (20% of FTSE 100 index value comes from mining and oil – pretty tangible assets) however seem to be following traditional supply and demand model, with the management and constraint in supply driving prices up. The last large oil field was found 40 years ago.
Along with the cost of mopping up the world financial crisis, estimated by the IMF @£7.1tr. It may be that there is a new age of companies making less money, banks with less to lend making each pound work harder; as a result shares could start to trade on lower multiples of their profits. The cost in mopping up the crisis will still have to be paid back, and current low interest rates cannot be sustained for ever. Against this backdrop it is hard to see why company valuation should get anywhere near where their previous highs.
Whilst European economies have different bases, the short term restructuring of bad debt is a necessity. What has been typical in the past, profits, valuation, revenue and sources of revenue are no longer indicators of the present or future. Furthermore public sector investment in infrastructure needs to follow suit, there is an estimated shortfall in UK electricity supply, along with a need for the financial sector get off the fence to focus on lending to and supporting these businesses that are making the changes required to survive.
What is clear in the private sector is there is a real need to let go of capabilities that are not longer a source of value; those capabilities that with the focus on specialisation in emerging markets have become commodities, and focus on addressing the tough issues, building intangible assets and build a flexible business model capable of managing the remaining chain of capabilities in a truly global sustainable way.
A common Far Eastern strategy model is to evolve the business model, to meet the hypothetical challenges of the future, over a short 3-6m time frame, rather than planning for the more traditional and ridiculous 5 year horizons.
The capabilities should fit with sustainable sources of revenue, with profits earned through a demonstrable ability to develop and maintain capability. The orchestrator will earn their position by setting the targets and overseeing the capability and delivery of the entire chain. This emerging model undermines the traditional source intellectual property as a source sustainable source of value, it is more the way organisations interact, and the rate of their incremental development that will keep them ahead.
Its time we woke up and smelt the coffee.
Icebreaker Business model goes some way to having the tools to bring some certainty. This is the reason why Icebreaker incorporate, financial restructuring, team development, collecting hard competitive and market facts, along with the ability to integrate and implement change. Our supporting CPD retain that value by developing a people capability to offer a lasting legacy.
