• 055 11/05/2016 Aswath Damodaran Interview
    I generally find it difficult to listen to long interviews and podcasts. One recent exception to this is an interview with Aswath Damodaran titled "Aswath Damodaran on the Art of Corporate Valuation" (click on the link for the interview). 

    I would highly recommend listening to the interview in its entirety, but if you struggle listening for extended periods of time, you can use the guide that follows to skip parts that may not be as interesting to you. If you are new to finance and valuation, tune in for the first 26 minutes before skipping around.

    00:03:40

    First thing investors have to be asking is whether or not they should be doing a valuation in the first place.

    Valuation requires two things: 
    1) A willingness to learn the basic tools. Many investors want to do valuation but the don't want to learn about accounting / present value / etc. 

    If you don't have time to learn, put your money in an index fund. Ninety percent of the world would be far better off.

    2) Doing it for the right reason. Most people do it for the wrong reason: they want to get rich.

    00:05:15

    How to approach accounting? "I would say keep it simple." "The problem is if you take an accounting course it's all about debit and credits, and getting you into the nitty gritty of the footnotes." 

    Explains a podcast he did where he explained how little of the 10-K is actually relevant to valuation. The problem is that accountants throw everything in. They cannot distinguish between what is significant and what isn't. "They're encapable of telling the difference between the stuff that matters and the stuff that does not because they are accountants. They are detail oriented."

    "Data is not information. We are mistaking the two." Typical 10-K is five times longer than it was 30 years ago. Argues for going back to 15 page 10-K. 

    Example of worthless section: Risk factors. All boilerplate text written by lawyers.

    00:07:05

    Do you know the difference between gross income, operating income and net income? If you don't you're in trouble.

    Wants to know that you can read a cash flow statement.

    00:07:40

    "I've described goodwill as the most destructive accounting item ever created in history."

    "Goodwill is the accountant admitting he screwed up."

    00:09:00 

    Valuation of Tesla.

    00:13:05

    Valuation of Amazon. "Amazon has been one of my pet obsessions for 20 years." 

    00:17:00

    Valuing a private company. "Knowing the price is a crutch." "Value should not be a function of knowing the price." "We use [price] when valuing public companies as a feedback loop to make sure we are not screwing up."

    "In a regular market you have hundreds and hundreds of people trying to assess the price." VC pricing, in contrast, can get out of control "because all you need is one crazy person to drive the pricing process out of control."

    Some comments on the reason VCs get sweeter deals than what is publicly disclosed. Options and protections that come with the investment.

    00:20:35

    Valuation of Uber. "They know how to grow ... but they have a business model that is indefensible. Entry is easy."

    00:22:33

    Valuing stocks in the market. Commentary on valuations creeping up over the last few years. If you look at any metric, P/E, P/BV all are at highs. "Investing is a relative game. If you are not going to invest in stocks, where are you going to invest instead." 

    "Stocks look expensive relative to their own history, but they don't look expensive relative to what my other options are."

    Valuation is not about any single metric. Commentary on flaws of this approach (using one metric to make a decision).

    00:28:10

    Commentary on how the amount of capital required to start a business has dropped considerably. Old economy businesses vs. new economy businesses. "It's a mixed blessing because you can grow really fast, but you can also shrink really fast."

    00:30:15

    Valuation techniques. Companies should be priced based on three things:

    1) Cash Flows
    2) Value of a Company's Growth - "Not growth per say, but how much it is costing them to get the growth." "55% of companies globally destroy value as they grow. ... It's one of the scariest statistics on growth."
    3) Risk

    00:33:00

    Valuation of Coca Cola.

    "The physical investments Coca Cola makes are completely useless in my determining what the value of Coca Cola is." 

    "If they can charge you a dollar for a can with water and crap and sugar and syrup thrown into it ... it costs them 3 cents to make. It's all about pricing power." That pricing power is not reflected in the value of their plants and equipment. It's the purest branding play you can make.

    00:33:54

    Valuation of Disney

    00:35:00

    "I describe myself as a Kim Kardashian of valuation."

    00:39:10

    Comments on being "transparently wrong" vs. "opaquely right." References to Philip Tetlock.

    00:42:25

    "The whole idea in investing is to separate the 5% of companies that are cheap that shouldn't be cheap from the 95% that are cheap for a reason."

    00:43:10

    The problems with "old-time" value investing strategy. "The fact that we keep going back to Warren Buffett as the name is more revealing than anything else. And even Warren hasn't been Warren for quite a while." Commentary on how Warren Buffett gets the best deals.

    00:48:10

    Investing has been focused on mean reversion. There has been a structural shift. Commentary on why 2008 was the wake up moment for Damodaran.

    00:51:20

    The investment world has become a flatter place. "In 1986 if you started out as an investor in New York you already had an advantage over an investor in Des Moines, Iowa." As the investing world has become a flatter place, the payoff for active investing has dropped.

    01:02:00

    How finance as an industry has evolved. As disciplines age, they narrow creating specialists. We have lost the generalist. 

    01:04:25 

    Investors that influence Damodaran. 

    01:06:40

    Favorite books:


    01:17:00

    Advice for students trying to get into finance.


 



  • 054 11/05/2016

    We are making baby steps towards profitability at ASimpleModel.com! This month revenue covered all fixed expenses excluding web design / development efforts and my time. A small victory, but it was exciting nonetheless. The most recent installment walks through these updates, and demonstrates how quickly you can update a business dashboard once you have one built. For those that are interested I have included an image of the business dashboard at the bottom of this post.

    For the uninitiated, ASM has a video series showcasing the business model behind this website. In this series you will learn how to organize real revenue and expense data, and transform it into useful information. The image below shows this first step (click to enlarge).

    Startup Business Dashboard

    Once we have all data organized longitudinally by revenue or expense category, the next step is to develop a business dashboard. To date we have developed a template with the following information:

    1. Daily Revenue

    2. Monthly Subscriber Count

    3. Monthly Revenue

    4. Monthly Expense Data

    5. Profit / (Loss)

    6. Investment to Date

    All of this information fits on one page, a portion of which is visible below (click on the image for an enlarged view).

    Startup Business Dashboard
 



  • 053 08/28/2016

    Note: Excel file available for download at the bottom of this post.

    Distribution waterfalls define the economic relationship between the equity participants involved in an investment. In private equity transactions this generally focuses on the relationship between the general partner (“GP”) and limited partners (“LP”). If these terms are unfamiliar to you, think of the general partner as the private equity fund, and the limited partners as all of the investors participating in the fund. In this context, the purpose of a distribution waterfall is to prioritize the distribution of cash flows between the investors and private equity fund managers. 

    I believe the easiest way to grasp this concept is to focus on the acquisition and sale of one business. This limits the exercise to two cash flows, the capital invested to make the acquisition, and the transaction proceeds received at exit (when the business is sold). In this process, the limited partners would provide the capital to make the acquisition, and the general partner would identify the target company, work towards an acquisition, manage the investment over a three to seven year period, and finally identify a buyer. Upon a successful exit (sale of the business), the GP would earn a carried interest (share of the proceeds) for their efforts.

    In the Excel file attached you will find four simple examples in increasing order of complexity. The first tab titled "80_20," includes only two steps (see below). Real estate distribution waterfalls often follow a similar approach, but the split between the GP and LP is more favorable to the GP. You might see a 50/50 split in place of an 80/20 split, for example.

    First, 100% of all cash inflows to the LP until the cumulative distributions equal the original capital invested plus some preferred return. In the examples provided in this post, the preferred return is equivalent to 8% per annum. 

    Second, thereafter, cash flows in excess of distributions made in step 1 (if any) are distributed 80% to the LP and 20% to the GP. This is often referred to as an "80/20 split."

    The second tab titled "20% & 80_20" includes three steps. Within the private equity community, some variation of this approach, including additional detail around fees and, in the case of a fund, whether or not this should be calculated for each deal or the fund as a whole, is not uncommon. 

    First, 100% of all cash inflows to the LP until the cumulative distributions equal the original capital invested plus some preferred return.  

    Second, a "20% catch-up" to the GP equivalent to 20% of the of the distributions realized in step 1 plus the distributions realized in this step. 

    Third, thereafter, cash flows in excess of distributions made in step 1 and step 2 (if any) are distributed 80% to the LP and 20% to the GP. 

    The third tab titled "20% After Pref & 80_20" adds one step to the sequence above so that the 20% catch up is limited to distributions made after the return of invested capital. Though simplified, this is perhaps the most frequently cited example for a private equity transaction. Hopefully the jump from tab two to tab three makes it a little easier to understand.

    First, 100% of all cash inflows to the LP until the cumulative distributions equal the original capital invested.

    Second, 100% of all cash inflows to the LP until the LP has received a preferred return on the capital invested in step 1.  

    Third, a "20% catch-up" to the GP equivalent to 20% of the distributions realized in step 2 plus the distributions realized in this step. 

    Fourth, thereafter, cash flows in excess of distributions made in step 1, 2 and 3 (if any) are distributed 80% to the LP and 20% to the GP. 

    The final tab gets a little more creative, and rewards the management team and sponsor according to IRR hurdles achieved. As the number of private equity groups and fundless sponsors has grown, I have seen a variety of new approaches, this being one of them. I also wanted to include it to demonstrate the degree to which there is flexibility in negotiating the terms of a distribution waterfall.  A screenshot of this tab has been provided below.

    CLICK HERE TO DOWNLOAD THE EXCEL FILE

    For an example of a real estate distribution waterfall click HERE.

    For an explanation of the math behind the 20% catch up click HERE.

    Click HERE to have posts like this one sent directly to your inbox.

    Private Equity
 Distribution Waterfall

     

     
 




 



Models are:
 
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above

 

 


*Answers a, b, c, d, e, f and g are all correct.