Saturday, March 29, 2008

Illustrating Market Value vs. Intrinsic Value with Starbucks

Starbucks is favorite company of mine to use in various finance and business strategy lectures, (and to get a jolt before our Sunday strategy meetings at Altos Research). Over the past decade, Starbucks enjoyed a steady rise up, initiated aggressive international expansions plans, and with their recent reappointment of Harold Schultz as CEO, is now working to repair some erosion of their brand and product quality.

Most recently, I’ve been watching the Starbucks’ market valuation plummet over the past year with great intrigue. The current share price movement provides another great illustration of the difference between "market value” of a firm and the actual “intrinsic value” of a firm

In early January 2007, SBUX traded at about $35/share, yielding a market capitalization of over $25 billion (=$35/share x 725 million shares outstanding). At Friday’s market close, SBUX traded at $17.05/share, yielding a market valuation of only $12.36 billion.

While the company is focusing itself on re-establishing its brand, quality, service, and products, there certainly haven’t been any fundamental shifts in the demand for coffee. It doesn’t appear that Starbucks customers are flocking to Peet’s Coffee & Tea or Caribou Coffee to get their daily caffeine fix. Share prices at Peet’s are down about 20% since last year, and shares of Caribou have fallen from about $7/share to $2.75 in the same period. McDonald’s is rolling out a plan to compete in the specialized coffee business and their stock is up from $45/share to $55/share over the past year, but can they really take significant market share from Starbucks? Probably not.

So have operations at SBUX really taken such a negative turn that the company is now worth less than half of its value from early 2007? Clearly stock market thinks so, but this is why there is a difference between market value and intrinsic value.

When SBUX traded north of $30/share, that run up was based on increased demand for the market supply of shares (the 725 million outstanding). Strangely, in the middle of this run-up, the stock had a 2:1 split which changed the supply from about 362 million shares to the current 725 million shares outstanding. Supply doubled and the demand continued to force the market price per share to the $40/share range. The change in price reflects increased demand for shares, not necessarily a change in the intrinsic value per share of Starbucks.

According to Starbucks’ financial statements, the company increased its net income over 33% and increased their assets by over 50% in this two-year period. Let’s look at the market price per share during this same period.

In January 2005, SBUX traded at about $30/share. Taking into account the 2 for 1 stock split in October 2005, this means that the shares trading at nearly $40/share in April 2006 were really trading at $80/share. From at the same time that SBUX increased net income by 33% and increased their company assets by 50%, individual shares (actual pieces of ownership of the company) increased in value by over 250%. This means that the market value of a share of SBUX was increasing at a pace much faster than the actual value of the Starbucks.

Remember, market value ≠ intrinsic value.

Read the financial statements. Look at the assets and cash before making a decision on any company’s value – public or private. This isn’t my own idea, Ben Graham and David Dodd wrote about this in Security Analysis and this has long been the mantra of Warren Buffett.


Saturday, March 22, 2008

Tips for Entrepreneurs from Sequoia Capital

If you're an aspiring entrepreneur, the "Ideas" page on the Sequoia Capital website is an outstanding resource. It's rare (very rare) that a start-up can submit a business plan without any prior contacts and meetings with a venture capital firm and receive financing. But, this page is an outstanding primer of the themes and ideas that you'll need to tackle in order to build a successful company.


Friday, March 21, 2008

More on the Bear Stearns Valuation

At market close on Thursday, Bear Stearns was trading at nearly $6/share, yielding a market capitalization of just over $800 million, nearly a tripling of the publicly-announced offer of $2/share ($236 million) from last weekend.

The general consensus indicates that the real estate owned by Bear Stearns in New York City is worth about $1 - 1.3 billion. On March 16, Paul Kedrosky wrote that that this real estate asset would account for a large portion of the sale price.

If this is the case, some things still don't add up to -

1. At the original sale price of $2/share ($236 million), it seems that JP Morgan was buying a $1 billion real estate asset for about 25% of market value. There are proponents of the $236 million price tag that argue that JP Morgan is "buying the stock, not the assets." In the simplest terms however, when you own a stock, you own a share of the company. When you own a share of a company, you own a share of all of its assets. This is the basis of intrinsic valuation.

This is my fundamental position againt the low valuation. I agree that Bear Stearns is not worth the $20+ billion when BSC share traded at $170, but their largest underlying real estate asset is worth more than $236 million.

2. What about the human capital at Bear Stearns? The company paid $3.4 billion in compensation in 2007 (according to their 10K). Assuming that anyone worth their salt has left the company by now, you can probably estimate that the remaining human capital still with the firm by the time this shakes out is worth some value of what they were paid in 2007. Let's call it 10%, which provides a current human capital value of about $340 million.

By these estimates, assuming all other assets in the company are worthless:

Real Estate + Remaining Human Capital = Total Current Value of Bear Stearns


$1 bln + $0.340 bln = $1.340 billion, which calculates to $11.35/share. Given the risk profile of BSC right now, JP Morgan could justify a discount, a "risk incentive" to take the shares at a price slightly below this level.

So with a share price at the $6/share area and a secondary market valuation of about $800 million, we're getting warmer. But it's not surprising to see current shareholders balk at the $2/share originally proposed.


Wednesday, March 19, 2008

University of San Francisco Entrepreneur Team Wins 3rd place in Business Plan Competition

Congratulations to Tom Monaghan (University of San Francisco, EMBA 2007) and Tesh Khullar (University of San Francisco, EMBA 2006) for their outstanding achievement in winning 3rd place in the National Seed Business Plan Competition in Santa Barbara last weekend.

Tom and Tesh were one of 10 teams invited from among the 72 applications for the contest. They edged out teams from Harvard and Univ. of Wisconsin-Madison and others for one of the 4 finalist positions.

They will compete again at the San Diego State University Business Plan Competition (the nation's oldest event) next week.


Bear Stearns, Portfolios, and Waldo

Where's Waldo?

Courtesy of the Bear Stearns 10-K for the year ending November 30, 2007:
Some basic math indicates that 33.4% of Bear Stearns' portfolio was held in Mortgages, mortgage- and asset-backed securities. Add the Derivatives line item and you come to 47.5% of their portfolio is relatively risky assets. So how does this compare to a few of the other bulge bracket investment banks?

Hard to say in some ways with the numerous write-downs recently - $8 billion by Merrill Lynch, $9.4 by Morgan Stanley, $17.4 billion by Citigroup. But, some digging reveals how Bear Stearns is certainly outside of all of these firms regarding their risk exposure.

According to some recent 10Ks/Annual Reports:

Goldman Sachs - 11.9% of their portfolio is held in Mortgage-related. Add Derivatives, and 35% is in these two security types.

Merrill Lynch - 11.9% of their portfolio is held in Mortgage-related (no, that's not a typo - it's also 11.9%....). Add Derivatives, you get 43% in these two securities.

Lehman Brothers - 28.4% of their portfolio is held in Mortgage-related. Add Derivatives, and you get 42.7% of their portfolio.

This is a fairly cursory analysis, but looking at the most recent and pending results of the firms above, perhaps there's a linkage in there somewhere? There are many-a-bankers asking themselves what sort of business strategy that Bear Stearns was undertaking, and certainly comparing results might yield some cause and effect in retrospect.

Or maybe Bear Stearns just missed the memo....


Sunday, March 16, 2008

The first Internet IPO "Gold Rush" - in retrospect

I found an interesting spot on the PBS website - dot.con - that was aired and published back in 2002. Now that we're starting to get some perspective on the first Internet rush, reading these pieces in retrospect offers some valuable lessons going forward.


Venture Capital Investment Trends since 1995 (Deal Sizes)

Another snapshot of data provided by PWCMoneyTree.showing the size per venture capital per deal in companies of various stages since 1995.

The magnitude of the upward spike for Expansion and Late State companies is rather startling, but not surprising in retrospect, with the quick upslope from 1998 through 2000. Of course, this was the heydey of the first Internet boom, only to be followed by the impending crash in 2000-2001. One can only surmise that this free flow of capital into later stage companies is the 3rd, 4th, 5th round financings to get the original dotcoms to IPO.

To go from $7 mln/deal to nearly $25/mln deal provides some perspective on where the Internet IPOs took the imagination of venture capitalists and Wall Street alike, and where the imagination of venture capitalists and Wall Street took the Internet IPOs.


$236 million? Bear Stearns, Valuations, and Train Wrecks

An astonishing train wreck. That’s all that comes to mind in reading about Bear Stearns’ collapse and J.P. Morgan’s purchase of the Wall Street mainstay since 1923.

According to the Wall Street Journal – “J.P. Morgan Rescues Bear Stearns.” "Rescues?" Seems more like Cousin Vinny bailing out the “two youts” somewhere in Alabama after being charged for murder…

Part of me feels like the $236 million price tag might still subject J.P. Morgan to the “winner’s curse,” but seeing that no other bidders were evident, I guess not...

To put the $236 million number into perspective, the latest Bear Stearns balance sheet is showing over $600 million in Plant, Property, and Equipment, so at least J.P. Morgan can have a sidewalk sale to liquidate the remaining office equipment and cover the legal fees associated with the acquisition. And the $236 million would have been pocket change for the LBO equity firm about a year ago.

Or if you started with $200,000 in 1923, earning the market return of 8.66% per year would have yielded you $232 million by now.

The latest venture capital investment-based valuation of Yelp is somewhere around $200 million. So Web 2.0 companies with revenues at $10 million a year are worth more than Bear Stearns in its current state?

When I introduce the concept of fundamental analysis to my finance students at the University of San Francisco, we do an exercise to illustrate the difference between “market value” and “intrinsic value” of a firm. Guess I have a new company to use for next semester’s lecture.


Sunday, March 9, 2008

The Venture Capital Confidence Index

Just a quick mention of the Univeristy of San Francisco's "Venture Capital Confidence Index." This index is maintained by Mark Cannice, head of the Entrpreneurship program at the University of San Francisco.

The Index was recently mentioned in an article by Rebecca Beckman in The Wall Street Journal - "In Silicon Valley, Start-Ups Begin Hitting the Brakes."


Venture Capital - Moving up the Ladder

In an article earlier this month, I examined an interesting trend in venture capital based on data provided by PWCMoneyTree. In short, the data appears to indicate that venture capital is moving away from investments in the "Start-up/Seed stage" and more towards later stage companies - those companies in "Expansion" or "Later Stage."

A recent article by Joseph Bartlett on VC Experts seems to find similar observations, using Jensen's "Eclipse of the Public Corporation" for support to his argument. Bartlett refers to Rebecca Buckman's October 2007 article in The Wall Street Journal - "Venture Capital Goes Big" that discusses venture capital's increasing activity in the buyout arena of private equity.

While the private equity industry seemed to nicely partition itself in recent years - venture funds here, LBO/MBO firms there - a funny thing happened - the walls between participants in the private equity industry seem to have disintegrated to some degree. I referred to this in an article last summer based on Mark Boslet's article in the San Jose Mercury News.

The net result? Greater demand for LBO/MBO deals, causing valuations to rise and profit margins on these deals to fall, and in turn possibly contributing to private equity's troubles as the 2007 credit crunch hit the financial markets. Bartlett also discussess the increasing price of LBO activity due to this increased demand, more plainly referring to the "winner's curse" that haunts firms that overpay for acquisitions.

If this trends continues, the entrepreneur in her garage with next big thing will find that traditional venture funding may be more difficult to attain than ever, and start-up capital will likely to be better accessed through the increasing angel capital networks emerging throughout the country.


Friday, March 7, 2008

Launch: Silicon Valley 2008

Well, it's here (or at least it's on coming...) - Launch: Silicon Valley 2008. I attended last year's event and found the event to be a raw look at the start-up world.

At Launch: Silicon Valley, 30 presenting companies make a 10-minute onstage presentation, then receive candid feedback from a panel of venture capitalist and Silicon Valley professionals.

Companies that presented last year included several in the social media space, data security, and Guy Kawasaki's Truemors. Guy is well-known for his presenting ability - worth the price of admission on his own.

For entrepreneurs interesting in seeing companies that have gotten over some initial hurdles - developing a working organization, getting a product to market - but still a ways from getting to the finish line, this a great event. Check it out.

Monday, March 3, 2008

Short-term Project Financing: Case Study

This question (paraphrased) was submitted by one of my readers:

"Hi Scott - I have been reading some of your financial blogs. I have a question for you, yes is a needle in a haystack... I am looking for capital - short term - to announce a local sporting event with internationally-recognized sports figures. My original funding source was delayed out of by 30 days and I need some immediate cash for expenses related to the event. Do any of your contacts have access to immediate funds with ticket sales as collateral?"

Funding of this sort doesn't fall into the normal "venture capital" funding out there, but I see a couple of potential options for you:

1. Talk with your event partners, such as the arena hosting the event about providing a short-term loan in exhange for a return on ticket sales. In the arena is booked, they might find it difficult to re-book their location with another event, and thus both of you would be losing money if the event does not happen. Take a partnership approach.

2. Approach your local vendors that stand to lose planned revenues if the event is postponed - same principle applies as with the arena hosting the event. Agin, take a partnership approach and leverage the fact that you're bringing this event to your city - they'll be buying into you and your ability to make the event happen.

3. Talk with a leading local bank about some derivative of Accounts Receivable Financing (sometimes called "factoring"). This type of financing is normally reserved for firms that have revenues booked as Accounts Receivables, but have not yet collected. Because the terms extended to customers may include net-30, net-45, net-60, net-90, etc., some lenders provide financing based on these future revenues, with some risk premium charged to you in exchange. While this doesn't match your situation exactly, a local lender or credit union may be willing to provide a loan in exchange for the aforementioned risk premium and some hefty sponsorship recognition from your organization at the event.

A search in Google for "accounts receivable financing" yields thousands of results where you can learn more.

Because of the short-term nature of your capital requirements, you'll need to approach private banking institutions and lenders, and avoid SBA (Small Business Association) loans. SBA loans take months to get cleared and its likely that your situation doesn't fit their lending criteria.

I'm suggesting a local bank because they may have more autonomy to make a quick decision locally, instead of the probable "up-the-ladder" decision process with a large regional or national ban. Plus, the local banker will have more implicit interest in receiving sponsorship status in exchange for providing an event loan.

4. Meet with the local Chamber of Commerce to discuss business contacts of private business leaders that can help you out of your situation. From what I know about your city, there are bound to be a couple local business leaders that might be willing to take a risk in working with your event. They may have some lenders in mind for your as well.

5. Contact your previous sponsors and VIP ticketholders and offer a significant pre-pay discount for sponsorships and tickets if you've had this event in the past. This would provide you with some quick cash flow for promoting the event.

In short, I'd consider any and all options if you're in that much of a bind. Take the win-win approach that everyone that gets involved with the event and leverage your existing work with previous events and your foundation. Hope this helps.


Sunday, March 2, 2008

Venture Capital Investment Trends since 1995 (Deals by Stage)

Doing some research about Venture Capital trends, I came across some interesting data provided by PWCMoneyTree.showing convergence in the number of venture capital deals between Early Stage, Expansion, and Later Stage deals, while the Start-up/Seed Stage dropped considerably over the past 12-13 years:

Reading nothing more than the data presented in these graphs, I'm hypothesizing that this decline was a function of a number of factors:

1. Venture Capital followed itself.

If there were a plethora of start-ups in the mid-1990s at the start of the internet/tech bubble, then it would make sense that targets that received venture capital in the "Start-up/Seed Stage" would then receive subsequent rounds of funding while in their "Early Stage" and "Expansion Stages", then eventually as "Late Stage" investments. Seems there may be some evidence of this effect as you examine the decrease of Start-up/Seed Stage funding with increases (and then decreases) in Early Stage and Expansion targets. These Early Stage and Expansion investment targets then became targets for Late Stage funding.

2. Venture Capital has become more risk averse.

Following the fallout of the last tech bubble in the late 1990's, venture capitalists turned their attention to firms that were past the start-up stage and had a better chance of survival. This would certainly explain the dramatic rise in the percentage of deals in Later Stage companies from approximately 10% to 30% of investments.

3. Venture Capital has become more selective

Certainly there was not a drastic decrease in the number of firms seeking Start-up/Seed Stage funding during the past 12-13 years - just the number of venture capitalists willing and able to fund these start-ups.

4. The ongoing emergence of Angel Capital

As angel capital groups continue their emergence, they may be filling the void - funding Start-up/Seed Stage companies instead of traditional Venture Capital.

I am actively researching these thoughts to support with further evidence, but this certainly provides some interesting fodder for discussion. I'm interested in your feedback on this thought process.

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