Many finance directors must look enviously at those job adverts for FDs of dot.com companies. No doubt most eyes slide over the actual job description and concentrate on the large salaries and even larger potential in the form of share option packages. One recent advert describing the work to be done stated: ‘The FD will be in charge of profit and loss – well actually, as this is an Internet company, more losses than profits.’ You have to hope that particular company found an FD who at least shared their sense of humour.
But the advert did acknowledge one truth: in the e-economy, companies seem to be able to get away with not producing a return for their shareholders for a lot longer than a company in the old economy could possibly have imagined. The idea that ‘cash is king’, which became the mantra of every sensible FD after the recession of the early 1990s, seems to have been replaced in the past few months with the idea that ‘cash burn is king’.
Talking to those involved with e-businesses and those, such as venture capitalists, who are advising them, there is agreement that the old company valuation rule book, which FDs grew up with, has been, if not torn up, at least put firmly on the shelf. Valuing a company in the pre-e-era now looks simple: you made an intelligent guess about cash flow over the next few years by looking at recent history and by making assumptions about how the business and the world might change, and then, with the help of a discounted cash flow (DCF) analysis, you arrived at an answer.
Much has been written about bubbles and investors – professional and private – not wishing to be left out of this 21st century gold rush. Venture capital was always meant to be about backing people rather than business plans, and that philosophy is being tested to the full now.
But venture capitalists and financial modellers in the business of valuing
e-businesses say the fundamentals of DCF don’t go away. However, they are currently being overridden by other benchmarks that are trying to reflect the sizes of potential markets – or the potential sizes of potential markets. But there is a double jeopardy in this process. First, you have to work out if there is a market at all for the product which the e-business is proposing and, if you give the green light on that element, you have to make a stab at estimating what sort of market share your company will actually carve out for itself.
Clearly this process is not all guesswork. If you wish to set up (for instance) an Internet wine distribution business, you can present a business plan that shows how much claret or Liebfraumilch goes down the necks of your chosen market. What we don’t know is the pace of migration from people nipping down to the off-licence, to those people using their keyboard to effect the same transaction.
It is clear that you can forget using the cash flows over the first few years of the life of most e-businesses. The potential as one venture capitalist put it ‘is much further out’. This is broad picture stuff, and, at the moment, similar sorts of value are being applied to quite different businesses because these benchmarks represent little more than pricing points. There is much improvisation taking place.
One merchant banker who spoke to Financial Director is working on a yet-to-be announced business-to-business
e-procurement venture. He said that trying to turn out a sensible financial model and forecast is nigh impossible when you are so overwhelmed with uncertainties.
All this is having a considerable effect on non dot.com companies seeking finance, and last month’s Financial Director reported how the FTSE-100 had lost some venerable names – Thames Water, Hanson, PowerGen and NatWest among them – to make way for high-tech stocks.
The insatiable appetite for technology stock is taking its toll. According to figures released in April by the Centre for Management Buy-out Research (CMBOR), which carried out a survey sponsored by Deloitte & Touche Corporate Finance and Barclays Private Equity, in the first quarter of 2000 there was a drop in the number and the value of deals below £5m compared with the same period last year.
According to Deloitte’s Chris Ward, the Internet feeding frenzy is starving small-scale deals. At the same time, exit routes are blocked because of the lack of stock market interest in anything without a dot.com tag. As Tom Lamb of Barclays Private Equity puts it: ‘At the moment there is a divergence of opinion in the UK capital markets. The stock market has become a venture capitalist paradise, while stable cash generative businesses see the higher geared MBO structure as a safe haven. Clearly the buy-out funds are placing a higher value on cash flows than the stock market.’
But, one surmises, sometime the stock market will become less indulgent, and will demand a return to traditional accounting for values. What will happen to the dot.coms then?
Peter Williams is a chartered accountant and freelance journalist.
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