Stumpage, Synergy, and Valuation

I was walking around the East Woods last weekend, enjoying the wonderful Fall colors, and came to the conclusion that there are lots of valuable trees standing there. Big red oaks, tall and straight, that would surely fetch a hefty price at the sawmill. I came back home smug that a woodlot is a great investment (and me a savvy investor…)

However, my bubble was burst when I read up on the potential revenues from a timber sale. If I harvest a good number of acres, the net income would barely pay for the real-estate taxes on the rest of the lot! This disappointment is often what happens when owners of technologies or companies hope to sell their hard-earned products or assets. Beauty may be in the eye of the beholder, but the value lies completely in the hands of the marketplace.

In assessing value, the initial impulse of the seller is to assume that the buyer would realize some many-fold improvement in their situation. Not only would the newly acquired asset provide its expected value (e.g. x% net income, 3x processing speed, etc.), but some mystical force would lift the buyer to hitherto unknown levels of euphoria. This “synergy” is usually the most overvalued part of the sale by the seller. My oak trees do not instantly transform themselves into Nakashima tables.

• To combat synergy hallucinations is simple. First step is to look at the current market. Whether you are selling a new pipettor or a $20M company, there are some basic ranges of value that you can expect. Currently in the life sciences, a company is valued at about 2 times its top line revenue or about 7-8 times its earnings (EBITDA to be exact). So the $20M company is worth in the neighborhood of $40M to a prospective buyer, assuming it is operating well (but that’s a whole other topic…)

• Another quick approach to reel in your early-retirement plans is to look at your flow of money. Just sum up the estimated cash flow for the next 5 years, discounting the out years, and adding on the discounted value of your enterprise in the 5th year. So if your $20M shop is providing around $5M per year, you get a value of around $30-35M. This should also get you pretty close to reality.

So rather than dreamily wandering about your environs thinking about which island to buy, spend a few minutes to instill some reality into the expected worth of your assets. That said, we can still hope for that buyer who sees the tremendous untapped value growing in the forest.