Ramon Ecung's Personal Blog

Let’s take a look at how to value an organization. We’ll take the following company as an example:

Wide-Comm Wireless provides wireless broadband service using Wi-Max, a largely unproven technology, on a wide scale. As expected the company lost money it’s first few years as it built it’s infrastructure. It does not expect to reach profitability for another three years. It had a positive cash flow of $4M in 2008. By 2011, management projects $10M in positive cash flow.

Mega Telecomm, Inc. approached Wide-Comm about acquiring it. Mega Telecomm has offered $12M. Wide-Comm countered that it thinks it’s worth at least $50M.

How can there be such a difference in the valuations of the same company? Let’s explore.

Ever since I was a kid, my parents have told me that if I was to sell a business, I should take into consideration the future profits I would be giving up in consideration of the selling price. It is evident that Wide-Comm is doing just that. In the view of Wide-Comm’s management, they are operating a successful business that has survived it’s initial period of negative cash flow and has become profitable. Using their forecasts for future revenues, they see that they are poised to reach $10M in 2011. Even being conservative and not planning future growth after 2011, the positive cash flows for the next five years will be near $50M.

Management is probably either not being very objective or taking a hard line stance on negotiations by keeping their figure on the high side.

Mega Telecomm, on the other hand is being conservative with their estimate and probably valuing Wide-Comm based on the book value with maybe some profit in the mix because the company has recently become profitable.

One reason Mega Telecomm’s valuation of the company is so low could be because WiMax is still a new technology, and issues with it’s deployment, FCC regulation, or other matters seem to be greater risks to Mega’s management team than Wide-Comm’s. They may also see greater opportunities in other network technologies and want to liquidate Wide-Comm’s assets, but keep their customers in order to gain a revenue source.

As long as both companies are using facts to develop their valuations, both can be correct. In this rather extreme case, I feel that the deal will be made or not based on Wide-Comm’s management team’s exit strategy and if they’re willing to stay in business for the long haul.

One thing the companies may end up doing if they cannot reach a deal is to develop a strategic partnership where they share information, technologies, and infrastructures in a way that benefits both organizations.

NOTE: Example taken from Ben Compaine’s lecture at Northeastern University.