Over the years I’ve personally built dozens of financial models (ok maybe hundreds but I wouldn’t admit that in public) for companies ranging from $1 million to $10 billion in sales. Models forecast revenues, expenses, cash flows, and scores of other unpredictable metrics. They are built on a set of underlying assumptions about growth rates (note: in models things are always growing) and ratios between various metrics. Some small and simple businesses have financial projections that are relatively straightforward extrapolations of recent trends. For complex companies with a series of input costs and multiple streams of revenue based on supply, demand, and pricing, projections can get unbelievably robust. Whether models only occupy a few of your precious excel tabs or kill an entire forest to print, the only thing I can tell you for certain is they are wrong.
Nevertheless, I still believe in the process of building a model. If you’re the buyer of a company or an asset, creating a truly comprehensive financial forecast helps you learn the key drivers of the business and how sensitive profitability is to those items. If like me, you provide financing to people acquiring assets, a model can tell you if the person who built it is crazy! I’m shown “hockey sticks” all the time (a euphemism for exponential growth). If you show me projections of 25% growth on a company that has averaged 5% in the past 5 years... well that's all I need to know.
I believe past performance is the best indication of future results, especially when compared to a guess (model). If your company made $10 million in EBITDA for the last 5 years running, I’ll put good money on that rate continuing for the next few. If your profitability declined 50% in 2009 during the recession and then recovered, I’ll bet the same will happen the next recession. If you’ve built up companies and created profitable ventures in the past, then yes, you’ll probably do it again. I focus on historical results and quantifiable assets and cash flow to determine value and an investment's prospects. I dig deep into the company to understand the underlying drivers, trends, changes in the industry, management team, supply, and demand to see what has changed. I look for steady, increasing, or somehow replicable cash flow and/or hard liquid assets that I can sell if things go wrong. A forecast model won’t give me any of that information... but at least it will tell me if you’re crazy.
Sunday, June 26, 2011
Sunday, June 12, 2011
Bank Said "No"
This week in the New York Times there was an article about the type of lending we focus on at Catalus: “Bank Said No? Hedge Funds Fill a Void in Lending”. Banks are extremely conservative today, lending only into the most attractive geographies, requiring a very conservative LTV (loan to value) against hard/liquid assets, and expecting robust cash flow relative to loan payments. We partner with businesses that have been rejected for bank financing, wouldn’t be eligible, or didn’t get the full amount needed. Catalus provides capital where banks won’t.
I always tell borrowers, “Get as much bank financing as you can. It is the cheapest capital available. If they don’t give you enough or if they don’t give you anything, Catalus will try to work with you to fill the gap.”
The difference today in the lending markets of large versus smaller companies is striking. Blue chip companies like Johnson & Johnson, IBM, Google, and Microsoft are issuing debt at some of the lowest yields in corporate history (I’m talking 1-2%). The high yield index, tracking a basket of junk bonds, is also at historical lows after being at an all-time high during the apex of the financial crisis. Institutional investors who can only invest in investment grade debt or public markets are desperate for yield. On the other hand, companies not large enough to tap into public markets live the story described in New York Times article.
Investing in a smaller private business warrants a higher return because it is more complex and risky. Larger institutions are scrutinized daily by thousands of analysts, investors, the media, and other interested parties. They use the highest quality auditors, law firms, and advisors. Information about the history of the company, the management team, and the financial performance is readily available. None of this holds true for the private markets.
When Catalus partners with a private company it’s a very personal experience. We seek companies and people we believe in and get fully educated on the business, the industry, and the management team. Our investments are viewed as long-term partnerships and our financing package typically includes a minority ownership stake and a board seat. In this role we are active by making introductions to potential joint venture partners, working to improve efficiency/operations, conducting financial analysis, and assisting in the evaluation of acquisitions and expansion plans. Our goal is to add enough value that when our partner companies want additional capital they come to us first.
I always tell borrowers, “Get as much bank financing as you can. It is the cheapest capital available. If they don’t give you enough or if they don’t give you anything, Catalus will try to work with you to fill the gap.”
The difference today in the lending markets of large versus smaller companies is striking. Blue chip companies like Johnson & Johnson, IBM, Google, and Microsoft are issuing debt at some of the lowest yields in corporate history (I’m talking 1-2%). The high yield index, tracking a basket of junk bonds, is also at historical lows after being at an all-time high during the apex of the financial crisis. Institutional investors who can only invest in investment grade debt or public markets are desperate for yield. On the other hand, companies not large enough to tap into public markets live the story described in New York Times article.
Investing in a smaller private business warrants a higher return because it is more complex and risky. Larger institutions are scrutinized daily by thousands of analysts, investors, the media, and other interested parties. They use the highest quality auditors, law firms, and advisors. Information about the history of the company, the management team, and the financial performance is readily available. None of this holds true for the private markets.
When Catalus partners with a private company it’s a very personal experience. We seek companies and people we believe in and get fully educated on the business, the industry, and the management team. Our investments are viewed as long-term partnerships and our financing package typically includes a minority ownership stake and a board seat. In this role we are active by making introductions to potential joint venture partners, working to improve efficiency/operations, conducting financial analysis, and assisting in the evaluation of acquisitions and expansion plans. Our goal is to add enough value that when our partner companies want additional capital they come to us first.
Subscribe to:
Posts (Atom)