Whenever the economy’s in bad shape and companies are going bankrupt left-and-right, you start hearing talk of liquidations and “liquidation valuations.”
While this type of valution is useful for companies on the brink of bankruptcy, it also comes up in other situations – so let’s take a look at why we use liquidation valuations, what they are, how you create one, and how you can learn to use them in investment banking.
Why a Liquidation Valuation?
At the most basic level, a liquidation valuation tells you how much a company is worth just by looking at its tangible – so-real-you-can-touch them – assets and liabilities.
This is important because lots of companies have much of their value embedded in fluffy concepts like “good customer relationships” and “brand equity.”
That’s fine, but it’s hard to precisely measure the true value of that stuff – it’s easier to say what a factory and some inventory is worth vs. what “brand equity” is worth.
So it’s more concrete than other valuation methods – which is important both for healthy companies and for when a company is bleeding cash and needs to rapidly sell off assets to stay afloat.
What is a Liquidation Valuation?
The mechanics are very simple: you take a company’s balance sheet, estimate a “recovery value” for all of its assets, and then sum up everything.
Then, you take this total and subtract all the liabilities on the company’s balance sheet to arrive at the company’s “liquidation value.”
And that’s what shareholders get.
So you’re assuming that you sell off all the company’s assets for a certain price, use the proceeds to repay debt and other liabilities, and then give the remainder to shareholders.
How Do You Build a Liquidation Valuation?
The best way to illustrate this is to go through a simple example and divide the process into steps.
Step 1: Put the company’s balance sheet in Excel format.
You can look up your company’s balance sheet in its 10-K (annual) or 10-Q (quarterly) filing via the EDGAR database right here.
For non-US companies, you can visit their websites and look for their annual and interim reports under “Investor Relations.”
Once you have the report, go to the balance sheet and enter all the data. Here’s an example:
Note: We are leaving out Shareholders’ Equity here because all we care about are assets and liabilities.
Step 2: Assign a recovery percentage to each asset.
This is the trickiest part of the liquidation valuation, and often you need to ask the CFO or accountants for the correct values to use – only they know how much a sold factory or sold investment might be worth. Here are some guidelines:
- Cash: Usually close to 100% recovery value is assumed because it’s the most liquid asset.
- Investments: Close to 100% for short-term, liquid ones, and significantly less than that for debt, non-liquid investments, or investments in other companies.
- Accounts Receivable: Less than cash because many customers might “forget” to pay a distressed company. 70%-90% is a common range.
- Inventory: Even less than Accounts Receivable, because unprocessed inventory is of little use to other companies. Often you assume around 50% here, but more than that if the inventory is closer to finished products.
- PP&E: Close to 100% for land and buildings, and less than that for equipment because it depreciates faster and is worth less when you re-sell it.
- Goodwill & Intangible Assets: 0%. You can’t “sell” your brand name or your relationships with customers, so these are worth nothing to possible buyers.
You can see the values that we’re using right here:
Step 3: Multiply the asset values by the recovery percentages to get the liquidation value for each asset.
This is a simple Excel formula – just multiply each asset by each recovery percentage:
Step 4: Add up all the asset liquidation values.
Use the SUM function in Excel to do this – make sure that you add both current and long-term assets.
Step 5: Add up all the liabilities on the company’s balance sheet.
Again, you can use the SUM function here and be sure to add up both current and long-term liabilities.
In this example, we’re creating a separate, identical column for the liabilities simply to align it with the asset liquidation values above. This is not completely necessary, but it does make our model more flexible – in case we wanted to add recovery values for these in the future.
Step 6: Take the total of the asset liquidation values and subtract the total liabilities.
Simply go up to the total asset cell and subtract the total liabilities:
Step 7: Divide by the company’s shares outstanding to get the per-share liquidation value.
You don’t always need to do this, but if you have this information it’s a good idea to divide by the company’s total shares to get a per-share value – this represents what each shareholder gets for each share he owns:
Go and find a company that you follow, look at its balance sheet, and create one of these valuations on your own.
You can use our sample Excel file right here for guidance:
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Inside the Advanced Modeling course, we also go into the liquidation valuation in-depth for a real company – Yahoo! – so check out the sample videos there to learn more.
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