Numbers and Narratives

to a Picasso exhibit I want you to give him a little bit of cultural exposure so it doesn't look good Picasso exhibit that came through New York so after we come out of the exhibit I asked him Ryan what do you think about that he said I wasn't impressed at see this guy can't get the nose in the right place you know this is about Picasso Santos comes out of this side of the head the top of the head either he's drugged or drunk or whatever it was the nose is all over the place but we've all gathered together and decided for better or was it the cast was over 200 million the essence of an art is you cannot teach it you're either a great artist or you're not thank God valuation is not an art because if it were or not I wasted 31 years of my life trying to teach something that cannot be taught so it's not a science and it's not an art what the heck is it I'll give you the word that I use to describe valuation it's a craft the analogy I would give that's closest to valuation is cooking think of how you master cooking you can do what my daughter does she watches cooking shows on TV all day long she can't cook a lick but she watches shows all day about how to cook you don't learn cooking by watching TV shows you don't learn cooking by reading cookbooks he learned cooking by going into that room in your apartment or house called the kitchen remember that place because you've been taking a card for so long you haven't been in there for a while and starting to cook in the first time you cook guess what happens disaster strikes I do remember the first time I scrambled eggs nobody told me I was supposed to spray the damp and after scrambling day I'm really proud of myself I tried to get the egg off the pan doesn't come off egg and pan went into the trashcan I learned a very important lesson though never again would I scrambled eggs without spraying the pan you don't learn valuation by watching somebody talk about valuation the next hour is wasted you don't learn valuation by reading what other people write about valuation some you've been reading my valuation books what a waste of time you learn valuation by doing and the more different the companies you value the more you will learn about valuation I still surprised myself when I value a company about things in valuation I didn't know till I value that company I've been doing valuation for a long time but that to me is the most amazing part of valuation is how much more of this craft I still don't know so what I'd like to talk about is one aspect of this craft where I think I've had to work at it and I'd like you to take you on your journey on what I had to do to get where I am today so I'm gonna ask you my second question so right after I asked is it not or science says the second question asked if I asked you to categorize yourself as a person would you more naturally think of yourself as a number cruncher or are you more naturally a storyteller think about it for just a moment there's no right answer don't look at your neighbor don't look at me think about yourself what comes more easily to you number crunching a storytelling thought about it you saying how would I know you've known for a long time you know when I knew I knew when I was like 12 or 13 right after my first English literature class cause I read Moby Dick and I did I was a good kid I showed up in class ready for a discussion of whales and captains and 15 minutes into the session I noticed nobody was talking about fish so I put up my hand said when are we gonna talk about the whale the instructor said there's no well said what did I read the wrong book I distinctly remember a big fish all the way through the book and she said it's a metaphor and I said for what and for the rest of the class she talked about hidden meanings in the book and I remember sitting that with my jaw drop saying really that's what Herman Melville was thinking when he did that when he wrote that and when I came out of that class I came out with a singular conclusion I said never again am I gonna subject myself to that kind of and the rest of my high school life was laid out for me I avoided the literature classes like the plague you knows Algebra one algebra to algebra three out of high school and these were the good old days when you could go to college and not take this core curriculum crap that they make you take today you could take numbers class numbers class numbers class numbers degree you can you went for a numbers job my typical valuation class there are 300 MBAs in that class every semester so I asked this question not surprisingly about a hundred and eighty of the people in the class put up their hands there were more naturally number crunchers selection bias but only 180 out of the 300 do you say what about the other 120 they were the people actually love that hidden meaning stuff to the port's they're like my youngest son writes poetry he showed me his first poem I don't think he's gonna show me anymore so what do you think dad and I looked and said Karen I like it but aren't the words supposed to rhyme because that's the way I think about poetry like nursery rhyme so the last words don't rhyme it's not poetry to me he said dad you're not a poet and I said you're right Claire keep writing poetry don't show any more to me 180 people are number crunchers the remaining 120 our storytellers they're the ones who go literature one literature literature three go on to become history majors at Yale and then discover after they come out that even Yale history majors don't get paid very much so four years afterwards they come back to business school they're in my class 180 number crap they don't sit together for some reason they segregate and when I ask this question of course the number crunchers think that they owned the high ground they look at the stories oh what the hell are you doing in this class it's a valuation class it's all about numbers and that's when I have to let them in and what I think is the biggest hidden secret in valuation valuation can never be just about the numbers if all you have is a collection of numbers in a spreadsheet don't have a valuation you have a spreadsheet so much of what we think about valuation now has become model you notice this it's all Excel modeling there's very little valuation you're just modeling things on a spreadsheet good valuation is a bridge between story and numbers so what are you talking about if you show me a valuation a discounted cash flow valuation and I point your revenues in your six and there's six billions a wire revenues six billion in year six no the answer I don't want to hear us it's because I used to thirty five percent growth rate for the first three years and fifteen percent for the next three that tells me absolutely nothing I need to know what your story is about this company that will allow it to have a six billion dollar revenue in your sex every number should have a story at that soon when you tell me a story about the company every story should have a number attached to it like what you talked about the great brand name this company has this incredible management team I'm gonna ask you where is it showing up in the numbers that to me is the test of whether this is evaluation is just a collection of numbers or a collection of stories the reason I think we need to do this more than ever before is we live in a world of specialization if you're a number cruncher guess what you do you hang out with other number crunchers you talked on the number crunchers you live with other number crunchers you forget that there are stories and if you live with storytellers all you do is tell each other stories and left to our own devices we wallow in our delusions so let's start with the delusions that number crunchers have and because I'm a number cruncher I can list these delusions and if you're a fellow number cruncher tell me whether you share these delusions the first is the dilution of precision you know that is when number crunches if you feel uncertain you know what makes you feel less uncertain add a decimal that's what number crunchers do I feel uncertain let me add a decimal I feel much better now the dilution of precision if you make it look more precise it's become more precise the second is the delusion that because you're using numbers your unbiased as if you can't hide bias in the number and third the delusion of being in control you think if you put a number on something you're in control of it those are the delusions of number crunchers if nu hang out with other number crunchers you forget these are delusions storytellers have their own set of delusions and because I'm not a storyteller if you're one tell me whether I'm missing a delusion or mischaracterizing one the first is the delusion that you really can't quantify this really big story I've heard people say what brand name can't be quantified the quality of Management can't be quantified it's such a big story you also think being creative should bring its own reward I told you such a big story it should be worth at least three billion right and the third is you love using anecdotal evidence storytellers are like my mother-in-law and I don't mean that as a compliment she comes up with the most outrageous hypotheses she doesn't call them hypotheses she calls them facts so I remember about seven or eight years ago I was sitting at dinner and out of the blue she says the best car to drive in a snowstorm he's an old Volkswagen bug I said what so how do you come up with the stuff Judy I should never ask her this question because she always tells me she said well twenty-five years ago she was in lake tahoe in the middle of a snowstorm driving her walks wagenbach and she had arrived to poo two miles from the grocery store back home she made it back safe but there were two other cars that ran off the road this is so so that proves it doesn't it a Volkswagen bug is the best card it's amazing sample size of one how much you can extrapolate from there left to your own devices you're not even going to see these exclusions and increasingly we live in a world where we hang out with people who think like we do act like we do have the same training that we do and of course we all find each other completely reasonable so here's what led me to the conclusion that I had to do things differently I said I started teaching valuation in 1986 for the first six years that I taught valuation I taught it like a number cruncher day which means when in doubt put up an equation there an even more dot put up two equations about six years into this process I realized that a problem here was my problem I could value just about anything I knew the mechanics but I had no faith strange word to use right but let me explain what I mean by faith when you value a company and you come up with the value higher than the price why do you wear your companies I don't know about you but I don't lie awake at night wondering what's Facebook worth right now I don't it's not because you're intellectually curious you value companies because if you come up with value higher than the price you should be willing to buy right and to buy what do you need you need faith in your own valuations and faith that the market will correct I found myself faithless it's a bad place to be you're teaching the class you have no faith in your own valuation so what am I missing and what I realized I was missing was I was being completely mechanical I knew exactly what the mechanics evaluation were but there were no stories that connected the numbers together I had to teach myself how to tell stories and the first time I did it was like scrambling eggs the very first time it was a disaster but 25 years later I think I'm a little better at telling stories and I used to be when I first started so what I'd like to do is take you on a journey of how I approach valuation because I have to be disciplined because left to my own devices I'm gonna open up that spreadsheet inside and drink numbers because that's where my number crunching will lead me so I almost have to force myself to slow down and perhaps as I describe what I do you can find your own devices for how to connect with your weaker side you know what I mean by your weaker side if you're a number cruncher how you connect with your storytelling side if you're a storyteller how you can connect with your number-crunching side so in my valuation class after I do this survey I turn to each group and I tell them what my end mission or mission for this classes so first I turn to the storytellers and I said look by the end of this class 15 weeks I hope you develop enough number-crunching skills that you develop some discipline because left to telling stories we don't watch out your storytelling is going to wander off into Fantasyland so hopefully you'll develop enough number-crunching that you know when you wanted into fantasy that discipline story tell us then I turn to the number cruncher by the end of this class I hope you develop an imagination imaginative number crunchers or discipline storytellers guess who I have more trouble with every single semester getting storytellers to develop discipline or number crunchers let loose with their imagination number crunchers every single semester give me more trouble you give me a hundred history majors I can teach them in evaluation value company tomorrow valuation is not complicated you give me a hundred engineers I throw up mines in the I'll give up right here right and one of my problems the CFA it's one of the problems one of the problems begin a key note of this here being the only person in the room it doesn't have a CFA with no desire to ever want to CFA or be near a CFA is how mechanical so much of it has become so I still think to see if it's a great way to see the landscape in terms of mechanics understanding what's out there but walk away from the mechanics the mechanics can really get in the way of doing valuation understand the mechanics but make it work for you so here's what I'm gonna do I'm gonna lay out the five-step process I use to value a company why five steps because I'm a number cruncher I have to think in Lanier's so if you are a storyteller why five steps jumble them up use your own sequence I need a sequence because without a sequence I am going to run to the spreadsheet my first step and I sit down the value company is I have to tell a story about the company notice what I said my first step is not to open the spreadsheet and start entering numbers not to take a financial analysis and project out numbers but to tell a story about the company of course you tell that story I need to understand what the company does who its competition is what the business is so I need to understand the company enough that I can tell a story about the company let's face it if you think Cisco makes vegetable oil then the rest of the evaluation isn't as cisco make vegetable oil in doesn't it that's Crisco you're thinking about but if you think Cisco makes vegetable oil it doesn't matter how well you can do spreadsheets your valuation is going to be crappy so the first step in the process is understanding the company enough so you can tell a story about the company second step in the process and this to me is a critical step is you got to stop and make sure the story you've told is not a fairy tale that it's possible or you can't stop that you have to ask is it plausible a tougher test impossible has anybody else done something like this before and the third step is it probable what have you put in place for this to happen so each step you can actually see that you're getting more stringent about your requirements is it possible plausible problem so that's the second step once you got through the first steps two steps you got a story that you think is more not just possible plausible and probable you make each part of your story when you convert it into a number in your valuation this to me is the craft but I view it as a challenge when you give me a story say where in my valuation would I reflect that story by the time I convert my story into numbers step four my valuation does itself the valuation just an output for my story so in step four you're done with the evaluation right but then there is a step five which is painful but the step you have to go through anyway they ask you question you tell a story about the company you convert the story into numbers and numbers become a valuation do you like your own valuation of course you do it's your company you told the story you've come up with a valuation so when you show your valuation or other people what do you want them to tell you amazing job this is exactly how I'd rally the company and if you hang out with people who think just like you that's exactly the reaction you will get a free cash flow to the firm that's why you should value every company cost a capital of course here's my suggestion find people who think least like you present your valuation to them and be ready for some blowback you say that's horrible that's not the way I think about valuation don't get defensive listen they call this a feedback loop because that's the way you tell a better story you take your story and said what can I change what can I improve about the story and for that to happen you got to listen to what people disagree with you on the most five-step process and if you can follow that process you will have a value that's not just numbers but a story connected to numbers it sounds abstract right so that's what I'm going to do I'm going to use two companies to illustrate this process I could do this is any of the company's a value but I'll take these two companies because I'm sure you're familiar with both the first company I'm going to values uber in June of 2014 I just took an uber from dupe and Dorff over here so Hoover's obviously here you know what does latest pricing for the company was about 70 billion so clearly people think it's worth a lot maybe it's worth less than it was three months ago but it's still 50 60 70 billion so this is so the first company I'm gonna values uber in June of 2014 using why the June of 2014 because I valued uber every year since 2014 and guess what my story has changed because the world has changed and it's a story change my values changed so I'll take you back to June of 2014 and show you the story I told and how that story became numbers into my evaluation and final valuation the other company I'm going to use is Ferrari in October of 2015 at the time of the initial public offering Ferraris been around a long time since 1948 but Enzo Ferrari in the 1960s got into a little bit of financial trouble or a lot of financial trouble I had to sell off 90% of Ferrari to Fiat and it stayed as part of Fiat Chrysler till 2015 so in October of 2015 there went public and at the time they filed their prospect is I chose to value Ferrari so I'll take you through the process of how I valued Ferrari again starting with the story and in the valuation and because you should be familiar with both companies here's what I'd encourage you to do as I tell my story rather than and moan about what you don't like about my story remember it's my story whatever story I want this is my evaluation of uber and Ferrari you don't like it tell your own story and I'll give you the tools to convert your story into valuation that's the essence evaluation drug then no fight about revenue growth rates which is such an arid abstract discussion we should be talking about what's your story about this company what's my story because different stories can lead to different valuations you ready let's get started the first step in valuation before you sit down to value companies you got to understand what your company does you got to understand the business it's in you got to figure out what its competitors do you got to understand why people buy stuff from the company why people work for the company and one of the problems with how things have evolved over the last thirty years is we have access to so much more data than we did 30 years ago then when I ask you to do research in a company what's your first instinct go to the computer collect data and start putting into spreadsheets that's useful you can look at them the historical revenue growth the historical margins etc but don't stop there to really understand the company you got to talk to people like who like the customers of the company like the employees without it you really don't get a sense of the company so I take you back to June of 2014 and tell you a story about how I got interested over June 3rd I think 2014 open up the Wall Street Journal and there's a little new story this venture capitalist had just invested in this company called uber and I'd never heard of uber before June of 2014 because I live underground in New York City I take the subway I don't take cars service anyway I don't take cabs it's a venture capitalist at priced the company at 17 billion what's the word that I just used to say venture capital is that price whatever word that I did not use high-value venture capitalists never value companies their price that's an entirely different discussion price and value are not interchangeable price comes from a very different process than value does if you believe in efficient markets of course the two will converge but there's a pricing price of venture capitalists price the company at 17 billion no surprise had never heard of the company let me take that back I'd seen the word uber on my credit card statements in the three months leading into June of 2014 because it turned out that my second son was going to college in North Carolina was using uber and using my credit card but I thought he was taking German language classes to be quite honest the no moon lard and the user I kind of given it away right so I said okay let me call him and find out what the zubur company is all about maybe it's not a German language class because I can't imagine a German language company be worth 17 bill so I called my son and he was sleeping 11:30 in the morning you kept college student hours which means you go to bed six o'clock in the morning you wake up at 2:00 in the afternoon god only knows what she was still sleeping so you wouldn't pick up the phone so I called my niece who is working in Chicago so she had to be awake but she was in a terrible mood she says what do you want there's no way to talk to your uncle who's been called not called you in a few weeks so I said no if you to the zoo but she said it's a ride-sharing company so what the heck is a ride-sharing company she said I don't have the time to talk to you why don't you just download the app and find out for yourself need to talk to her mother about this behavior she hangs up the phone they said okay download the app for my phone hit the App magical things start to happen on my phone a GPS opens up and I see a car trying to drive towards me it's New York City you don't drive towards me you try to drive towards me a lot of one-way streets and I can see a guy called George sitting in the front seat this has never happened to me with the yellow cab so fascinated i watch 15 minutes lady pulls up in front of 44 West 4th Street which is where NYU is I run out to the car and say hi George he says where do you want to go there's no way can you drive me around for about 35 minutes have some questions to ask you I thought for a moment that I was a serial killer but he said I can take your just get in the back so I get in the back and I start asking questions questions like is this an uber car you're driving you said no this is my car I said are you an uber employees no I'm an independent contractor I just why do you do this he said you know what I have a regular job I don't make enough money on it I already own my car I pay insurance on it and this is a way for me to make a second income on the car so that's interesting why do you need over we said in New York City you can't pick up people on the street it's against the law Moomba connects me with customers okay I can see why you drive the car I can see why you need over thirty five minutes later he drops me off back in my office and I offered to pay him he should've just taken the money said you don't have to pay me I said it's free I said no it's not free he said when you downloaded the app they ask you for a credit card number is I said yes and so they'll charge you so how do you get they said they'd send me 80% of whatever your fare is I said why 80% he said I don't know that's what they all do now I could see why whoop I did what they did they don't own the cars they don't hire the drivers for being matchmakers that's all they are they get to keep 20% of the fare so I could understand why this guy drove through but I could see why uber did what they did it's one missing piece why do people like my son like uber I see my son I can I can't even imagine him calling a regular cab on the street it's beyond his comprehension going out in the street waving his hands you know so I called I mean this time it a civilized hour but I knew he could not be asleep like 3:30 in the afternoon so I put him on the defensive right away it's a good strategy if you have kids I said I noticed you've been using my credit card to back up your right share had to like a new Hoover as a ride-sharing company I said you already own a car North Carolina what the heck are you doing taking over all over the place he said dad on Friday nights and Saturday nights I really like uber there are no follow-up questions you want to ask here because you're afraid of what the answers might be but I kind of got it I said okay I said what do you like about Ober he said I can call the car from the bar okay that's good I said but these cars must be more expensive than a cab right he said no no they're cheaper than a cab I said really you must wait forever right they come quicker than a cat I said okay the cheaper than a cab they come quicker than a cab these cars must be filthy right there's another cleaner than a cab that's when a new cab service was destined for do the cheaper they're faster they're cleaner over time they're going to take off the only question I had left was what's so special about uber why can't I go into my basement and start a matchmaking service and I could think of three reasons why work one was three billion that's how much a venture capitalist is given oh but they didn't get they forgot to send me the three billion the second is there is a networking benefit in this business the word we use loosely but if you're a ride sharing company as you get bigger it actually gets easier to get bigger that's what a networking benefit is and here's why it happens if you're a driver signing up for a ride-sharing company guess where you want to go you want to go to the biggest ride-sharing company because that's where the customers are and if you're a customer guess which ride-sharing app you want to use you want to use the ride-sharing app of not the smallest startup but the company that's been around the most because there are more cars around so Ober has three billion they've got this networking benefit because they got started earlier than I did and the third potential benefit I could think of this uber does collect data about you so if you use uber they know more about you then you want them to know they know where you left when you left who you met you know they're pretty much keeping tabs on you and they use it in creative ways like what you heard of uber surge pricing right I don't know whether it's it's it's true in Zurich but in much of the world the fare you pay an uber will depend on the time of the day you take an uber and where you take the over from because they adjust the price to demand and supply very sensible way to ration they're using the data in fact in the US they actually have coded it by zip code what the income level of each zip code is which means if you call for an uber from a high-income zip code your fare is actually different I tell my kids if they're in a higher income zip code walk three blocks away to a lower income don't get mugged but call from there because your fare will be about twenty five percent lower so when I was done with if you can even call you think why don't you look at the financials why are you wasting your time why don't I look at the financials uber is a private company there are not financials look at even if I'd wanted to but even if I'd been able to look at the financials what would I have learned by looking at the financials there's nothing there it's a young company it's a start of the financials are going to tell you very little about a company if it's that young this is exactly the kind of research I need to do to understand the company so when I was drunk when I was done I drew a picture and I tried to do this almost every company I value a picture of what makes this company tick what makes it succeed what it does well what it does badly why no why it might acquire more market share forms competitor why less so this was my uber picture based on that research if he can call it research that I did of asking people questions about the company so this stage I kind of understood what Oberer did as a company I kind of understood the ride-sharing company kind of is about all I aspire to do I don't want to be an expert in ride-sharing I'd far better things to do with my life but I knew enough about this business that I could get started so that's I call this surveying the landscape understanding the business you're in understanding the company let me move the Ferrari October of 2015 what business is Ferrari loosely speaking the automobile business and that's really bad news you know what every year I go through this perverse exercise of listing the 10 worst businesses in the world to be it and if you work for a company hope and pray you're not one of these 10 I'll give away some clues you don't want to be in the airline business ever you know the other business that consistently shows up in the 10 worst businesses the automobile business do you think what's so bad about the automobile business let me nail the coffin shut on the automobile business here are the things I don't like about the business leading into 2015 in the 10 years prior the collective revenue growth at all automobile companies in every single market put together was only 5.6 percent and half that growth came from thank you China I tell my MBAs whenever somebody asks you a question to which you don't know the answer just say China notice how well it works for almost any question why are interest rates low China while interest rates high Chinese just make it sound profound like you thought through this it usually works pretty well as the answer to pretty much every question you think so what if China slows down that 5.6 percent growth is very quickly going to become 4% growth so you got low revenue growth first nail in the coffin second this is a business where companies make abysmal operating margins one-third of all automobile companies lost money in 2014 and was in a recession year the median operating margin I'm not talkin net profit margin I'm climbing the income statement the median operating margin for automobile company is 4.4 percent no revenue growth bad margins let's nail the coffin shut usually we're a company with low revenue growth one of the few bonuses you get is you don't have to invest much in capex why is he not growing very fast unfortunately for automobile companies they've had to invest a great deal of money in the ten years leading into 2015 not in assembly plants but in R&D you know what you if you can do new car notice it's more computer than car that's what the R&D has been is investing in that computerization process if you have low revenue growth bad margins and lots of reinvestment you know exactly what's gonna happen the kind of returns you're gonna generate as a business are going to reflect it and in 9 of the 10 years leading into 2015 automobile companies have earned a return on capital less than the cost of capital this is a bad business so you gave me a Volkswagen to value my best case scenario is still going to look like a horror story you give me GM or Ford there's no good ending to the story but luck luckily in the case of Ferrari Ferrari is not just another automobile company I'm not even sure it's an automobile to be quite honest it's a very impractical car there's one guy in my town owns a Ferrari I've never seen him drive it it's kept in an extra armored garage with two guys standing in front of it guarding the garage you can break into this guy's house multiple times every day he wouldn't even notice but his car is well protected the rumor is that once every year he takes a car out of the garage he drives it around town and back into the garage and parks it for the next year can hope and blame the guy when are you going to drive your Ferrari can you imagine grocery shopping in your Ferrari you go and park your car you're going to grocery store you come out that's $15,000 worth of damage on the car how about driving carpool in a Ferrari that must be fun you got to pick up four kids in one seat you got to stack them up so why does this guy pay all this money to own a car he never drives what people in Ferraris did anybody you're on a Ferrari you're on a Ferrari very exclusive dreams if everybody had the same dream you wouldn't buy the dream they price the dream enough it is you want to be part of an exclusive club that's a reality that's why you buy a Ferrari in fact to show you how exclusive it is we should tell you a little bit about Ferrari in 2014 the entire year all over the globe Ferrari sold seven thousand two hundred and fifty five cars think about it seventh out that's how many cars walk swag and probably rejects on its assembly line every day seven thousand two fifty five cars entire globe that's the bad news didn't sell very many cars but here's the good news they're operating margin is 18.2% what is it median margin for an automobile company to remember it's about four point four six percent their operating margin is four times higher why because they charge sky-high prices and they spend almost nothing on traditional advertising almost all of their I'd spendings on sponsorship of the the races that they do have you ever seen a Ferrari ad that says come on in 10% off they don't want the kind of people who'd come in with 10% off in fact I live in a part of the country La Jolla where I run buy a Ferrari dealership every morning on my job and I've been trying to steal my courage up to go in to the dealership because I'm afraid I'm afraid they'll ask me for references like how many billionaires do you know not get out of here this is an exclusive club they're not gonna let anybody walk off the street and here's the final bonus for being an exclusive club usually when you sell a luxury good your revenues tend to be very volatile depending on how well or badly the economy's doing Gucci Tiffany you look at the economy and you basically see the revenue swing around Ferrari has sold about 7,200 cars every year for the ten years leading into 2015 including 2009 the year after the great crisis seeing how come if you ask a Ferrari owner how's the economy doing you know what their response is what's an economy did you talk about do them bad years I'm with only four billion I used to be what 6 billion there are exactly cutting coupons you know what this is going to show up right when I do my caustic capital Ferrari I'm going to reflect the fact that they're an exclusive cab they sell to people they're so exclusive that they in a sense have less risk than somebody who's less exclusive but it goes with the story at this stage I kind of knew enough about Ferrari to tell a story so now comes the part where I have to tell a story and here I have to remind myself that I'm not a novelist I'm telling a business story you're saying so what two suggestions if you ever have to tell a business story so if you're a startup founder first keep it simple as opposed to what I remember about 10 years ago my oldest son the same one I took to see the Picasso exhibit gives me a book to read he says dad you got to read the series it's amazing book is about thousand pages thick and look at the book it says Game of Thrones regula says George or Martin it's okay I'll try it because I take my kids book suggestions very seriously two weeks later I call my son and said nein I'm too old for this I'm halfway through the book they're like hundreds of characters they walk on they walk off they die they come back to light they're in this Empire there in that apart I've completely lost control of this story I give up so here's my suggestion you're telling a business story don't make it Game of Thrones you don't have seven seasons in 70 episodes to tell a story yeah like 15 minutes so keep it simple keep it focused what's the end game for every business tell me how you expect to make money I don't expect you to make money next year but tell me what your plans are you'd be amazed at how many founder pitches upside through we're about 15 minutes in I stop like I'd say the guy's so excited I have this tremendous app look at how many people are downloading and friendly stop and say how do you plan to make money he says I have to make money let me go back to how great the app is now many people know you have to tell me how you eventually expect to make money is it on a subscription model is it from advertising so keep it simple keep it focused so I'm going to take those pieces of advice and show you the stories at least tell you the stories I told for these companies at the time that I valued since June of 2014 after doing that Masek research and over just the story I told by uber remember what I told you as I tell the story you say that's wrong I'd have told a different story this is my story you can tell your own story here's the story I told about over and every word in the story is gonna matter in my evaluation I describe uber as an urban car service company called ready I'm trying to tell you where I think we'll both succeed right urban basically means cities and big towns and I see its primary business as car service who's robbing car service company that will attract new users into this business like whom like my son somebody would never have taken a traditional cab it's going to come into the business with local networking benefits I already talked about what networking benefits are rubra becomes the largest ride-sharing company in New York there's going to be a tipping point where it says dominating the market you think what's a local doing in there let's assume that Ruben does become the dominant ride-sharing company in New York but I fly to Chicago I don't care who the largest ride-sharing company in New York is I care about the largest ride-sharing company in Chicago so my story here's what can happen uber can end up dominating New York lifts can end up dominating Chicago grab taxi can end up dominating kuala lumpur all I can end up dominating Mumbai and Dede chuckling can end up dominating Beijing you think so what it's going to have consequences for what kind of market share I can give the company in steady-state and I'm going to assume that they can keep doing what they're doing in terms of that 8020 mix it's completely arbitrary why not 85 15 like grab taxi so basically I'm going to assume they can keep doing what they're doing and that they can continue to not own the cars and not hire the drivers there's my uber story and every part of that story is going to become a number in my evaluation now let me show you my Ferrari story my Ferrari stories that they're going to stay an exclusive club as a post-war as opposed to pulling off a Maserati Maserati in 2008 looked a lot like Ferrari in 2015 it sold about 7,000 cars very exclusive club but they had bigger ambitions they wanted to grow faster so you know what they did in 2009 they introduced a cheap Maserati don't get too excited it's not that cheap called the Ghibli a hundred and twenty thousand dollar Maserati and they succeeded in terms of growing faster but guess what they had to give up as a result their margins for 18% dropped to 14% and instead of selling to people who were so great you said what's an economy they were selling to people who were rich who felt what the economy was doing there's a trade-off here so in my story I'm going to assume that Ferrari stays an exclusive club and later as what if I'd assume that Ferrari pulls a Maserati so Ferrari is going to stay an exclusive club with all its pluses and minuses the pluses are it maintained high margins never low-cost to capital the minuses that I can't get them 10% revenue growth not because they can't grow at 10% but if they did they would not be an exclusive club and I can't give them the good stuff so you're going to see low revenue growth high margins low cost to capital reflecting the exclusive club I've got my story going I've got to stop and ask the question is this story a fairy tale so the first test is a very simple test am i telling you an impossible story you'd be amazed at how many valuations I see where I looked through the valuation that this just cannot happen it's impossible so if you pass that test and I'm going to ask is this plausible and then if you pass a test is it probable I'll give you a very simple example of the difference be impossible plausible improbable that came I was in Latin America a month ago for CFA Brasil CFA Peru and CFA Chile so I started in Brazil besides the question is it possible that Brazil in the World Cup what do you think the answer wasn't that audience of course I said is it plausible that there win the World Cup and Brazil's mean playing it's plausible then I said it's probable and they said you know what Neymar play keeps playing well so in a sense possible they clearly everybody said it's clearly possible then it's a plausible no no plausible clearly probable you have to start bringing pieces into place for probability one so I leave Brazil and I fly to Santiago Chile and I don't know what had happened the previous weeks I ask this question without knowing what had happened so I said is it possible that Chile could win the World Cup and people started crying seriously and the reason was the previous week Chile had actually got knocked out of World Cup contention because it actually lost two days prior to my they thought I was no picking at scabs I really didn't know so this is it's not possible because it's not going to be there you can't win the World Cup if you haven't qualified it's impossible so if I told you this elaborate story about Chile winning the next World Cup it's not going to happen nice fairytale we have to start thinking about business stories through those same lens is it possible is it plausible is it probable and the best way I play I can have of illustrating that is to give you examples of impossible stories implausible stories and improbable stories let's start with impossible stories about a year ago I was looking at you know what fairness opinions are there like fig leaves that investment banks give companies overpaid saying you're okay we gave you a fig leaf they're kind of pointless exercise is a number crunching to justify a number that cannot be justified so usually I cut bankers slack when it comes to fairness opinions knowing there's nothing fair or even opinion about a fairness opinion so this wasn't a Tesla SolarCity deal for those of you know this was a tremendously conflicted deal for a simple reason who's the largest shareholder in Tesla Elon Musk was the largest shareholder in SolarCity Elon Musk you know who the CEO of Solar City was Elon Musk cousin so when Tesla bought solar city they knew they were buying a heap of legal trouble so he decided to insulate themselves and the way they decided Slade themselves barring two different investment bankers and paying them a lot of money to buy insulation too they hired Lazard so basically Solar City hired lozad and Tesla hired Evercore which is the somatic investment bank in New York so they do the valuations it becomes part of a filing with the SEC and I was able to get to my hands it's a public filing so I take a look at the filing to see how they'd value because they had to justify this merger and I was willing to cut them a lot of slack on what they did so I was looking at however core value Tesla so they done it a DDOT CDOT happened you know that's how they describe so I'll stick with their own terminology they done it discounted cash flow valuation and here's where they got the cash flows they asked the Tesla Board of Directors to give them the cash flows you say where did the Tesla board of directors get it from they got it from goldman sachs equity research so that the tangled web gets more tangled goldman sachs was there the local innocent banker so basically they got the cash flows in the next five years from the tesla board i said okay of course after five years a spreadsheet goes black they said we kind of blanked numbers so after five years they said okay we're going to assume a perpetuity into a terminal value this is their reading out of the same script you all did right for the CFA so after the fifth year they decide to put in a six percent growth rate forever in calculating the terminal value my first response was what currency you guys doing the valuation and maybe it's argentine pesos and forgot to tell me we're doing evaluation in u.s. dollars that's an impossible valuation think of what if I let Tesla grow at 6% a year forever in dollar terms in an economy growing at 2% or two and a half percent year what's going to happen to Tesla in about twenty five years or thirty years it's going to become the US economy okay globalization let's keep going 15 years later will be the global economy I can't even visualize what that's all Tesla all the time you'd have to live in your Tesla eat your test like it health care from your Tesla the only way I can justified maybe SpaceX meets Tesla and the next thing you know Tesla stopped flying off into space now maybe you're selling to me it's an impossible valuation here's another example of an impossible valuation every student in my class has to pick a company to value so by two years ago no last year actually one of my students picks Netflixed value fascinating company fun company to value but a company where it's really difficult to get the intrinsic value above the price because it's so richly priced stock was trading it like 120 comes back with $500 per share as this value and I said what did you do so I look at his revenue and in your ten years six hundred billion dollars six hundred billion dollars in revenues for Netflix so I called a man this was like a mid semester feedback so it's a called mine and said do you have Netflix he said yes and so how much do you pay for your you put out this calculator that seemed to be attached to accept about $100 here so they ask you a follow-up question how many subscribers would Netflix need to have in your tent to get to six hundred billion and revenue again he pulls out his calculated say you don't need a dime calculator six hundred million divided by a hundred is six million subscribers he says I don't see where this is going so hang in there you more question see I said what's the population of the world he says I don't I have to go check Wikipedia I said let me save you the trouble it's about seven million is there something you need to tell me maybe there's something I missed maybe there's a law that's been passed that says every man woman and child had pet on the face of the earth had their own netflix account in which case your 600 billion is completely reasonable he says don't be absurd I said I'm not the one estimated 600 million revenue you did you said I was just using last year's number so what he said I looked at last year's revenue user growth and I plugged it in for the next ten years the power of compounding amazing what it can do to you that's an impossible valuation you can believe that Netflix is undervalued but it cannot be because you believe that they can make a six hundred million dollar revenue in possible valuations let me give an example of an implausible valuation one of my students actually works for the NFL you know the NFL is National Football League perhaps the best round most lucrative sporting league in the world it works with the NFL any valued an NFL team and he sent to me for some feedback so he'd projected out revenue growth and cash flows but didn't I look to see that know whether they own their own stadium so I was expecting to some reinvestment back in the stadium he was investing nothing so I called him and I said no I see a revenue growth it seems reasonable your margins look okay your your TV contract revenues look okay how come you're not spending any money on your stadium and he said that's easy to explain every time we need to spruce up the stadium here's what we do we go to the city and we threaten them with what well leave it we're moving to San Diego we're moving to Las Vegas and they pick up the cost I said now I get it implausible valuations if you can give me a really good reason why you have the combination that you do I can let it go so implausible can happen but you better have a really good reason why it's happening which brings me to improbable valuations when I look at DCs and I look a lot at a lot of them seven I do my in my class three hundred DCFS come in mid semester for me for feedbacks people expect me to do miracles things like look at the revenue growth number and say your revenue growth to this company should be twenty two point three percent not twenty three point five I don't know what they think I do I'm some idiot savant who can look at all that's not the right revenue growth all I do when I get a spreadsheet and I do this with any valuation is I check it for internal consistency let me explain why what I call my valuation triangle and the other three sides of the triangle on one side you have growth the second side of reinvestment the third side of risk if I see high growth in evaluation what should I expect to see in the reinvestment side high reinvestment the law reinvestment I should see high reinvestment and when I look at the risk usually high risk high high high makes sense low low low makes sense high low low I'm going to push back so how come your growth is so high and you're so little reinvestment in perhaps you have a really good explanation I'll give you an example somebody is buying a toll road company last year and he had this high revenue growth almost no reinvestment and almost no risk so I said how come and he explained to me and I was okay with it here's what he said we've missed all road company had spent the previous fifteen years building the toll roads they were just done they were just opening the toll roads which meant that they never reinvest very much because they already had done the reinvestment of the infrastructure and because it was the only toll road connecting the airport to the city in a sense at a captive market and the government had kept it captain I can show you high revenue growth low reinvestment low risk in this company given what you told me I'm okay with them so improbable valuations again my job is to push and for you to explain to me why that inconsistency is okay because if you don't have a good reason and I'm gonna say maybe you're missing something it's amazing how many valuations you see where I am is are at war with themselves it's almost like they have three personalities there's a growth time there's a reinvestment guy and there's a risk guy it's all the same type but it's almost like you drink different liquors before you do each one growth you drink the optimist liquor let me use the highest number I can reinvest mean you could forget entirely about reinvestment maybe you drunk enough that you forgot about net capex and working capital and when you get to risk it's a different person I did get low risk so if you have that inconsistency it's your job to tell me why so I took my uber story and check to see whether it was probable from possible plausible of probable what's the story i'm i'm describing goober as an urban car service company right and in 2014 it was already succeeding as an urban car service company so i wasn't pretty solid ground i assumed it could attract new users into the market i could give you my son as evidence but that's acting like my mother-in-law's ioniq total evidence so i'll give you something more substantial the part of the word were right sharing is its deepest roots is the Bay Area San Francisco round there you know that the car service market in the Bay Area is 300 percent of what it was in 2008 what does that tell you there are people taking car service who used to take mass transit there are people taking car service used to drive their own cars it's changed the way people transport them since a barrier we know it changes the way people behave so I feel again on pretty solid ground assuming it attracts users I wasn't willing in June of 2014 to go far enough to say that rubra could become a replacement for your second car because that makes the market even bigger right so instead of buying that second car you're gonna take uber instead so I felt pretty okay with my uber story just as I did with a Ferrari story because I'm just assuming that can continue to do what they did if I'd given a shift in the Ferrari story then I'd have to ask a question can they pull off a Maserati is this even feasible is it possible is it plausible is it probable they're just as a cautionary in order I've got to tell you that sometimes you listen to a story and it sounds so good you want it to be true and when you want something to be true it's amazing how you will hold back and asking questions I'll give you an example let's assume you quit your jobs to board these spreadsheets and CFA stuff you decide to become a movie producer and you moved to Hollywood to hang out at the Beverly Hilton and I'm going come and pitch a story didn't you tell me whether the story it sounds good enough that you want to make a movie out of it's about a 19 year old who drops out of Stanford who does that you know the acceptance rate in Stanford was last year it's like minus 3% it's the most selective school in the entire world this person got in and dropped out let's make it interesting rather than another male geek dropping out and starting a technology company this is a 19 year old woman who drops out of Stanford and starts a blood-testing company when she's gonna change the way blood testing is done how instead of taking two buckets of your blood which is what traditional blood testing does and taking six weeks to tell you what's wrong with you she's going to take two drops of your blood and 45 minutes later email you the results for 32 different s in your blood so it's going to cost you $50 it's $1,500 if you want the story to be true right I wish I'd made up the story because this is actually a true story where did I go that has been oh I'm sorry the 19 year old was called Elizabeth Holmes she dropped out of Stanford and she started Tara knows there's an anode painter that sounds fancy already two drops of blood in the nano Taner 32 different - great sounding story and you're not the only one sort of like that story venture capitalists piled on in fact by the start of 2015 Tara knows is valued at more than nine billion dollars some of the biggest name VCS were on the list and it wasn't just VCS who are getting excited the Cleveland Clinic which is one of America's leading healthcare organizations said there were new partner with Tara knows Walgreens one of the biggest pharmacies in the u.s. said they're going to start a Tara Knowles lab in it so this was almost a collective buying that their nose was going to succeed so we know in the middle of 2015 it asked me do you think Tara nose has some substance would my answer is I don't know much about the company is a private company but given the kind of VCS invested in it and given that the Cleveland Clinic and Walgreens apart that there must be something there but let me ask you a question you're an investor in a blood-testing company it's not a social media company it's not an app company it's a blood-testing company I would assume the first question you'd probably ask is does this test work right sounds like a fundamental question no I'd assume somebody to ask that question and I turned out to be wrong because the Wall Street Journal reported decides in October of 2015 to ask that question do these blood cuz on the on the website for the company they said 32 different nas in the blood 45 minutes later she went to the FDA and he said Sarah knows been approved for all these tests and the FDA said no we've approved them for one of the 32 so what about the other 31 so the tests are a little noisy what's a noisy blood test I'll give you the example of the noisy blood tears it's a import test but take it for what it's worth you get tested for leukemia the test comes back and it says you know what you might have leukemia oh you might not what can tell but snip something bad happens come back it's not exactly a feature you look credible I want a bloody I wanted noisy blood tests but the amazing thing was you know all these people had piled into the company and nobody nobody had asked that question you see huh no that's crazy I don't do something that it's easy to pass judgment from the outside but if you were an investor in that room and Elizabeth Holmes was at that time one of the leading lights in this business and she thought up there and said I have this great way nude friends like asking question and it turned out that your question was the one that deflated the company the first like the hunter would could Bambi's mother it's a great story and you destroyed it right there so that's what I call it a runaway story a story that sounds so good that nobody wants to ask that question see what was the Board of Directors doing well all of this was going on so everyone then looked up who is in the board of directors so this was the board of directors look like my first reaction as I looked at that list was he's still alive him too yes George Shultz he used to be Secretary of State under Ronald Reagan in 1981 he's a spritely 94 right next to him is Henry Kissinger what the hell is he doing in a blood testing company he's probably talking with the Iron Curtain and Vietnam half of this board looks like a CIA front and the other half looks like you know people are sold they have no idea what's going on this is a runaway story and when you see runaway stories you're gonna see phenomena like these unfold a megalomaniac CEO with a board of directors that's either too old or too decrepit to ask questions and investors a pile-on because none of them wants to ask the question it's going to deflate the story as a follow-up we do one other improbable story and I'll let this go now we're almost at the end there so just for laughs I often look at Investment Banking valuations it's kind of funny sometimes what they get away with so this is actually from an equity research report and he sells out Equity Research Analyst here nobody wants to admit to it if you are don't take this personally or take it personally frankly I don't care so this was a sell side equity research report and Tesla company I valued off and on my blog so I feel pretty comfortable with the country so it's a company I actually like but a company I wouldn't buy it today's price so this was an no 2014 the valuation comes out and I just valued the company in my blog at about a hundred and twenty five dollars per share so in this equity research report the analyst comes up with a value of $450 for sure some curious as to why the analyst thinks it's worth so much more so pull up his equity research reports 250 pages thick which should mean the first clue that yet no he was trying to hide something so I'd leave through and on page 54 years is d dot C dot F so say okay let me take a look at this d dot C dot F because that's where the clues would be as to why is value so much higher so here's what I was expecting you see revenues which are much higher than mine or margins much higher than mine so first I check the revenues and his revenues are buried close to what I projected some puzzled because revenues are close and your margins my simulator don't that his margins are a little lower than mine now I'm really befuddled how can your revenues be like mine your margins be lower than mine your value before times higher so I keep going down the spread to the spreadsheet from revenues to operating income to reinvest into free cash sure and notice there's almost no reinvestment for the next ten years now this is an automobile company and if you look at the very top line of the sheet he's estimating that the number of cars Tesla will sell is going from 24,000 to 1.1 million over the next 10 years now Tesla does have an assembly plant in Fremont at the capacity of that plant even on a good day it's 250,000 cars what are the extra 800,000 cars going to come from so I called the analyst he's actually an airport on a flight to California to visit Tesla must be enshrined that he goes and be all great Tesla in the sky you know I said look you know I've been looking at UD dot C dot F and I have some questions he said I can't answer those questions I said how come he said well I have a team that works on the spreadsheet yeah I said you have a team he said five people I said you have five people that turned out this lease yeah he said you can call me next week when everybody is going to be around I said okay he said you're not going to write about this on your blog or anything are you I said I'll wait for a week and then I'll slaughter you so week later I call in the entire team is gathered round so I call him the lead analyst picks up the phone he says you know what I can't answer these questions I really don't do the number crunching I'm really the chief schmoozer he says a schmooze a lot he doesn't know the words you know I talked to the CEO and then I turned to the second-in-command he says I'm the secondary schmoozer I go along with this guy he's not available to schmooze I suppose instead of him I said okay the third guy said I'm the backup schmoozer in case the first two guys are not so I said who does all the work here and they all pointed his 23 year old kid that they hired last year our business was that he's the guy he said I already feel badly about what I'm going to do so you know ask him you know did you do the dcpip he already can see doom and gloom he says yes and as can I lead you through some questions here and he says yes and I take them 20 gets it very quickly that know that there isn't enough reinvestment to build new assembly plans so I said what happened he said it slipped my mind I said what slipped your mind that I have to build assembly plants says I just was doing projections and I was doing percent of revenue projections you know DC UPS you just bring and as I did it completely slipped my mind that I wasn't setting aside mine I said you realize you have a problem right he said yes but I don't know how we can go public with this we can't go and say to people that it slipped our minds no give any suggestions I did give my suggestion but he didn't take it I said have you ever watch this movie Willy Wonka's chocolate factory yeah he was too young but the oldest Chiefs Moses said I've seen that movie I said I remember seeing that movie and I was strange young person I'm a strange older person when I came out of the movie I had a singular question I said if you remember in that movie there Willy Wonka chocolates everywhere every store carries them but there's only one factory very inefficiently laid out Factory with chocolate rivers running through it I wondered how the hell do they produce all these chocolates in that one factory the answer is actually in the movie it's a balloon purse that do it have you seen these dancing little creatures the dad's and chocolates come flying out I said here's my suggestion put out a press release that Tesla has fired all of its Fremont workers and replace them with Oompa Loompas I call these my Loompa valuations which is growth with no reinvestment so either you figure out a way to break the Oompa Loompas work for you or you just forgot it slipped your mind to put in the reinvestment so now I'm ready to convert my uber story into numbers I described it as an urban car service company right here's where it shows up my total market that I aim for with the urban car service market of a hundred billion I said would attract new users into the market the way I showed this is the urban car service market had been growing at about one and a half to two percent in the previous five years I let it grow at 6% new users coming in I assume that uber has local net working benefits not global networking benefits in the market sure I gave them in steady state was 10% of the global urban car service market huge relative to the typical car service company then but not at 30 or 40 percent market share I assume they could keep this 80/20 mix completely arbitrary but if they can maintain that makes their margins are going to be sky-high in steady-state they're going to be about 40 percent and I also assumed that they could grow without buying the cars and owning the drivers in the way this shows up is when I asked to matreya Nuba needs it's going to be small because they can grow without buying new cars and the way that showed up is when I estimated the reinvestment I assume that for every $5 in revenues that had been west only $1 in capital you saying how do I know it's a high number or the the average for that is about 2.3 that's a typical US company for every 2.3 dollars in revenues gets $1 invested they can get away with $1 invested for every $5 in revenues and to discount all of these cash flows I'm going to use a high cost of capital now here's where I saved myself a lot of time you know how I submitted the cost of capital and got the beta risk-free rate risk premium all the stuff they make you do in the CFA for weeks and weeks and week probably partly because I've you know thrown out a lot of stuff in there it's a waste of time even doing that for a company like this I have actually a histogram of casa capital for US companies basically distribution I went to the 95th percentile it's a 12% cost of capital I gave me one 12% cost to capital why because I think they're going to be a risky company now I could finesse it and I put a second decimal point but what's that going to accomplish and in doing all of this I also have to remember that there's a very real chance Luba will not make it every discounted cash flow valuation is a going concern valuation remember that and if your company will not make it you're going to over value that company the DCF model I attached a 10% chance that the company would not make it every single part of my story has become a number and I did the same thing with and if you take those numbers there's my valuation so when you look at it looks like a spreadsheet right but every single number in that spreadsheet comes from a part of my story so if you ask me why am revenues what they are in your den I'm gonna tell you the story about no urban car service company local networking benefits if you ask me why my margins are so high I'm going to tell you the story about the 80/20 mix and how that plays out in steady state if you ask me why my reinvestment is so low I'm gonna tell you the story about how this company can grow with very little capital investment because it doesn't own the cars and with that story I've told you about uber and the numbers that come out of it the value that I got ruber adjusted for the 10% chance that they would not make it it's about six million dollars I put this post up on June 8th of 2014 ten minutes later I get a call from a Wall Street Journal reporter she says I noticed you put up a blog post no but I said thank you for noticing she said I also noticed that you put a value for the company of six billion I said yes that's true she said you do know that venture capitalists have valued the company at 17 billion I almost corrected that right they're saying little value companies that price her but she'd have no idea what I was talking about so I let it go I said yeah she said how do you explain the 17 million I said I don't have to I didn't pay it I've never felt the urge to explain what other people do what business is it of mine she said what does it all mean then I said all this means is I wouldn't invest nuber at 17 billion but if you want invest nuber go ahead you have to tell a story that justifies your investment investing to me is a very personal game it's not my job to tell you what to invest and it's my job to tell myself what to invest in so it's very surface when I value companies early for me it's my story and what I'm comfortable with my story what do I care that you're not comfortable with my story that's your problem not mine that's the advantage I have of not being a cell sorry I couldn't research our lives because then I have to convince you that my story is the story thank god I'm not so I'm going to close with that feedback loop thing because it it to me is captures the entire focus evaluations I put this valuation up on my blog and it got picked up in four very different places the first with a site called 538 heard of this this is a site that was created by a guy called Nate silver statistics game it's a great site if you like so it applies statistical techniques to sports to politics to business they like the fact that I put numbers and they said can we post your blood your entire poster I said as long as you don't mess with it and make changes in it put the post up they put the post up the second place it got picked up was the Forbes blog you know who reads Forbes blogs people who are at least 75 years old with flip phones very old time old value investors it's a very different audience the third place it got picked up was TechCrunch occurences is actually Silicon Valley inside so it's read mostly by tech geeks and PCs and the fourth place it got picked up was the right sharing that this is actually a blog for people who drive for uber or lyft there are enough people who drive for uber or lyft that they can actually write a blog just for them same post in four different places I get four very different sets of reaction 538 I'm being read by numbers geeks so the kinds of questions I ask reflect that they said how come using 10% chance of failure why not nine point nine seven percent so nine then I always leave my spreadsheets as open spreadsheet so why'd you try four nine point nine seven percent and tell me what happens five minutes later I got emails and now I see why you did what you did nothing happen just let it go to the Forbes world loved what I did they said this is the way the tech guy should be valuing companies I ignored that blog completely the TechCrunch guy's absolutely detested what I did they said how dare you value one of ours here a DCF guy we don't do that stuff in Silicon Valley get out of here and I think there were 5,000 comments on the pet Crunch article and 4,000 were pure abuse things like you academic you DCF guy they managed to convert almost everything in an insult but a thousand of them actually told me things about the business that I'm not a tech I don't know how the ride-sharing business works and if I was willing to be open I could learn about the business by listening to people who know a lot more about the business and on the ride sharing blog I heard from uber and lyft drivers and that was the most informative set of possible because they said things like you know this 8020 mix and Oba claims with the investors that it gets to keep that's a lie they said in most cities here's what they do they keep 20% but then they kick it back in the form of special bonuses and they're probably lucky they make six or seven percent you know what did hindsight that turns out to be exactly true uber claims to its investors that it keeps twenty percent but the time it gets done with all the rest of the processes its contribution margin is closer to six or seven percent I would never have learned that if I talk to the top management to doober my suggestion to you save the value company don't waste your time with the top management they either don't know what's going on or they're masking what's going on talked to the janitor you will learn more about the company talking to the janitor and the male person then you would to the top management it all came to fruition for me when I was sitting in Munich Airport about two weeks after I write this blog post my flights delayed so I start checking my emails and there's an email from a guy called bill Gurley those of you don't know who bill is he's actually a partner at benchmark capital which actually was one of the earliest VC investors Liuba the investment uber I had a two billion dollar value and rumor was he was the guy was closest to Travis collecting at that time CEO of uber so let me ask a question this is an easy one it does Bill Curley know more about uber than I do absolutely right so I open up the email and he said I read your posts about uber and it did not like it I said okay he said I built my own blog post to counter your blog post its blog post blog post warfare very high tech and I've said some mean things about you and I just want to let you know and of email I closed email I have an hour and a half left my flight guess where I go next I got above the crowd which is Bill girlies blood here's what the first post says the modern misses by a mile get it Boober driving misses by a mile and he essentially took issue with every part of my story he said uber is not a car service company it's a logistics company notice how words of consequences what's he just done he's expanded his business from car service delivery to moving he said it's not just urban it's going to be everywhere he gave examples of suburban service they were introducing and he said we're going to connect with credit-card companies in Airlines so when you make a reservation on an airline you're gonna be able to book an uber basically and we're gonna be able to expand our local networking benefits of global he didn't use a single number but I'd read his post I was fascinated by his story I'd finish up the story and I still have an hour and 15 minutes left for my flight so email him back saying do you want to put a number on your story he said what are you talking about I think he told a really fascinating story about hookah I can convert the number he said be my guest so here's what I did I took my hundred million dollar total market which is a car service market replaced with the logistics marker which is three times larger 300 billion I took my 10% market share which is a local networking benefit replaced with a 40 percent market share which is what you're gonna have if you have a global networking benefit with those two changes put in the value that I get for uber is 53 belly I sent him is do you like this number more he said a lot I said and he says you know what this 80/20 makes I have to tell you and just between you and I it's probably gonna drop to about ninety ten we don't really make twenty percent I said that's easy to fix I go to my spreadsheet change the 8020 to ninety ten my belly goes to twenty nine belly don't you saying this is and that means I can use a DCF to get any number you want that's not what I read out of this if I get big differences in values for companies it's not because your revenue growth assumptions are different for mine it's because you're telling a different story than I am now one of us is going to be more right than the other we won't know till later but it's hubris to think you owned the story on a company so when I value a company when people disagree with me I said look you know if you know I'll give you the spreadsheet and in fact I set up almost every single valuation I do as an open spreadsheet because I want people to disagree with me on the story and rather than tell me I'm wrong I draw rather they take the spreadsheet and change the story to make it theirs and that's how you make valuations connect up the numbers connect to stories is but forcing yourself to think about the story you're telling that drives about so I close with a couple of things one is the company I'm valuing it to my two-day valuation session this handcart that story I'm going to tell about Henkel is not going to surprise you it's a solid corporate citizen it's a very solid company but I can't tell you a soaring story about hanker that makes its revenues grow 20% a year and a margin go up to 35% it's not going to happen it's a story that reflects the company as it exists today and I have to be realistic if you ask me to value Volkswagen the story I'm gonna go give you it's not going to be a happy story but how can you tell a happy story about a company that's in a bad business that's had the kinds of trouble that walks wagon did the Deutsche Bank valuation I didn't October of 2016 was a horror story but that was not my horror that I put in there it was their own horror of their own creation so the one thing to remember our business stories is not all of them have happy endings so sometimes you gotta tell a realistic story and said this is the endgame it's not going to end well I'm gonna have to reflect that in my evaluation it actually makes valuation a lot more fun to bring in stories because it forces you to think about where your numbers come from and it's my final final anecdote and I have to be done so my youngest son the port graduated from high school last year and it's actually this year and he had to pick a college to go to and he got some really good choices in fact his final two choices were Wharton and Yale now he never asked me for advice but for some reason series I think he was really know if he had the end he said no it comes to me and says that what do you think I should do I was thinking about my strategy should I give him the answer that I think it's right are given the opposite because then he will do there because it's an 18 year old so you can't tell them one thing you do the exact opposite but my if you think about what we've just talked about you kind of can guess what I wanted him to do if you go to Wharton you go to a business school if you get a mini MBA well you're an undergrad should you'd be trained as a number cruncher and I told you writes poetry forget about poetry if you go to Wharton every class you take is going to be a business class they could trained him to be a good number cruncher and guess what number crunches are going to get out sourced really fast we live in a world where what you do is mechanical remember a machine is gonna be a lot better mechanical stuff than you and I are so I tell people to just take a inventory of the day and look at how much they do each day that's mechanical they're 80 85 90 percent of what you do is mechanical start looking for another job because it's sooner or later the machines are going to take over businesses that are mechanical increasingly will get outsourced it's happening an act of money management already those money managers are mechanical and most of them are when you screen and you hope for mean reversion hey a machine can screen and do mean reversion just as well as you can we have to start thinking about kind of combining different skill sets that last two years ago during the summer my family and I went to Florence and you seen the Forenza dome right bernal s Keys dome so after we come out as I look at how to write a blog process it's the middle of Education what are you going to write a blog post on and I wrote a blog post and Brunelleschi's dome those of you never been there Brunelleschi had absolutely no training in architecture engineering he was one of those he actually carved the doors on and he got picked to build the dome largest freestanding dome in fifteen hundred years nobody knew how to build a free-standing dome that big he toured himself enough architecture and enough science to be able to build that dome you think what's this got to do I mean that's a classic Renaissance man right there knew a little of this I mean basically that was the skill set you basically expand your skill set to be able to do lots of different things I'm not suggesting we all can become ready so we don't have enough Renaissance people around anymore we have lots of specialists people who can trade one thing and they've done it for all of their lives there's there in silos that are so deep they have no idea what to do they pulled out of their silos so whatever your weak point is whether it's storytelling a number crunching work on it and if there's anything I hope you out of this it's this hope even if you're a pure number cruncher to be able to tell stories it is enough of a skill set that you can pick it up it won't come naturally to me to you just like it didn't come naturally to me but it can be done so I'm going to stop with that because as I said I've got to run to wherever no idea where I am and somewhere in that direction no no I get that thank you very much [Applause]

Channel: CFA Society Switzerland

Views: 44,961

Rating: 4.9413795 out of 5

Keywords: CFA, Switzerland, valuation, Damodaran

Id: MN1RU9i3ngg

Length: 82min 29sec (4949 seconds)

Published: Sun Dec 03 2017