- July 28, 2022
- Posted by: Ramkumar
- Category: Posts
Challenges in Valuing Businesses in Transition – Case of Volkswagen
One of the challenging aspects of #valuations is to 𝘃𝗮𝗹𝘂𝗲 𝗯𝘂𝘀𝗶𝗻𝗲𝘀𝘀𝗲𝘀 𝘂𝗻𝗱𝗲𝗿𝗴𝗼𝗶𝗻𝗴 𝘁𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻. For example, one of the auto sector companies in the news is Volkswagen AG after the removal of its CEO and its challenges in transitioning its business model from conventional #ICE to #EV.
Whenever an industry undergoes transition, firms that can adapt to transition by changing their #businessmodel will survive.
How do you 𝘃𝗮𝗹𝘂𝗲 𝗮 𝗳𝗶𝗿𝗺 𝗹𝗶𝗸𝗲 𝗩𝗼𝗹𝗸𝘄𝗮𝗴𝗲𝗻 𝘁𝗵𝗮𝘁 𝗹𝗼𝗼𝗸𝘀 𝘁𝗼 𝗽𝗶𝘃𝗼𝘁 𝗶𝘁𝘀 𝗜𝗖𝗘 𝗯𝘂𝘀𝗶𝗻𝗲𝘀𝘀 𝘁𝗼 𝟭𝟬𝟬% 𝗘𝗩?
In my view, the best approach can be:
1)Estimate the 𝗽𝗲𝗿𝗰𝗲𝗻𝘁𝗮𝗴𝗲 𝗼𝗳 𝗩𝗪’𝘀 𝗶𝗻𝘁𝗿𝗶𝗻𝘀𝗶𝗰 𝘃𝗮𝗹𝘂𝗲 𝗲𝘅𝗽𝗼𝘀𝗲𝗱 𝘁𝗼 𝗶𝘁𝘀 𝘀𝘂𝗰𝗰𝗲𝘀𝘀𝗳𝘂𝗹 𝗘𝗩 𝘁𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻.
2)Estimate the 𝘁𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻 𝗽𝗿𝗼𝗯𝗮𝗯𝗶𝗹𝗶𝘁𝘆 𝗳𝗿𝗼𝗺 𝗜𝗖𝗘 𝘁𝗼 𝗘𝗩 𝗶𝗻 𝘁𝗵𝗲 𝗮𝘂𝘁𝗼 𝘀𝗲𝗰𝘁𝗼𝗿.
3)𝗣𝗲𝗿𝗰𝗲𝗻𝘁𝗮𝗴𝗲 𝗰𝗵𝗮𝗻𝗴𝗲 𝗶𝗻 𝗩𝗪’𝘀 𝗶𝗻𝘁𝗿𝗶𝗻𝘀𝗶𝗰 𝘃𝗮𝗹𝘂𝗲 𝘄𝗵𝗲𝗻 𝘁𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻𝗶𝗻𝗴 𝗳𝗿𝗼𝗺 𝗜𝗖𝗘 𝘁𝗼 𝗘𝗩. This change in value depends on the management’s quality and ability to sustain #competitiveadvantage through correct pricing, suitable investments and a firm brand name. Firms that can 𝘀𝘂𝗰𝗰𝗲𝘀𝘀𝗳𝘂𝗹𝗹𝘆 𝗽𝗶𝘃𝗼𝘁 to EV 𝗵𝗮𝘃𝗲 𝗺𝗶𝗻𝗶𝗺𝗮𝗹 𝘁𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻 𝗹𝗼𝘀𝘀𝗲𝘀.
Let us derive these numbers for VW by comparing it with Tesla, which has pivoted to 100% EV and has a #firstmoveradvantage. Further, the entire auto sector will shift to 100% EV, especially in developed countries. 𝗩𝗪’𝘀 𝘀𝗼𝗳𝘁𝘄𝗮𝗿𝗲 𝗽𝗿𝗼𝘄𝗲𝘀𝘀 (its software problems at CARIAD) 𝗶𝘀 𝗶𝗻𝗳𝗲𝗿𝗶𝗼𝗿 𝘁𝗼 𝗧𝗲𝘀𝗹𝗮, 𝘄𝗵𝗶𝗰𝗵 𝘀𝗵𝗶𝗽𝘀 𝘃𝗲𝗵𝗶𝗰𝗹𝗲𝘀 𝗮𝘀 𝗿𝗼𝗹𝗹𝗶𝗻𝗴 𝘀𝗼𝗳𝘁𝘄𝗮𝗿𝗲 𝗱𝗲𝘃𝗶𝗰𝗲𝘀. Thus, VW’s adaptability to shifting to EV is less relative to Tesla, and the industry estimate it at ~40%, implying that transition losses amount to ~60%.
Despite the large TAM for EV and VW’s future value linked to potential growth in its TAM, analysts valuing Volkswagen need to incorporate this value loss when it attempts to pivot from ICE to EV.
Similarly, we can link this approach to Amazon and Walmart. Despite the high TAM for online retail, Walmart could not displace Amazon due to the difficulty in pivoting its business model successfully from brick and mortar to online retail. We can extend this approach to Yahoo/Google, Nokia/Apple and others.
In my view, valuing firms, especially the ones in transition due to changes in industry structure, we need to 𝗳𝗼𝗰𝘂𝘀 𝗼𝗻 𝗰𝗼𝗺𝗽𝗮𝗻𝗶𝗲𝘀’ 𝗰𝗼𝗺𝗽𝗲𝘁𝗶𝘁𝗶𝘃𝗲 𝗽𝗼𝘀𝗶𝘁𝗶𝗼𝗻 𝗶𝗻 𝗻𝗮𝘃𝗶𝗴𝗮𝘁𝗶𝗻𝗴 𝘁𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻. However, analysts do not incorporate these factors while developing #financialmodels. Firms that experience higher adaptation costs experience a decline in their value of assets, and there is a 𝗵𝗶𝗴𝗵𝗲𝗿 𝗿𝗶𝘀𝗸 𝘁𝗵𝗮𝘁 𝘁𝗵𝗲𝘀𝗲 𝗮𝘀𝘀𝗲𝘁𝘀 𝗰𝗮𝗻 𝘁𝘂𝗿𝗻 𝗶𝗻𝘁𝗼 𝘀𝘁𝗿𝗮𝗻𝗱𝗲𝗱 𝗮𝘀𝘀𝗲𝘁𝘀.