"Is Liquidation Value Really Much Higher Than Market Value?
We often read investment write-ups that assert a discount to liquidation value. We find many of these assertions suspect, as they tend to implicitly assume a benign environment for liquidation to take place. Imagine a case for an ocean shipping company that estimates liquidation value as the private market sale value of the company’s ships minus the net debt on the company’s books. Would an argument that the equity has strong downside protection because it trades below liquidation value be credible? In our experience, such an argument may hint at potential undervaluation of the equity, but it is rather weak when it comes to downside protection. In reality, a liquidation scenario would most likely play out in conditions of industry distress, in which it might be exceedingly difficult to find buyers for a fleet of ships. Even if such buyers existed, they would hold tremendous negotiating leverage over a competitor seeking to liquidate assets. The value of other assets may also start looking shaky in such a scenario, as accounts receivable suddenly become more difficult to collect and prepaid assets lose value. Meanwhile, we can be quite sure that the company’s liabilities will remain constant or even increase. In some countries, the obligations of a business toward employees increase in case of a mass layoff. Similarly, the operating expenses of a liquidating business may spike as lawyers enter the picture and management demands an incremental incentive to see through the liquidation process. Graham adjusted balance sheet asset values downward in a liquidation scenario, but such adjustments may prove inadequate in modern practice. Many factors affect the likely course of a liquidation process, including the size of a company, the nature of the assets on the books, the incentives of management, the pace at which a liquidation is completed, the prevailing industry conditions, the number of parties who might be interested in the company’s key assets, and the existence of contingent liabilities such as unresolved litigation or environmental liabilities. Some of these factors are rarely considered in a back-of-the-envelope liquidation analysis, rendering many such exercises too optimistic in their estimate of value. The onerous process of liquidating a business rarely becomes the course chosen by the board of directors. According to Toby Carlisle, “The assets of a company are typically worth more as part of a going concern than in liquidation, so liquidation value is generally a worst-case outcome. In my experience, most ‘net net’ companies have been turned around, rather than liquidated.”
John Mihaljevic. The Manual of Ideas (Posición en Kindle1043-1063). Wiley. Edición de Kindle.
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