Very high prices are often paid for new companies. Are they worth it?
Anyone who has ever bought or sold anything – a house, a company, a car – knows there is often a difference between value and price. Companies frequently pay more for goodwill than the target company merits; the gap between the true value and the amount paid can be considerable. The central driver behind arriving at a true valuation is to narrow that gap as much as possible, to map price and value on to each other for both the buyer and the seller.
The fluctuations in the public markets in recent years have seen experts – academic and in the City – scrambling to understand the underlying principles of a listed business’s market cap. And it’s not easy. Not when you can wipe a third off the value of the company in one interview.
For an example of how management behaviour influences valuation, look no further than Elon Musk. His outbursts, which ranged from a terse tweet musing that he wanted to take Tesla private and had the “funding secured”, to apparently smoking marijuana during a podcast with comedian Joe Rogan, did little to shore up Tesla’s share price (it ultimately fell by 6%, later recovering a further 11%). The now-infamous tweets about funding led to Musk stepping down as chairman in September following a $20m settlement with the Securities and Exchange Commission, which had launched a federal lawsuit against him.
That’s not to mention the sight of all those glistening unicorns – a start-up with a market value of more than $1bn – prancing across the scene, as fintech superstars TransferWise, Credit Karma and Adyen all went public in 2018. This was followed by Farfetch, which finished its first day of trading up 50% on the issue price, reaching a tidy $8.6bn market cap. Add in Apple’s ascension to the first trillion dollar market cap, and it’s understandable that some believe valuations have become entirely untethered from any sense of real value.
This is an extract from the Business & Management Magazine, Issue 268, October 2018.
Full article is available to Business and Management Faculty members and subscribers of Faculties Online.