Saturday, August 15, 2015

Storied Asset Sales: Valuing and Pricing "Trophy" Assets

Pearson PLC, the British publishing/education company, has been busy this summer, shedding itself of its ownership in two iconic media investments, the Financial Times and the Economist. On July 23, 2015, it sold its stake in the Financial Times for $1.3 billion to Nikkei, the Japanese media company, after flirting with Bloomberg, Reuters and Axel Springer. It followed up by selling its 50% stake in the Economist for $738 million, with 38% going to Exor, the investment vehicle for the Agnelli family, and the remaining 12% being purchased by the Economist Group itself. The motive for the divestitures seems to be a desire on the part of Pearson to stay focused on the education business but what caught my eye was the description of both the Financial Times and the Economist as “trophy” assets, a characterization that almost invariably accompanies an inability on the part of analysts to explain the prices paid by the acquirer, with conventional business metrics (earnings, cash flows, revenues etc.).

What is a trophy asset?
My first task in this analysis was to find other cases where the term was used and I found that its use spreads across asset classes. For instance, it seems to be commonplace in real estate transactions like this one, where high-profile properties are being acquired. As in the stories about the Economist and the Financial times, it seems to also be used in the context of media properties that have a long and storied tradition, like the Washington Post and the Boston Globe. In the last few years, sports franchises have increasingly made the list as well, as billionaires bid up their prices for these franchises. I have seen it used in the context of natural resources, with some mines and reserves being categorized as trophy assets for mining companies. While this is a diverse list, here are some of what they share in common:
  1. They are unique or rare: The rarity can be the result of natural scarcity (mining resources or an island in Hawaii), history (a newspaper that has survived a hundred years) or regulation/restriction (professional sports leagues restrict the creation of new franchises). 
  2. They have name recognition: For the most part, trophy assets have name recognition that they acquire either because they have been around for a long time, are in the news or have wide following.
  3. They are cash flow generating businesses or investments: In contrast with collectibles and fine art, trophy assets are generally cash flow generating and can be valued as conventional assets/businesses.
There is undoubtedly both a subjective and a negative component to the “trophy asset” label. The subjective component lies in how “rare” is defined, since some seem to define it more stringently than others. The negative aspect of labeling an asset as a trophy asset is that the buyer is perceived as paying a premium for the asset. Thus, an asset is more likely to be labeled as a trophy asset, when the buyer is a wealthy individual, driven more by ego and less by business reasons in making that investment.

Valuing a trophy asset
Rather than take it as a given that buyers overpay for trophy assets, let us look at the possibility that these assets are being acquired for their value rather than their glamor. We have the full financial statements for the Economist but only partial estimates for the Financial Times, and I have used this information to estimate base values for the two assets:
Spreadsheet with valuation
Thus, based on the earnings power in the two assets and low growth rates, reflecting their recent static history, the estimated value for the Economist is about £800 million and the Financial Times is worth £410 million. I will label these values in this table as the status quo estimates, since they reflect the ways in these media names are managed currently. While you could take issue with some of my assumptions about both properties, it seems to me that Nikkei’s acquisition price (£844 million) for the Financial Times represents a much larger premium over value than Exor's acquisition of the Economist Group for £952 million.  Does that imply that Nikkei is paying a trophy asset premium for the Financial Times? Perhaps, but there are three other value possibilities that have to be considered.
  1. Inefficiently utilized: If a trophy asset is under utilized or inefficiently run, a buyer who can use the asset to its full potential will pay a premium over the value estimated using status quo numbers. That is difficult to see in the acquisition of the Economist stake, at least to the Agnellis, since the interest is a non-controlling one (with voting rights restricted to 20%), suggesting that the acquirer of the stake cannot change the way the Economist is run. With the Financial Times, the possibilities are greater, since there are some who believe that the Pearson Group has not invested as much as it could have to increase the paper's US presence. 
  2. Synergy benefits to another business: If the buyer of the trophy asset is another business, it is possible that the trophy asset can be utilized to increase cash flows and value at the acquiring business. The value of those incremental cash flows, which can be labeled synergy, can be the basis for a premium over the status quo value. With the Nikkei acquisition of the Financial Times, this is a possibility, especially if growth in Asia is being targeted. With the Agnelli acquisition of the Economist, it is difficult to see this as a rationale since Exor is an investment holding company, not an operating business.
  3. Optionality: There is a third possibility and it relates to other aspects of the business that currently may not be generating earnings but could, if technology or markets change. With both the Economist and the Financial Times, the digital versions of the publications in conjunction with large, rich and loyal reader bases offer tantalizing possibilities for future revenues. That option value may justify paying a premium over intrinsic value. In fact, at the risk of playing the pricing game, note that you are acquiring the Economist at roughly the same price that investors paid for Buzzfeed, a purely digital property with a fraction of its history and content. 
With the Financial Times, adding these factors into the equation reinforces the point that the price paid by Nikkei can be justified with conventional value measures. With the Economist, and especially with the Exor acquisition, it does look like the buyers are paying a premium over value.

Pricing a trophy asset
As many of you who read my blog know, I have a fetish when it comes to differentiating between the value of an asset and its price. If value is a function of the cash flows from, growth in and risk of a business (estimated using intrinsic valuation models), price is determined by demand and supply and driven often by mood and momentum. If “trophy assets” are sought after by buyers just because they are rare and have name recognition, it is entirely possible that the pricing process can yield a number (price) very different from that delivered by the value process. In particular, the more sought after the trophy asset, the greater will be the premium that buyers are willing to pay (price) over value.

In June 2014, when Steve Ballmer bid $2 billion to buy the Los Angeles Clippers, I tried first explaining his bid by valuing the Clippers as a business. Even my most optimistic estimates of earnings and cash flows at the franchise generated a value of $1.2 billion for the franchise, leading me to conclude that Ballmer was paying the excess amount ($800 million) for an expensive play toy. While it is possible that the same motivations may be driving John Elkann, the scion of the Agnelli family and chairs Exor, in his acquisition of the Economist, I hope that Nikkei, a privately held business, is not paying for an expensive toy.

I am not arguing that paying this price premium is irrational or foolish. Far from it! First, it is possible that the emotional dividends that you receive from owning a trophy asset make up for the higher price up front. After all, Steve Ballmer’s friends are likely to be much more excited about being invited to have a ring side view of a Clippers game than watch Microsoft introduce Windows 10. Second, paying a premium over value does not preclude you from generating nosebleed returns from your investment, if you can find other buyers who are willing to pay even bigger premiums to take these trophy assets of your hands. In fact, many sports franchise buyers in the last decade who were viewed as paying nosebleed prices for their acquisitions have been able to sell them to new buyers for even higher prices. 

Implications
I tend to be skeptical of when an assets is casually labeled as a trophy asset, since it the labeling allows us to categorize its buyers as driven by non-financial considerations, without having to back up that contention. While both the Economist and the Financial Times have been labeled trophy assets, I think we have to hold back on that judgment, especially with the latter, to see what Nikkei has in mind for its new addition. After all, people were quick to label the acquisition of the Washington Post by Jeff Bezos as a trophy buy, but news stories suggests that there have been major changes at the Post since the deal was completed, which may be laying the foundations for delivering value.

If an asset class becomes a repository for trophy assets, it will attract buyers who will pay for non-economic benefits and the pricing of assets will lose connection to fundamentals. At the MIT Sloan Sports Conference this year, I was on a panel about the “valuation” of sports franchises and I made the argument that wealthy buyers in search of glamorous toys were increasingly changing these markets into pricing markets. In fact, as long as the number of sports franchises is static and the number of billionaires keeps increasing, I see no reason for this trend to stop. So, if the New York Yankees or Real Madrid go on the auction block, be prepared for some jaw-dropping prices for these franchises.

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Spreadsheets

14 comments:

Ed Baraban said...

Prof. Damodaran,

I believe you have en error in your formula for Value of Operating Assets. Should be (1+g) in the numerator. Feel free to not show this comment. I enjoyed this post and I just wanted to point this out to you.

Unknown said...

Thanks for the wonderful post
Price (and not value) drives transactions in ‘trophy assets’ – for example, the IPL (Indian Premier League) cricket franchisees were picked at prices that made them ‘trophy assets’
A high price is integral to a trophy asset – owning such assets, suggests that you have arrived.
When the race is about making such statements, then value takes a back seat – it becomes an exercise to merely to justify the price (many invoke real options, intangibles like brand value, synergy between owner and the asset etc.)

Aswath Damodaran said...

Ed,
I have no problem admitting to errors in Excel spreadsheets. I have made my share but I see a (1+g) in my numerator and the numbers you see in my post mirror that spreadsheet. I may have uploaded an earlier version of the spreadsheet which did not have it. If so, I will fix it.
Unknown,
You are right about the IPL. Not only is it a signal that you have arrived but it seems to be a way in which you can create synergy through political connections and I will leave the rest unsaid.

Yniim said...
This comment has been removed by the author.
Aswath Damodaran said...

Ynlim,
Why did I not think of it? I hope that you are kidding or you on the wrong blog.

Sinduja Shukla said...

Hi Prof. Damodaran,

Could you please explain the difference between the premium paid over trophy assets and goodwill?

Thank You

Yniim said...

I'm not a native english speaker, I think I used the wrong expressions.
my apologies

Unknown said...

What makes you say that Nikkei is a publicly traded company? Where do its shares trade? How much do they trade for?

Aswath Damodaran said...

First on the goodwill question, since it seems to be serious, you may want to read this:
http://aswathdamodaran.blogspot.com/2012/12/acquisition-accounting-ii-goodwill-more.html
On the last question about Nikkei, the newsreports do describe it as a media company, but you are right about it being privately held (and I will fix that in my post). That was my mistake, but I don't see how that changes any of the rest of the post.

Anonymous said...

Prof Damodaran,
I believe Ed Baraban is referring to the "Details" column of the "Op profits" row in the figure as it appears in your post. Numberator says FCFF(1-g) which is most likely a simple typo in the description text entry and not in your formula.

Unrelated, I am enjoying all 40-ish hours of your Spring 2015 lectures. Thanks very much for making them available via YouTube!

Anonymous said...

Dear Prof,

should we value now (for whatever reason) just the minority interest owned by Exor in the Economist, I presume this value should now reflect the more efficient use of the operating assets by the majority shareholder; more efficient use that should impact the value of all the minority interests because of change in control. Don't you think so?

Rgds.

Giovanni

Senith Mathews said...

Prof Damodaran,

Here is a clear example of a trophy asset. Hyundai Outbids Samsung for Property in Seoul's Posh Gangnam District. THEY WON. But Investors React to $10.19 Billion Offer by Sending Hyundai's Stock Down 9.2%! WSJ article from Sept. 18, 2014 ( http://www.wsj.com/articles/hyundai-goes-gangnam-as-samsung-loses-plot-1411019957 )

Remove the feel good factors and emotions aside, this is what should happen to your net worth (or value) - Drop.

Anonymous said...

Prof. Damodaran,

Thank you again for sharing the wealth of knowledge you carry. As a student of finance, may I ask two questions:

1. The Economist's valuation shows a 19% premium in Pounds and 6.5% premium in USD. I'm struggling digesting that. Mathematically it looks fine, but conceptually makes little sense. A US investor would look at it as only a 6.5% premium, right?

2. You perhaps may have written a paper on this. But how do you derive Reinvestment Rate being equal to g/ROC?

Aswath Damodaran said...

On the difference in premiums across the two valuations, it should not happen. I will check the spreadsheet again. May be just different exchange rates used on one versus the other.