Liquidation Value

What is Liquidation Value?

Liquidation value is defined as the value of the assets that remain if the company goes out of business and is no more a going concern; assets included in liquidation value includes tangible assets like real estate, machinery, equipment, investment etc but excludes the intangible assets.

Unlike human beings, a company is not a natural person. Its identity is different from that of its owners and managers. So, a death which seems to be inevitable for human beings is something which can be avoided from a company’s point of view. Many companies go on for hundreds of years. However, even a company can shut down at either on account of law (mostly on account of bankruptcy) or at the discretion of the management or the desire of the owners of the company.

Let us look at Fitbit’s share price movement over the past few quarters. We note that Fitbit stock plummeted by more than 90%. Does this mean Fitbit is now trading at an all-time low and is a buying opportunity? One way to perform a valuation check is to compare Fitbit’s share price with its Liquidation Value.

Is Fitbit trading below its liquidation value? 

Fitbit-Trading-Below-Its-liquidation-value

In this article, we discuss Liquidation value in detail –

Liquidation Value Definition

Liquidation is nothing but the process by which the company’s business is brought to an end, and the company is dissolved. All the assets which belong to the company are distributed amongst its creditors, lenders, shareholders, etc. on the basis of seniority of claims.

Liquidation value is the total worth of a company’s tangible assets (physical assets) when it goes out of business. Tangible assetsTangible AssetsAny physical assets owned by a firm that can be quantified with reasonable ease and are used to carry out its business activities are defined as tangible assets. For example, a company's land, as well as any structures erected on it, furniture, machinery, and equipment.read more – fixed as well as current – are considered while calculating the liquidation value of the company. However, intangible assets such as goodwill are not included in the same.

Book Value vs. Liquidation Value of an asset

Before understanding more about liquidation value, let us understand the meaning of “book value of assets”Book Value of Assets is the asset's value in the books of records of a company or an institution at any given instance. Assets Book Value Formula = Total Value of an Asset – Depreciation – Other Expenses Directly Related to it read more of a company. The book value of the asset is the value at which the asset is carried on a balance sheet. This is arrived by deducting total accumulated depreciationTotal Accumulated DepreciationThe accumulated depreciation of an asset is the amount of cumulative depreciation charged on the asset from its purchase date until the reporting date. It is a contra-account, the difference between the asset's purchase price and its carrying value on the balance sheet.read more from the total cost of acquisition.

E.g.: Company ABC purchases a piece of office furniture at the price of $ 1,00,000. Apart from the purchase price, they also end up paying the following expenses to bring the furniture to the required location:

  • Loading & unloading charges – $ 1,000
  • Interest charges to be paid on borrowed funds for buying furniture – $ 2,500

So total cost of acquisition will be $ 1,00,000 + $ 1,000 + $ 2,500 = $ 1,03,500

Depreciation on furniture (for the sake of convenience let us say that the depreciation rate is 10% p.a. on the written down value)

  • Year 1 = 10% * $ 1,03,500 = $ 10,350
  • Year 2 = 10% * ($ 1,03,500 – $ 10,350) = $ 9,315

So, the book value of this piece of office furniture at the end of year 2 will be $ 1,03,500 – $ 10,350 – $ 9,315 = $ 83,835.

If we were to take the liquidation value of the above furniture, we would look more at the market value of the asset rather than the book value of the asset. The current market price, which it can fetch at the end of 2 years, is $ 90,000, and this will be considered as the liquidation value and not $ 83,835, which is the book value of the asset.

The simplest explanation for the above is that when a company is in the liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more phase, it is putting an end to its business and selling its assets to pay its debt. In this case, it is obvious that the selling price will be considered as the liquidation value and not the book value.

Salvage Value vs. Liquidation Value of an asset

Now, there is something known as the “salvage value” of assets. This, again, is different from the liquidation value of the asset. The salvage valueThe Salvage ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company's machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000.read more is the estimated value of the asset at the end of the asset’s useful life. At the time of liquidation, the asset may or may not have reached the end of its useful life, and it may fetch more than the salvage value.

E.g., The office furniture in the above example has a useful life of 10 years, after which its salvage value is expected to be $ 5000. But as clearly seen above that the market value is $ 90,000 for the given asset, it will be considered as the liquidation value.

Liquidation Value Calculation of a Company

The above pointers help us understand the liquidation value of a single asset. On similar lines, let us now understand how to calculate the liquidation value of the company as a whole. In the simplest terms, liquidation value tells you the quantum which will be available to the shareholders if the company were to shut down in a very short span of time.

The simplest way to find out this value is to go through the following steps:

Liquidation-value

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For eg:
Source: Liquidation Value (wallstreetmojo.com)

Step 1 – Prepare the Balance Sheet of the company.

Prepare the balance sheet of the company as per normal accounting policiesNormal Accounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level.read more as on the date on which you would like to find out the liquidation value.

Following is the balance sheet of ABC Limited as on 31st December 2015:

Liquidation Value Example

Step 2 – Find the Market value of Tangible Assets.

Now, you take the tangible assets of the company and find the market values of the same. At times, the purpose of finding the liquidation value may not necessarily be to wind up the company. It can be done for analysis purposes, as well. In this case, finding the market value for each and every asset may be inconvenient, and many companies resort to assigning a recovery percentage to each asset. This has to be as close to the market value as possible.

Some of the examples of recovery ratios are as follows:

Now coming back to the above example, let us apply the above pointers to figure out the recovery ratios for the assets:

AssetsAmountRecovery RatioRecovery ValueComments
Fixed Assets
Freehold Land$ 50,00,000150%$ 75,00,000The value of land in the area has been appreciated since the time the company had purchased it. The current property prices in the area suggest that we can earn a 50% profit over the original purchase price. Since there was no depreciation on freehold land, we have applied a flat recovery ratio of 150% of the book value.
Office Furniture$ 12,25,00050%$ 6,12,500The company has found similar second-hand office furniture listed on e-commerce websites at this price. That is why the company assumes it can sell its furniture at the same rate.
Plant & Machinery$ 4,30,00025%$ 1,07,500The machinery has been used on an overtime basis over the past years. The depreciated value itself is less, and the company expects that that they will have to sell it for a value very close to its salvage value.
Transportation Vehicles$ 4,50,00075%$ 3,37,500In this case, the company has spoken to a second-hand car dealer, and the rate is determined after consultation with them.
Total Fixed Assets$ 71,05,000 $ 85,57,500 
Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more
Accounts Receivable$ 3,00,00075%$ 2,25,000As mentioned earlier, small-timers don’t end up paying their debt if the company is going to liquidate, and they will never have to worry about their future orders with them. A prudent estimate is that they will be able to fetch 75% from its debtors.
Inventory    
a) Raw Materials$ 1,70,00090%$ 1,53,000Raw material lying in the goods will fetch a good value as it is not very aged inventory. So we can fairly assume that the fresh stock can be sold in the market at 100% of its value.
b) Work-in-progress$ 1,25,0005%$6,250The company does not want to spend its time and resources on completing the work-in-progress. It intends to sell the work-in-progress inventory as scrap, and the scrap value will fetch only 5% of the total value.
c) Finished Goods$ 3,00,00090%$ 2,70,000Finished goods should fetch 100% but considering the time frame to liquidate the goods, the company might offer a discount, which is why the recovery ratio is assumed to be 90%.
Balances in bank  $ 70,000100%$ 70,000The bank balance is also liquid, and it will definitely fetch 100%. However, at times there are charges on the closure of an account
Cash-in-hand$ 5,000100%$ 5,000Cash is already liquid, and there is no point in applying a recovery ratio to it.
Prepaid Insurance$ 10,0000%The company has already paid prepaid insurance for its stock, and on the closure of business, the insurance company will not pay back the premium. It is a kind of loss which the company will have to suffer and hence the recovery ratio of 0%
Total Current Assets$ 9,80,000 $ 7,29,250 

Since liquidation value does not take into account intangible assets; the market value of all intangible assets will be marked as 0. (Recovery ratio will be 0% in this case)

In the above example, there are no intangible assets like goodwill. But the company would have taken the recovery ratio as 0%, just like prepaid insurance.

Step 3 – Liquidation Value of Liabilities

Now, from the total liquidation value of all assets, you need to subtract all liabilities. There is no point in calculating the market value of liabilities because, unlike assets, there will be no separate book value and market value. You will have to end up paying the entire amount reflected in the balance sheet.

Step 4 – Calculate Net Liquidation Value

The net amount derived from the amount will be the liquidation value of the company, which will be available to the shareholders. There is a possibility (especially in the case of bankrupt companies) that the liquidation value may be negative, which means that the company does not have enough assets to repay its lenders. In this case, the lenders will be paid on the basis of the priority of claims they hold on the assets of the company.

Let us drill down the above example of ABC Limited to determine how to arrive at the final liquidation value for different stakeholders.

Total Liquidation Value of Assets$ 92,86,750
Less: Current Liabilities$ 10,50,000
Amount available for Debt fund investors$ 82,36,750In this case, the debt fund of the company is only $ 4,50,000, as opposed to the total $ 82,36,750 available as liquidation value. This is a very positive sign for the company because, in most cases, the company is not even able to pay its current liabilities to the fullest extent.
Less: Amount outstanding towards Debt funds$ 4,50,000
Amount available for Preference Shareholders$ 77,86,750Again, here the amount available for preference shareholders is more than the value of preference shares, which is just $ 15,00,000. So we pay them in full, and the net amount will be available to the equity shareholders.
Less: Amount outstanding towards Preference Shareholders$ 15,00,000
Amount available for Equity Shareholders$ 62,86,750As per the balance sheet, we need to add Reserves & Surplus to the total Equity Shares issued by the companyShares Issued By The CompanyShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.read more to figure out what is the actual amount the shareholders should have got ($ 50,85,000). In this case, the shareholders will get a profit over and above the reserves and surplusReserves And SurplusReserves and Surplus is the amount kept aside from the profits that are to be used either for the business or for the shareholders to pay out dividends. Reserves and surplus is reflected under shareholders funds in the balance sheet.read more of the company. This is a dream come true for any shareholder

FITBIT’s Example

Fitbit’s stock has taken a beating in the last few quarters (as seen from the graph below).

In this example, we find out whether Fitbit is trading below its liquidation value.

Fitbit-Trading-Below-Its-liquidation-value

source: ycharts

Step 1 – Download Fitbit’s Balance Sheet.

You can download the latest Fitbit’s Financials from here.

Fitbit's Balance Sheet

Step 2 – Find Liquidation Value of Fitbit’s Assets

In order to find the liquidation value of Fitbit’s asset, we assign a recovery rate to each class of assets. The reasons for the recovery rate was discussed in the earlier example.

Fitbit Liquidation Value of Assets

The total Liquidation value of Assets comes out to be $1,154,433 (‘000)

Step 3 – Find Liquidation Value of Fitbit’s Liabilities

  • We have assumed that all liabilities have to be paid out in full.
  • Each type of liabilities is therefore assigned a recovery rate of 100%
Fitbit Liquidation Value of Liabilities

The total Liquidation value of Fitbit’s Liabilities is $573,122 (‘000).

Please note that Fitbit does not have debt in its book.

Step 4 – Calculate Net Liquidation Value of Fitbit

  • Net Liquidation Value Formula = Liquidation value of Assets – Liquidation value of Liabilities
  • Net Liquidation Value of Fitbit = $1,154,433 (‘000) – $573,122 (‘000) = $581,312 (‘000)

Step 5 – Find Per Share Liquidation Value of Fitbit

In order to find the per share liquidation value, we require the total number of shares outstanding.

We note that the total number of basic shares outstandingShares OutstandingOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more is 222,412 (‘000)

Fitbit Shares Outstanding

source: Fitbit SEC Filings

Liquidation Value Per Share =  $581,312 (‘000) / 222,412 (‘000) = 2.61x

Fitbit is trading at 2.61x of its liquidation value. This implies that Fitbit is trading very close to its liquidation value. If this stock falls further, then it will be a buy.

Using Tangible Book Value as a proxy

Tangible book value is calculated by subtracting all intangible assets like GoodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more, Patents, Copyrights, etc. from the Book Value of the firm.

  • Tangible Book Value Formula = Book Value of Assets – Book Value of Liabilities – Intangible Assets

Let’s compare the Tangible Book Value formulaBook Value FormulaThe book value formula determines the net asset value receivable by the common shareholders if the company dissolves. It is calculated by deducting the preferred stocks and total liabilities from the total assets of the company.read more with that of the Liquidation Value formula.

  • Liquidation Value Formula = Liquidation Value of Assets – Liquidation Value of Liabilities

While liquidation, the Liquidation value of Liabilities = Book Value of Liabilities.

So the formula above becomes,

  • Liquidation Value Formula = Liquidation Value of Assets – Book  Value of Liabilities

Now coming to the calculation of Liquidation Value of Assets = SUM (recovery rate of each asset x book value of assets).

In this formula, we assume that the recovery rate of Intangible Assets is 0%.  This removes intangible assets from the liquidation value of Assets.

For other assets, the recovery rate is less than 100%, and therefore Liquidation value of Assets is less than (Book value of Assets – Intangible Assets).

We note that even though Liquidation value is less than the Tangible book value, it is a great proxy for identifying stocks that are trading close (below) the liquidation value.

Using the Price to tangible book value ratio provides us with a relative valuation multiple for making such a comparison.

  • If Price to tangible book value is less than 1, then the share price is trading below its tangible book value. This implies that if the company is liquidated today, the shareholders will profit from higher tangible book value.
  • If Price to tangible book value is greater than 1, then the share price is trading above its tangible book value. This implies that if the company is liquidated today, the shareholders will be at a loss.

Let us pick some practical examples where Tangible Book Value (~Liquidation value) is greater than the Share Price.

Noble Corp Example

Take a look at Noble Corp Price to Tangible Book Value. Noble Corp owns and operates advanced fleets in the offshore drilling industry.

Noble-Corp-Liquidiation-Value

source: ycharts

Noble Corp’s tangible book value was above 1.0x in 2012-2013. Due to the slowdown in the commodities (Oil), Noble Corp stock prices plummeted from a high of $32.50 in July 2013 to $6.87 currently. This resulted in a share decrease in Price to Tangible book value and is currently trading at 0.23x.

Noble-Corp-Share-Price-Decrease

source: ycharts

Transocean Example

Likewise, have a look at Transocean’s Price to Tangible Book Value. Transocean is an offshore drilling contractor and is based in Vernier, Switzerland.

Transocean-Liquidiation-Value

source: ycharts

We note a similar trend in Transocean Price to Tangible Book value. In 2013, Transocean was trading at a price to tangible book value of 1.62x; however, it has sharply declined to 0.361x currently. Transocean is another example where Liquidation value is greater than that of the Stock Price.

Let us now pick some other examples where the Liquidation value is negative.

Fiat Chrysler Example

Stocks with negative Liquidation Value implies that if these companies are liquidated today, the shareholders will not be able to recover their investments. Let us take Fiat Chrysler’s example.

Fiat Chrysler’s price to book value is 0.966x; however, its Price to “tangible” book value is -2.08x. This implies that if Fiat Chrysler is to liquidate today, the shareholders will not recover their money (forgot about profiting from the investment).

Fiat-Chrysler-Liquidation-Value

source: ycharts

Liquidation Value Video

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