- Valuation Basics
- Discounted Cash Flows
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- Free Cash Flow to Equity (FCFE)
- Terminal Value
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- Market Risk Premium
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- Weighted Average Cost of Capital (WACC)
- Security Market Line (SML)
- Systematic Risk vs Unsystematic risk
- Free Cash Flow (FCF)
- Free Cash Flow Yield (FCFY)
- Mistakes in DCF
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- Cash Flow vs Free Cash Flow
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- Business Risk
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- Equity Value vs Enterprise Value
- Trading Multiples
- Comparable Company Analysis
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- (Price Earning Ratio (P/E)
- PE Ratio formula
- Price to Cash Flow (P/CF)
- Price to Book Value Ratio (P/B)
- Price To Book Value formula
- Price Earning Growth Ratio (PEG)
- Trailing PE vs Forward PE
- Forward PE
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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?
In this article, we discuss Liquidation value in detail –
- Liquidation Value Definition
- Book Value vs Liquidation Value of an asset
- Salvage Value vs Liquidation Value of an asset
- Liquidation Value Calculation of a Company
- FITBIT’s Liquidation Value Example
- Tangible Book Value as a proxy to Liquidation Value
- Noble Corp – Price to Tangible Book Value / Liquidation Value
- Transocean – Price to Tangible Book Value / Liquidation Value
- Fiat Chrysler Tangible Book Value / Liquidation Value
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. All tangible assets – 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” of a company. Book value of the asset is the value at which the asset is carried on a balance sheet. This is arrived by deducting the total accumulated depreciation 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 the above 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 liquidation phase, it is putting an end to its business and selling its assets to pay its debt. In this case, it is obvious that 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 value 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:
Step 1 – Prepare the Balance Sheet of the company
Prepare the balance sheet of the company as per normal accounting policies 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:
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:
- Cash and bank deposits will have a recovery of 100%
- Land owned by the company in a prime area may have a recovery of 150% as land prices generally appreciate in most developed / developing areas.
- Accounts receivables generally have a recovery percentage of around 65% to 70%. This is because the business is coming to an end and companies do get away by not paying small amounts in case of winding up.
Now coming back to the above example, let us apply the above pointers to figure out the recovery ratios for the assets:
|Assets||Amount||Recovery Ratio||Recovery Value||Comments|
|Freehold Land||$ 50,00,000||150%||$ 75,00,000||The value of land in the area has 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||$ 12,25,000||50%||$ 6,12,500||The 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||$ 4,30,000||25%||$ 1,07,500||The machinery has been used on 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||$ 4,50,000||75%||$ 3,37,500||In 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|
|Assets||Amount||Recovery Ratio||Recovery Value||Comments|
|Accounts Receivable||$ 3,00,000||75%||$ 2,25,000||As 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.|
|a) Raw Materials||$ 1,70,000||90%||$ 1,53,000||Raw 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||$ 1,25,000||5%||$ 6,250||The company does not want to spend its time and resources in 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||$ 3,00,000||90%||$ 2,70,000||Finished goods should fetch 100% but considering the time frame to liquidate the goods, the company might offer discount which is why the recovery ratio is assumed to be 90%.|
|Balances in bank||$ 70,000||100%||$ 70,000||Bank balance is also liquid and it will definitely fetch 100%. However, at times there are charges on closure of account|
|Cash-in-hand||$ 5,000||100%||$ 5,000||Cash is already liquid and there is no point of applying a recovery ratio to it.|
|Prepaid Insurance||$ 10,000||0%||–||The company has already paid prepaid insurance for its stock and on 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 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 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||$ 82,36,750||In this case, 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||$ 77,86,750||Again, 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||$ 62,86,750||As per the balance sheet, we need to add Reserves & Surplus to the total Equity Shares issued by the company 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 surplus of the company. This is a dream come true for any shareholder|
FITBIT’s Liquidation Value 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 the whether Fitbit is trading at below its liquidation value.
Step 1 – Download Fitbit’s Balance Sheet.
You can download the latest Fitbit’s Financials from here.
Step 2 – Find Liquidation Value of Fitbit’s Assets
In order to find the liquidation value of Fitbit’s asset, we assign recovery rate to each class of assets. Reasons for the recovery rate was discussed in the earlier example.
- Cash and Cash equivalents and Marketable Securities is assigned 100% recovery rate
- Accounts Receivables is assigned a recovery rate of 75%
- Inventories is assigned a recovery of 50%
- Prepaid expenses is assigned a recovery of 0%
- Property Plant and equipment is assigned a recovery rate of 25%
- Other assets is assigned a recovery rate of 50%
- Goodwill, Intangible Assets and Deferred Tax Assets is assigned a recovery rate of 0%
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%
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 outstanding is 222,412 (‘000)
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 to Liquidation Value
Tangible book value is calculated by subtracting all intangible assets like Goodwill, 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 formula with that of Liquidation Value formula.
- Liquidation Value Formula = Liquidation Value of Assets – Liquidation Value of Liabilities
While liquidation, 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 assets x book value of assets).
In this formula, we assume that recovery rate of Intangible Assets is 0%. This removes intangible assets from 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 Tangible book value, it is a great proxy for identifying stocks that are trading close (below) the liquidation value.
Using Price to tangible book value ratio provides us with a relative valuation multiple for making such 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 shareholder’s will profit from a 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 shareholder’s 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 – Price to Tangible Book Value / Liquidation Value
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 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 current trading at 0.23x.
Transocean – Price to Tangible Book Value / Liquidation Value
Likewise, have a look at Transocean’s Price to Tangible Book Value. Transocean is an offshore drilling contractor and is based in Vernier, Switzerland.
We note a similar trend in Transocean Price to Tangible Book value. In 2013, Transocean was trading at 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 Liquidation value is negative.
Fiat Chrysler Tangible Book Value / Liquidation Value
Stocks with negative Liquidation Value implies that if these companies are liquidated today, the shareholder’s will not be able to recover their investments. Let us take Fiat Chrysler example.
Fiat Chrysler 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 shareholder’s will not recover their money (forgot about profiting from the investment).