What’s Your Real Value in China?

Tuesday, June 16, 2009 8:00
Posted in category Uncategorized

In China, there are few mistakes more difficult to recover from than misjudging value.

It is a lesson that I learned early on while working for a valuation firm and assisting firms purchase state-owned assets, invest in joint ventures, pick up non performing loan portfolios on the cheap, or funds develop their residential real estate portfolios, and an issue that I regularly must consider as I develop partnerships, sell product, and work with clients to develop their China plays.

At a fundamental level, everything (tangible and intangible) can be valued, but what was interesting to witness early on was just how far apart the same product, asset, or concept could have such widely different “values” depending on the perspective.  More interesting, and more important to this post, is the fact that many fims failed to anticipate or understand where the other side was coming from.

A situation that killed many deals prematurely, or worse, resulted in nasty breakups later on.

Asset valuation aside (download my previous article  ), where the concept of value ( real vs. perceived) is most important for many entering the China market is that many have simply failed to accurately understand the various ways that value can be influenced, or what their own value was.

From a consumer market perspective there are of course over a billion people that must drink water, and firms like Evian and Watson are banking on getting x% of that market, but there is a reason why more people select Wahaha vs. Evian in China. Wahaha’s value proposition of providing a 1 kuai square bottle of water is more attractive than a well designed Evian bottle containing Swiss alp spring water.

Continuing with Wahaha, and looking at the role of value within a partnership, Mr Zong obviously saw more value in working outside the JV than within it, or perhaps from Mr. Zong’s perspective Dannon believe that his product idea did not offer value to the JV lead him to explore opportunities.

Of course both examples can be debated, as all arts can be, but the greater point still stands.  That many entering and operating in China fail to understand the value that they themselves possess, their firms offer the market, that a partnership will bring, or that an asset possess.

It occurs in the profit and non-profit arenas alike, within foreign firms run by foreigners and Chinese, and results can vary wildely on a regional basis.  Some questions you may ask include (in the context of your own self, firm, or product):

  • What is your value (self, firm, or product) to a situation, to a market, to a partner, etc?
  • How is this value defined?
  • What are the drivers or value?
  • What are the forces that define those drivers?
  • How sensitive to time duration is that value
  • What adjustments need to occur during short term or over the long term?
  • What can be done to enhance value, or destroy it?
  • What is the cost of misjudging value?

In answering these questions myself, or with clients, what I often find is that it is often more important to think about these questions as if you were sitting on the other side of the table.  Working out not jsut what you percieve your value to be, but to also take the time to understand what will ultimately be the real value to others, and then moving forward to develop business models, advertising campaigns, etc.

Certainly a process the new owner of Hummer would have benefitted from.

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2 Responses to “What’s Your Real Value in China?”

  1. Jay Boyle says:

    June 19th, 2009 at 6:47 pm

    My financial consultancy has been doing valuations in China for the past eight years and I could not agree more with the opening statement of the post: “In China, there are few mistakes more difficult to recover from than misjudging value.” Not that it is necessarily worse to misjudge value in China than in developed markets, but it is certainly easier.

    There are many reasons for this, and one of the big ones is definitely the (sometimes catastrophic) misjudging of the value proposition itself that this post underscores in detail. In income statement terms, this translates into getting the top-line sales figure wrong, which renders everything else that goes on in the valuation analysis irrelevant.

    Without taking anything away from that point, I would argue that another big way to get it wrong that is only slightly less lethal than misjudging the market is misunderstanding the underlying operation itself. The amount of analysis and thoughtfulness that goes into a valuation varies dramatically from instance to instance. I have seen preposterously lazy attempts to apply a developed-market sales, cash or EBITDA multiple, arbitrarily adjusted “for China risk” (or even adjusted upwards “for China opportunity”!) without any attempt to understand the “guts” of the business or how reported cash and EBITDA were arrived at. This can certainly yield a number in just minutes, but it is one that will mean nothing, even if you got your top-line right. These and other less-extreme labor-saving approaches carry with them both upside and downside risk—they may fail to reflect an operational Achilles’ heel or allow an opportunity to add value to the transaction by tweaking the operation remain hidden.

    The more I conduct valuations, the more I feel that it is absolutely crucial to build a bottom-up model, starting with the basic operation (which will already reflect many of the opportunities and drawbacks associated with being in China), using this model to recalculate the financials, then applying various valuation methods based on these financials. Such an exercise certainly involves more time and expertise, but it yields a robust figure that is defensible in front of investors. It also greatly expands the number of variables according to which you can stress-test. Essentially, the steps are: (1) due diligence; (2) model and stress-test; (3) valuation.

    The list of common pitfalls to look out for at the due diligence step is long (see my other posts), but failure to consider, for example, vulnerability of intellectual property (and the importance of IP to the success of the particular transaction), compliance issues such as back taxes, or the presence of a hidden subsidy/ a local protector (See Jay’s law of Guangxi) (advantages that are generally not transferable to the post-transaction business) can also scupper the value proposition of the contemplated deal.


  2. Jay Boyle says:

    June 19th, 2009 at 6:50 pm

    There is one more issue I forgot to mention. A lot of the firms doing asset deals with state run companies today. The assets by law can not be sold below book value but the depreciation schedules are the old tax ones thus the assets are often overvalued. This should cause some serious sole searching for investors when doing these deals.