Class Overview

A description of the class, what it covers and who it is aimed at...

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The Search for a Unifying Theory
In this session, I look at the appeal of the a unifying theory, something that explains everything in a discipline, and where that search has taken us in finance, befor introducing the corporate life cycle as a qualifying entrant, because it explains so much of what is observable in corporate, investment and management behavior.

a.     Pick five companies that span the life cycle spectrum, from young growth to declining. This may take a little experimentation, and you may have to revisit your choices as you move through the sessions. If you want, pick a company based upon corporate age:

1. A (young) company that has gone public in the last five years
2. A high growth (in revenues) company, with a small market cap
3. A growth company, with a large market cap
4. An older company that is still healthy and growing
5. An older company struggling to grow

b.     Look at each of these companies and assess where they were in the life cycle ten years ago.

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The Basics of the Corporate Life Cycle
In this session, I look at the six phases of the corporate life cycle (at least my version) from start up to corporate decline/demise. I look at the characteristics of companies in each phase, and the operating, financing and ownership changes that occur.

a.     For each of the five companies on your list, estimate the operating metrics (revenue growth, operating margins) in the most recent years.
b.     For each of the five companies on your list, evaluate whether there has been, and if yes, how much capital raised (from debt or equity) in the most recent years.
c.     For each of the five companies on your list, look at the shareholder ownership breakdown (founder, insiders, individuals, institutions) in the most recent year.

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Corporate Life Cycle: Measures and Determinants
In this session, I address a key question - how do you determine where a company (your own or one that you are interested in) falls in the life cycle, starting corporate age but moving on to operating metrics. I also look at the determinants of the length (how long a company survives), the height (how big it gets) and slope (how quickly it scales up) as a prelude to drawing a contrast between successful 21st century and 20th century companies.

a.     For each of the five companies on your list, estimate the corporate age (from founding year to today).
b.     For each of the five companies on your list, examine the revenue growth rates and operating margins of the industry groups they belong to.

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Corporate Life Cycle: Transitions
Moving from one phase of the life cycle to the next one can be a rite of passage, filled with hope and challenges. In this session, I look at the transitions as start-ups seek out venture capital, as young companies go public, as public companies try to raise additional capital and as middle-aged companies try to shrink and divest as they face decline.

a.     If any of your companies are private, find out whether it has accessed venture capital and if so, on what terms.
b.     If any of your five companies are public, examine when the company went public and what its operating metrics (revenue growth, operating margins) looked like at the time of its IPO.
c.     Have any of your companies, since going public, have raised more capital from external providers? If yes, did they raise additional equity or borrow more money?
d.     Have any of your firms been targeted by private equity investors or activists? If yes, when and why?

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Corporate Finance 101
Corporate finance, as a body of knowledge, looks at the first financial principles involved in running a business, with decisions broken down into three groupings - investment (where you decide what assets/projects to invest in), financing (where you find the right mix of debt & equity, as well as the right type of debt and dividends (where you determine how much (if any) cash to return to your owners. In this session, I do a quick overview of these first principles, with a preliminary assessment of how they evolve with the corporate life cycle.

a.     Given your assessments of the five companies, which corporate finance decision (investment, financing, dividend) would you expect to have primacy?
b. Are there any corporate finance mismatches (companies not behaving the way they should, given their life cycle position) in your firms?

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Investing across the Life Cycle
It is inarguable that deciding whether to invest and where to invest is central to building a successful business. I look at the the investment decision in terms of both coming up with an accetable hurdle rate as well as measuring returns on an investment project, and examine why the way that businesses assess hurdle rates and assess investment quality change over a company's life cycle.

a.     Estimate the costs of equity, debt and capital for each of the companies in your group. Discuss the differences.
b.     Estimate the accounting returns (to equity and invested capital) for each of the companies in your group. How would you read the excess returns that you get from comparing accounting returns to costs of equity/capital?
c.     What does a typical project (if any) look like for your company? What challenges would you face in assessing whether it is a good or bad investment?
d.     Is there optionality in investments in any of your companies? How would you make that judgment?

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Financing across the Life Cycle
There are only two ways that a business can be fund itself - your own money (equity) and borrowed money (debt). In this session, I look at the tradeoffs - illusory, financial and friction-driven - that drive the trade off between debt and equity, and how it plays out across the life cycle. I move on to to look at the right type of debt a firm, as one that matches its assets, and use this insight to look at why debt design is different for growth as opposed to mature firms.

a.     Evaluate the mix of debt and equity used by each of your companies to fund their businesses.
b.     If your company has debt, what type of debt does it have? (Debt maturity, currency, straight or convertible etc.)
c.     What tax benefits to each of your companies get from debt? (Look at marginal and effective tax rates, whether the company is making money, net operating losses carried forward)
d.     What is the expected bankruptcy cost from debt to each firm? (Look at volatility in earnings, current bond ratings if any, interest coverage ratios)?

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Dividends across the Life Cycle
If dividends represent residual cash flows, i.e., cash flows left over after every other need (taxes, reinvestment, debt payments) have been met, it stands to reason that the cash returned by a firm should reflect where it is in the life cycle. In this session, in addition to looking at cash return (potential and actual) as companies age, I also look at how the choice between dividends and stock buybacks can be affected a company's positioning in the life cycle.

a.     How much cash (FCFE) could each of your firms have returned in the most recent year(s)?
b.     How much cash did your firms return in the most recent years?
c.     In what form (dividends or buybacks) was the cash returned, if at all?

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Valuation and Pricing 101
In this session, I start by contrasting valuation, where we attach a number to an asset, based upon its cashflows, growth and risk, and pricing, where we decide how much to pay, based on what other investors are paying for similar assets. In the context of intrinsic valuation, I look at the drivers of value and then examine why the importance of the drivers can change as companies move through the life cycle, and in the context of pricing, I examine why pricing metrics and peer groups can shift across the life cycle.

a.     Estimate the historical values for revenue growth, margins and reinvestment (sales to capital) for each of your firms.
b.     Estimate at least three pricing multiples for each of your firms, with a mix of equity and enterprise value ratios.
c.     Find peer group companies for each of your firms, with median (and average) values for the pricing multiples of your choice.

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Valuing and Pricing Start-ups and Young Growth Firms

In this session, I look at why the absence of historical data, the lack of a working business model and the uncertainty about survival and success make valuation more challenging at young firms and start-ups, and why the payoff to making your best estimates, in the face of these challenges, is so large. I then examine the process of valuing and pricing a young firm or start-up, and techniques that can be used to face up to the uncertainty in your estimates.

For the youngest company in your peer group:
a.     Given what you have learned about your company, what is your valuation story?
b.     Does your valuation story pass the 3P test?
c.     How does your valuation story play out in your valuation inputs (revenue growth, margins, reinvestment, and risk)?
d.     Given these valuation inputs, what is your valuation for the company?
e.     How uncertain are you about this valuation? How do you deal with this uncertainty?
f.      Is there any optionality in this company? If yes, why and what drives that option’s value?

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Valuing and Pricing High Growth Firms
In this session, I examine the big questions involved in valuing high-growth firms, with established business models, but where the key question becomes one of whether and if yes, how much, a firm with strong past growth can continue to grow. I also look at pricing high growth firms, where the key difference to control for is in expected growth.

For the high growth company in your peer group:
a.     Given what you have learned about your company, what is your valuation story?
b.     Does your valuation story pass the 3P test?
c.     How does your valuation story play out in your valuation inputs (revenue growth, margins, reinvestment, and risk)?
d.     Given these valuation inputs, what is your valuation for the company?
e.     How uncertain are you about this valuation? How do you deal with this uncertainty?
f.      What is the value that growth is adding (or destroying) in your company?

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Valuing and Pricing Mature Firms
With long financial histories, and settled business models, firms in their mature phase should be easiest to value and price. That said, in this session, I look at the questions of how best to deal with the effects of changing the management of a mature firm, as well as imminent disruption of the core business. I argue that all mature firms can be valued for the status quo (existing management) and with change, and that the expected value of control stems from the difference between the two values.

For the mature company in your peer group:
a.     Given what you have learned about your company, what is your valuation story?
b.     Does your valuation story pass the 3P test?
c.     How does your valuation story play out in your valuation inputs (revenue growth, margins, reinvestment, and risk)?
d.     Given these valuation inputs, what is your valuation for the company?
e.     How uncertain are you about this valuation? How do you deal with this uncertainty?

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Valuing and Pricing Declining/Distressed Firms
In this session, I argue that valuing declining firms is daunting, since the value you attach to a business is very much a function of whether you believe that the management of these firms is in denial, acceptance or actively working towards a rebirth. I also look at pricing a firm with declining revenues and margins under pressure is different, with both healthy and declining peer group companies in the mix.

For the declining company in your peer group:
a.     Given what you have learned about your company, what is your valuation story?
b.     Does your valuation story pass the 3P test?
c.     How does your valuation story play out in your valuation inputs (revenue growth, margins, reinvestment, and risk)?
d.     Given these valuation inputs, what is your valuation for the company?
e.     How uncertain are you about this valuation? How do you deal with this uncertainty?

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Investing 101
In this session, I start by describing an investment philosophy as a set of beliefs about market behavior and misbehavior which translate into market mistakes that you try to exploit as an investor, and go on to contrast investment philosophies that are odds with each other - value versus growth investing, momentum versus reversal trading, market timing versus stock selection. I then look at how different investment philosophies lead you to companies at different stages in the life cycle, and why you should be aware of these links, as an investor.

a.     Are you an active investor?
b.     If yes, what types of mistakes do you think markets make, and why? If no, why not?
c.     What investment strategies do you use (or plan to use) to take advantage of those mistakes?
d.     What are the weakest links in your investment philosophy/strategies?
e.     Do you have an investment track record? Have you earned more than you would have as a passive investor (buying index funds)?

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Investing in Youth
In this session, I look at the investment philosophies (and strategies) most focused on young and high growth companies, starting with venture capital and then moving on to public market growth investors (and traders). I argue that to be successful with companies at this stage in the life cycle, you need to be a good judge of both narratives (company stories) as well as people (founders) and be willing to live with uncertainty and error.

a.     If you had the capital and the capacity, do you think you would be a successful venture capitalist? If yes, why? If no, why not?
b.     As a public market investor, what approach to investing in growth companies offers the best odds for you? Why?

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Investing in Middle Age
In this session, I look at value investing, at least as practiced by many in the space, as focused primarily on middle aged firms, trading at attractive prices. While value investing has an appealing mix of story and numbers, I look at the returns earned by value investors and find little cause for celebration. Active value mutual funds underperform value index funds by more than active growth mutual funds underperform their index counterparts. While there are pockets of outperformance among individual and activist value investors, the overall conclusion that I reach is that active value investing does not deliver on its promise. We close the session by looking at possible reasons for this gap between promise and practice.

a.     If you had the capital and the capacity, do you think you would be an activist value investor? If yes, why? If no, why not?
b.     As a public market investor, what approach to investing in mature companies offers the best odds for you? Why?

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Investing In Decline
In this session, I look at the investor groups, especially private equity and activists, who try to make their money by targeting companies in decline. In some cases, they do so, because the price is attractive, and in others, because they think that breaking up or even liquidating the firm can deliver more value than continuing as going concerns.

a.     If you had the capital and the capacity, do you think you would be a private equity investor? If yes, why? If no, why not?
b.     As a public market investor, what approach to investing in declining companies offers the best odds for you? Why?

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Managing across the Life Cycle
In this session, I look at what top managers in businesses do, and how the skill sets annd mindsets you need in these managers will change as a company moves through the life cycle, turning on its head the notion that there is one prototype for a "great CEO". I also argue that a mismatch between a firm and its top management can be value-destructive, and that the odds of this mismatch have increased as company life cycles get compressed.

a.     Who is the CEO of each of your companies? How long has he/she been CEO and how did he/she get the position (founder, hired from outside, hired from inside)?
b.     Is your CEO matched to your company?
c.     If there is a mismatch, is there a response building to that mismatch (activist investors, proxy challenges)?

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Fighting Aging
In this session, I look at the choices that managers face when put in charge of declining firms, starting with acceptance (where they accept aging and act accordingly) and why management fights that path so much. I also look at the more alluring paths of revamps and rebirths, with examples of success, but with cautionary notes on difficulties on those paths.

For the declining company in your group
a.     What would denial look like (in terms of investing, financing and cash return policies?
b.     What would acceptance look like (in terms of investing, financing and cash return policies)?
c.     What would a revamp/rebirth look like (in terms of investing, financing and cash return policies)?
d.     Which of the above paths is the management currently running the company most likely to pick?

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Aging Gracefully
In this session, I wrap up by looking at lessons for managers, as companies make their way through the life cycle, as well as for investors, navigating the same path. I end with suggestions for regulators and policy makers on how to approach disclosure and corporate governance for firms at different stages in the life cycle.

Given what you have learned about each of your five companies across the dimensions, has your view about where each of them falls in the life cycle changed? If yes, in what way and why?

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