Help me find the fair price for this private company

Hi forum

I have a few shares of a private company (inherited). The shares are not liquid and spreads are high (>10% Bid/Ask, if there are offers). I could buy some more, or I could sell them. The problem is that I am I’m not very experienced in the valuation of stocks. So, I wanted second opinions about a fair price.

Company summary

The company was founded more than a century ago and has a balance sheet of about 2 billion CHF.

Their main business is in industry. They globally produce and sell optical components that are used in a wide range of applications in aerospace, health, cars, food, etc. Their competitors remain unable to copy their most high-tech products.

Some years ago, they reorganized their production facilities, which left them with an oversized lot of industrial real estate (central and near Lausanne). They decided to develop it, and somewhat unexpectedly it seems to go well. They rent it to a mix of other industry, public secondary education, and commerce. Development is still ongoing.

Financials

Since I want to get a better understanding of the right price for a share, the following numbers are per share. The numbers are calculated from the annual report.

Optical Components

If I understood correctly, growing or selling off the inventory can strongly affect the yearly results. Earnings are sometimes higher than EBIT. I think that is because they don’t include extraordinary income for EBIT. But I calculated earnings from ROE (return on equity), which seems to do and also matches consolidated earnings.

Year 2023 2022 2021 2020 2019
Sales 2’848.67 3’011.49 2’848.11 2’461.69 2’659.60
EBITDA 299.35 534.72 491.41 345.02 342.92
EBIT 105.58 320.40 277.34 149.66 148.68
Earnings 171.87 204.99 278.75 180.61 144.82
Equity 2’858.48 2’962.68 2’981.56 2’852.80 2’805.96
Equity ratio 75.51% 74.54% 78.02% 77.33% 77.22%

Real Estate

Looking at the EBITDA, there is a very high return on equity. Book equity is probably undervalued.

Year 2023 2022 2021 2020 2019
Sales 68.90 63.50 60.73 60.60 58.08
EBITDA 58.02 52.07 41.41 47.19 46.56
EBIT 31.26 30.86 21.86 28.40 29.32
Earnings 20.96 22.31 15.08 20.47 21.57
Equity 329.92 307.57 279.75 266.31 245.87
Equity ratio 43.02% 41.88% 45.10% 46.35% 45.00%

Calculated share price with index fund measures (2023)

My best stab at getting a fair price was comparing it to other companies by index fund measures. But the suggested prices are all over the place.

VT (Global Stocks) Measure Components RE Consolidated
Price/Earnings 17.71 3’043.74 371.24 3’414.98
Price/Sales 1.80 5’127.61 124.02 5’251.63
Price/Book 2.51 7’174.79 828.09 8’002.87
IWVL (Enhanced Value)
Price/Earnings 10.00 1’718.66 209.62 1’928.28
Price/Sales 0.79 2’250.45 54.43 2’304.88
Price/Book 1.10 3’144.33 362.91 3’507.24
SPI Extra (Swiss Mid&Small)
Price/Earnings 19.08 3’279.20 399.96 3’679.15
Price/Sales 1.48 4’216.04 101.97 4’318.01
Price/Book 2.18 6’231.49 719.22 6’950.70

It is impossible to tell you with these informations only, but considering their limited return on the total asset, I would say about 15x earnings IF it was liquid. Don’t look at Price/book, it is meaningless most of the time

There are 400000 shares.

Free cashflows per share (defined as change of net liquidity after dividends):

Year 2023 2022 2021 2020 2019
Components -42.50 -162.85 130.86 -83.79 -65.84
RE -27.22 -10.43 -28.75 -10.06 -31.46

Dividends are stable at 100 CHF. I think it was 90 CHF some years ago.

There isn’t any older data in the annual report.

What else would be of use?

I also think that the stated equity is not very truthful. The machines of the optical components main business are probably not worth much outside the company. On the other hand, RE probably has a lot of hidden reserves (actual appreciation vs. depreciation in the books). Also, other industry lots could also be worth something.

How do you arrive at that number?

At first glance, the company seems to established and fairly large.

You can set a floor for the valuation by calculating the netto-substanzwert (net asset value?), which is essentially total equity.
Additionally you can take the reported tax value as an indication, although I can imagine it being conservatively valued.

Looking at multiples of peers will probably get you closer to the actual value. Examples are EV/EBITDA, EV/FCF, EV/EBIT or P/E. Is a bit of a pain to calculate all multiples manually (a Bloomberg Terminal would help) and identify relevant peers, but should be doable. Just remember valuation is an art not a science :grin:

Ask your bank how much you could borrow against it.

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Maybe your specific predicament serves as a motivation to learn more about valuation. Prof Aswath Damodaran has a great youtube channel

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  1. EBITDA is not reliable, especially in the industrial sector. It removes interest payments, taxes, and, most importantly, depreciation of capital expenditures (which are often high in the industrial sector). When you look at your net earnings, they are 50% smaller than your EBITDA (and i would argue that in the industrial sector, net earnings are a good proxy for free cash flows (i.e Cash Flow from Operations minus Capital Expenditures, not your definition with the dividend), especially if the business is not growing.

  2. Your business is well established but it does not grow, both the real-estate and the optical components divisions are roughly at the same place than 5 years ago. In a public market, a business that does not grow would not fetch more than 10x the earnings of its operations.

  3. The return on equity is actually not that high.
    Optical Components: 171.87/2858.48 = 6%
    Real Estate: 20.96/329.92 = 6%.
    Now it might be because the divisions are over-capitalized (i.e there could be a lot of excess cash that has not been distributed yet). But if that’s not the case, then the company is likely not meeting its cost of capital and is probably worth less than 10x earnings. Probably more around 7-8x, and that would be in a public market, which usually adds a premium to liquidity.

So all in all, i’d probably pay 5-6x total earnings, plus excess cash per share, i.e the business value would probably be between 950 million and 1150 millions, plus excess cash (or minus net debt).

If there are 400’000 shares outstanding, that would mean probably a value between 2’400 and 2’800 CHF per share, plus an adjustment for excess cash or net debt.

EDIT: after a second thought i would not value the real estate on an earnings basis but more on the local value of the real estate (at the scale of this company i would be suprised if the value of the real-estate had not been appraised.

So the market cap would be worth roughly 5-6 times earnings of optical components operations + value of the real estate on a local market basis + excess cash - financial liabilities. And then adjust on a per-share basis.

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I had quite some trouble calculating a sensible number for the actual optical components operations. The “earnings” I calculated from ROE for both divisions just added up to total company earnings. But those include return on liquid assets and AGBR (“Arbeitgeberbeitragsreserve”: money in pension fund owned by the company). Liquid assets are about 7.5% of the balance and AGBR about 8%.

The liquid assets probably belong in a business and so would their return. I left them alone. Luckily for ABGR, there were two rows having earnings per share with and without ABGR. I then corrected the industry earnings by the resulting factors. The average earnings over the five years got reduced by another 22%.

This number I then took for earnings and multiplied by 5.5 (~800 CHF per share).

The real estate appraisal I took out from a shareholders letter. It was around 7 times the equity. (~2200)

As excess cash I took things that looked like money: Liquid assets (~350), short-term receivables (~500), ABGR (~400). Notable positions I excluded were property and inventory.

I also subtracted all liabilities (~1450).

Gives me a final value of about 2800 CHF. Trades in the last year were a bit higher around 3100 CHF.

Ah @Julianek, may I ask how one could interpret the resulting valuation if it was “correct” or “good” (for a lack of better words)? For example: If the bids are higher, one should sell, if the asks are lower, one should buy?

Hi @Helix, a few points:

  • Receivables are not excess cash, they are short-term operating assets that you need to operate the optical components division (they represent the capital that is needed between the moment the customer purchases the goods, and the moment he pays cash). They are usually considered a liquid asset (to such an extent that banks will be happy to finance you against your receivables), but they should not be considered as “excess” (i.e cash you could take from the business and distribute to shareholders or re-invest in another division). Unless of course the company has a new policy saying that all customers need to pay cash immediately.

  • Same for the AGBR: i am less familiar with this account, but from what I understand it is money needed to fund the employees’ pension, so that’s probably tied to employees’ compensation, which is definitely part of the operations, i.e it is part of being in business.

I understand if you don’t want to give a lot more details in public, but if you wish you can send me a PM with the balance sheet so that we can distinguish operational assets/liabilities from financial ones. This will give a better idea of the true profitability of the business to see if it deserves a higher multiple.

Regarding your last question (what to do with your shares), i can’t decide for you but I can give you indications:

  • The optical division seems to be a large, established business, with few perspectives for further growth (at least from the numbers you posted - maybe i am wrong and management has new material projects for this division). If that’s the case, it is likely that the intrinsic value of this division won’t move much, unless management finds a way to use less capital to generate the same profits (in which case it would be worth a higher multiple). But if from what I understand, the mindset is mainly to provide wealth for the family, this business will be conservatively financed to not risk the long-term profitability. This means that probably all your returns will come from the dividend.
  • It would be worth checking if they expect to grow a lot the Real-Estate division (maybe they have access to cheap capital), in which case it would be interesting to have an estimate of the expected growth of the division - otherwise, as said, i would expect the value of the business to stay flat and most of your returns will come from the dividend.

As for buying/selling, you just did a back-of-the-napkin valuation that landed at 2’800 CHF, i.e 10% from the market price. I’d say that 10% is not a big enough margin of safety to know for sure if you are right and the market wrong, it seems that both you and the market are landing in the same ballpark.
So unless you see a lot of volatility in the share price (i.e some years it trades at 2000 CHF and other years at 4’000 CHF), i would not bother trying to do arbitrage the market.

I would rather ask whether from your perspective:

  • Is the dividend (which seems to be quite reliable) financing a lot of your lifestyle or is it negligible (maybe it is worth keeping the shares in the first case)
  • What is your opportunity cost (i.e the expected returns of your other opportunities) => it looks like the returns from your shares is likely going to come mainly from the dividend yield. Is this yield higher or lower than what you could expect in an index fund? In case this dividend is a large part of your revenues, can you afford more volatility if this wealth is invested in public markets?

My 2 cents,

Julien

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Thank you for your valuable input. Here the balance sheet scaled to one share:

Assets
Liquid Assets 343.25
Receivables 495.24
Inventory 800.62
Prepaid Expenses 23.31
Property* 2’379.05
Financial Assets** 64.44
ABGR 393.73
Intangible Assets*** 53.00
Liabilities
Short-Term Debt 511.19
Payables 165.03
Short-Term Provisions 17.22
Deferred Income 81.26
Long-Term Debt 371.95
Long-Term Provisions 217.59
Equity 3’188.40

* Mainly machines, real estate
** Mainly deferred tax assets
*** Mainly goodwill

Regarding AGBR: I think you are right; this money is gone and can only be used to replace payments to the pension fund.

Regarding excess cash and financial liabilities: If I understand you correctly, this should only include positions that are not tied directly to the operation. So:

  • Assets: Liquid Assets
  • Liabilities: Short-Term Debt, Long-Term Debt

As valuations are based on many assumptions, they should be considered an art rather than exact science. That’s what Prof. Damodaran teaches.

Great job, @Julianek !

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An important factor is what % of the company do you own and in particular, if you own a controlling stake or a stake large enough to influence the company e.g. block decisions etc.

Not even maybe. :laughing: It makes up a sizable portion of my total assets, but it is not the biggest position. I think, I can’t sell without leaving a bad impression, but the price seems to be in a fair range anyway.

The bad things are probably the lacking diversification and low liquidity. The company itself is somewhat diversified, but still exposed to one management. I would assume the ownership looks different from standard index companies, so that could be some diversification (or diworsification). If I think about this correctly, a P/E multiple of 5.5 on the optical components division means it is going to pay back in full every 5.5 years (at least internally). This is 18% per year (which seems like a lot, @Julianek?).

Lack of control and management issues counts for a lot too. What if they stopped paying dividends, raised salaries and basically kept all the economic benefits for themselves with you as a minority shareholder having limited ability to do anything about it?

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Ownership is dispersed and tied to multiple family trees. I doubt that management will be able to run off with the profits.

Anyway, if you are a minority shareholder and you have the opportunity to offload the shares, I would take it. 5x profits is not unusual for private companies.

Based on what? I’m a minority shareholder everywhere. And what would you buy instead? Why?

I value liquidity. While markets are good and there are buyers, I would sell and invest into listed companies.

Fair point, do you value it absolutely, or would you lock up funds for longer if it would have higher expected return? How much would you need for it to be worth your while?.