November 17, 2014

Business Valuation, Warren Buffett and Duracell

I have always been curious about how one is able to valuate a business that is not publicly traded. This past weekend, in our Advanced Financial Management class, I finally got my first glimpse on some ways how it is done.

Quite coincidentally, over the weekend, news broke on Warren Buffett's latest acquisition: Duracell.

Berkshire Hathaway purchased Duracell from P&G in exchange for the roughly 53 million P&G shares that Berkshire held worth around $4.7 billion. It's a unique exchange that saves Berkshire millions in capital gains tax it would have paid had it sold the shares in cash and paid the cash to P&G. For P&G, they too gain some tax savings while being able to gain back a large part of their outstanding shares which they can either retire or reissue.

Now, back to business valuation. Mr. Buffett is renowned for being able to spot companies that are undervalued. Although P&G is publicly traded, Duracell is not. So how does one arrive at a valuation? There are several ways like discounted cash flow method, but possibly the simplest way for an outsider like myself to conclude that the price paid was "good value" is to look at the ratio of EBITDA to sale price for the sale and compare it to the industry average. 

Based on TIME Magazine's computations (link here to the TIME article), this sale was 7 times EBITDA which is lower compared to the overall market which is trading at 11.5 times EBITDA and the consumer electronics industry which is trading at 9 times EBITDA. Based on this alone it seems like good value.

Factor in the estimated worth of the Duracell brand (worth an estimated $4.935B) and it seems like Mr. Buffett has done it yet again.

One day, I hope to be able to use what I have learned in business valuation in the same successful way that Mr. Buffet has done over the past few decades.