POP QUIZ: What’s it worth? Good or bad business?


 Case-Study-So-What-is-It-Worth  Buffett finally seeks an assistant to help him find and value companies.  You meet him at a diner in Omaha.   He slips you the above financials, then he asks you to comment.  Please take no more than 20 to 30 minutes.  Is this a good business? Why or why not? So what do YOU think it’s worth?  Should Buffett buy this Wall Street darling (at the time?). Show your back of napkin calculations and don’t spill any coffee.

The “Solution/Analysis” will be posted Friday-here.

Some people in the Deep Value course are nodding off.   Try the quiz to sharpen your thinking. If you don’t come close, you will have to meet:

11 responses to “POP QUIZ: What’s it worth? Good or bad business?

  1. “Take all numbers as fair and accurate.”?? Didn’t this company hire people to pretend they are working in a trading room? 🙂 Since most of the revenue are fake (hence earnings as well), I would value it based on liquidation value……humm……net of debts and payables, given “asset from price risk management” numbers are likely inflated I would say zero for the equity.


    What jumps out at me?

    Operating revenues up over seven-fold, but per share earnings barely budged. Total assets are up 4-fold, and revenues to assets have improved significantly. Market cap has nearly tripled. I’m asking myself: recovery share, cyclical, or accounting shenanigans? Is everything likely to be priced in? Knowing the sector would really help. Elsewhere in your blog, you seem to suggest it has something to do with gold. A gold miner, perhaps? Contrary to that, your hint says that it is a company changing the world. employing the brightest people with cutting edge technology. That hardly screams “gold mining company” to me, but perhaps you lifted that from the accounts as a cruel irony. The revenue increases seem to make us want to say it’s a growth company, especially with your description, but the erratic and go-nowhere EPS aren’t really sending me that message. PE ratio goes from 14.8 to 27.9

    Page 3. Revenues triple, but depreciation is the same. Hmmm, underdepreciating? Also, the number of shares going up year by year. I wouldn’t expect that for a normal recovery or cyclical company. The company seems to have caught the imagination of the market at any rate, judging by the escalation of PE.

    Page 4. What an odd balance sheet. I think John has kindly given the game away on this page! Total current assets has ballooned. What’s sticking out is the “assets from price risk management activities” has gone up a lot. And look at the odd collection of PPE. Natural gas transmission, fiber optics, what kind of company has that? Here we have an odd puzzle that we need to solve. Net PPE hasn’t budged that much, and “construction in progress” is actually down! Hmmm, I ask myself, how can a company generate so much extra revenue without significantly increasing its investments in fixed assets? John, this company has to be Enron. It all fits into place. The revenues aren’t being generated so much by PPE, but by their “risk management activities”. It’s Enron. Got to be.

    Unfortunately, now that I’ve figured it out (I sincerely hope I’m not embarassing myself here), and that everyone knows how this ends, I can’t unlearn my conclusion, and give it a price no higher than $0. Otherwise, I would have made some kind of quess at what it would have been worth, maybe 13 X average of last 5 years EPS.

    If this company isn’t Enron, then I’ll take Danny DeVito’s Pepsi challenge. Should I call an undertaker?

  3. Enron? A lot of hairy things going on within the current assets. Looks like a lot of derivatives being traded and counted towards revenue. Wouldn’t value, would be put into too hard.

  4. Definitely Enron

  5. For the year 2000, how does the total cost and expenses adds to $98,836 ? It doesn’t make sense.

  6. What jumps out?

    1. Summary page:

    Revenue up 8x, but Net Income barely up 2x. EPS is stagnant.

    The company is expanding rapidly, but profitability is being sacrificed. Either they’re expanding rapidly to gain market share, investing in something which is capital intensive, or there are strange things going on with accounting. I’m thinking “maybe it’s a tech company”?

    2. Income Statement:

    Revenue rising rapidly. Cost of Goods Sold rising rapidly.

    Cost of Goods Sold seems to be rising at a matching dollar amount to Revenues. The other expenses are the same, so net income is the same.

    That’s a coincidence? It’s very fishy.

    3. Balance Sheet:

    PPE has not moved?!?! The balance sheet is expanding, revenues are soaring, but the company doesn’t need any more PPE for some reason?

    Where is the revenue coming from? Acquisitions? Something is missing from the story.

    wtf are price risk management activities?

    4. Cash Flow Statement:

    The company’s Cash Flow from Ops has barely moved. If they weren’t selling assets, CFO would be basically zero. Possibly shifting numbers from cash flow from CFI or CFF into CFO.

    5. Conclusion: This is almost certainly a case of shady accounting and management destroying value. Ballpark valuation = 0.

    My guess would be Enron based on the Energy equipment.


    Mcturra2000, I concur.

    I looked at the ballooning revenues, small earnings increase, the dates and the balance sheet with the pipelines and the totally weird depreciation, for a growing pipeline and transmission company, and the gains on price risk and said Enron.

    At that point, first conclusion bias, I could not reasonably look at the figures “objectively” anymore. Now the problem is we are to assume everything here is honest and correct which Enron was not. So what to do.
    Now assuming that the numbers are accurate, then let’s go with the good tangible assets. To get there quickly, take the 1999 shareholder equity subtract the goodwill and get ~ 7,000. Assume that the growth is not particularly beneficial, since net income is going nowhere with the ballooning balance sheet.

    Next let’s look at income, well here I’m not going to add back anything to get cash flow,i.e. EBITDA, this is a pipeline company afterall. So, capitalize the earning at 10X, 700 earnings in 1998 also gets to 7,000. Remember Enron was once a real thriving business. I do not see any franchise type return on capital so I’m liking the 7,000. (I don’t know what the interest rates were in 2000, but I’m comfortable with a 10x on earnings.)

  8. What jumps out?
    The 40% earning increase in the 98-00 period as been financed by an equal increase of debt (+40%) and more important increase of shareholders equity (+60%) thorugh new shares issue and m&a activity. therefore ROE saw a reduction from 9,7% to 7,8%, with a decreasing marginal contribution from new equity on Roe (Roe calculated on new equity increase = 276/4422 = 6,2%) . Return on IC remained anyway around 3.6-3.9%, is it a utility company??? I guess so. Really disturbing the profit to revenues ratio, from 2,22% in 98-99 to less then 1% in 00, to get the same results of the 99 the revenues had to increase x 2,5 times.. 2,5 times??? Quite suspicious to me … The figures from 96 to 00 are by far more puzzling, with profits increasing 70% and equity and debt threefold higher …
    Another disturbing things is in the cash-flows : for both years 99 and 00 the Net Cash Provided by Operation Activitivies has been lower than the proceeds from sales … no cash generation at all
    Bottom line : business seeing margin compression, low ROIC figures (but this could be explain if it’s a utility company), heavy investments (equity and debt) 1. requested for growing 2) at a decreasing marginal contribution and no cash generation – this is not the kind of business I’ll suggest to invest in unless is particulary cheap (vs book value or liquidation value) BUT more due diligence should be done anyway in order to understand che changes occurred in 99-00 period (see revenus and total asset sharp variation vs equity and debt increase).
    How much this firm is worth assuming all the figures are honest and correct? Assuming it’s a utility company and using EV/ebit ratio = 10, I would say the market value of the company could be around 11/12 billion usd (2482 multiplied 10 – debt – minority interest and preferred shares) than could mean 7-8% earning yields and a 3-3,5% dividend yield – but the fact it seem to me they don’t produce any free cash flow is quite disturbing .. Does it make sense to you? How would you value this company? Which logic will you follow?
    Extra Credit : Is it Enron?

    • Ange, that’s a great point about ROE BTW. IIRC, it was Jim Chanos who had a short on Enron and pointed out their pitiful ROE.

      This really brings home the point that people like Terry Smith and Aswath Damodaran make about “growth for growth’s sake”. Wall Street is fixated on growth stories, but they rarely seem to check what the company is earning for its returns on capital.

      In the excitement, analysts also forgot to ask themselves a pretty simple question: how is it that an ostensibly boring utility company can grow so fast?

      John is right. Analysts are useless as tipsters (barring some very insightful ones that I’ve seen).

  9. Things that jump out
    1) Big jump in revenue, negative change in net income
    2) on Consolidated income statement the revenue increase 2.5x, the cost and expense increase 2.5x. The business doesn’t feel that attractive …
    3) Lot of equity dilutions taking place annually
    4) Big jump in Assets/liability and big part coming from “price risk management activity” : wtf is that! something seriously smells fishy.
    5) Natural gas, electricity generation and fiber optic network (Enron jumps to mind, first conclusion bias)
    6) The company revenue are growing but construction in progress is going down (fishy).
    7) On cash flow statement: “Change in component of working capital” goes from -1000 to +1769. No clarity on big change in Receivables and payable.

    Whole things feels uncomfortable, I won’t want to buy it.

  10. As many before said – and I agree – revenues up 2.5 fold, total assets up 2 fold while total earnings YoY are flat is not a healthy development.

    I wonder why ‘Assets/Liabilities from price risk management activities’ is in the balance sheet twice. And I’d ask why assets and liabilities increased about equally. Doesn’t make much sense inflating your balance sheet artificially.

    What I do like is that they returned a positive free cash flow for the first time in 3 years.

    They paid about 350mln in income taxes (1bln taxed at 35%) which leaves about 2.1bln in interest expenses. Considering that short and long term debt stands at 10bln, that’d be an interest rate of roughly 20%.

    As for what they’re worth:
    Taking into account those questions and no income growth I’d only buy them at a massive discount. Thereby I’m thinking of a P/E in the area of 5-7, suggesting a P/B of 0.07 – 0.1. I’d monitor their Cash Flow Statement very closely.

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