Business Valuation

Baltimore Resins Corporation (BRC) – PART 1

Introduction

Following a marital divorce between the part owners of the Baltimore Resins Corporation (BRC), a suit was brought to court to establish a fair market value of the firm to properly allocate the equity between the two parties. A business valuation requires an analyst experienced with Generally Accepted Accounting Principles, tax laws, and other subjective/objective valuation theories (i.e. asset based, income based, or market-based approaches as learned in this course). There are multiple subjective factors that affect the value of a firm, including, but not limited to, geographic location, the strategic value to ownership, market space, and competitive landscapes. In addition, there are multiple strategies that an analyst may utilize in their findings including earnings multiples, Discounted Cash Flow analysis (DCF) (which projects the future annual cash flow), the value of a firm’s total assets less working capital, and/or utilizing comparable firms in the market/industry. In order to properly allocate the assets of BRC appropriately, an analyst must research in depth the financial stability of the firm along with any item that may affect the value that will be presented to court. In addition, the analyst must be able to firmly stand behind this number while provide supporting documentation as to how they arrived at this conclusion. As such, the following below documents were utilized in out Teams deep dive of financial records in effort to provide a resulting monetary value of BRC:

Balance Sheet Baltimore Resins Inc. 2010

In our textbook readings, Trugman lists the balance sheet as one of the essential financial statements a valuation analyst should request when conducting the initial research and evaluations (page 97). The balance sheet essentially determines the net value of a firm or true equity to the owner by totaling the assets and subtracting any liabilities. In the attached document, the balance sheet lists the firm’s assets well over $1.4M. Per chapter 6, a balance sheet may be used as a tool to perform comparative analysis or common size financial analysis which illustrates a firms value based upon similar firms in the industry. The analyst can derive multiple financial ratios such as the Quick Ratio, Cash to Current Liabilities ratio, Accounts Payable/Accounts Receivable Period ratio, or a Debt to Equity ratio to understand the financial stability of the firm and future strategic direction of the firm. Figure 6.3 on page 207 further highlights the valuable insights the historical balance sheet provides in determining the value of a firm. In my opinion, the most important question to understand would be what the least amount of operating cash required to run the firm and to understand the status of all primary outstanding receivables (or invoices not paid/potential for bad debt). After all, the cash flow would be a key factor in the owner’s ability to keep the firm afloat.

2011 TAX RETURN serves as P_L-for other yrs. see spreadsheet

Along with the balance sheet, the US Income Tax Return will be one of the most beneficial financial forms for our team to review. Before watching our Professor’s zoom conference call in reference to this case, I was in favor of reviewing the P&L (or income statement) over the Tax Return. However, in our lessons, and aside from the ease of reading the statement, Trugman states on page 126 that a Tax Return must be requested in order to determine the true differences between tax and financial reporting. As it is mentioned in our case for the potential Townson spin off firm to BRC, a tax return will also highlight any subsidiaries on a consolidated return form that are listed under an umbrella firm “as defined by the IRC.” In the role of evaluations for the purpose of Martial separation, there are no specific set standards and one must look to case law for any prevailing results. Therefore, one must also be familiar with the IRS revenue rulings and impact on valuations (as listed on page 126). As stated in the first chapter of our text book on page 9, it is important to delineate between the difference of GAAP or Tax Oriented Guiding Principles when valuing the business (taxable income reported to governing agency versus how much is earned reported to shareholders results in difference on this tax statement). A few differences that arise may be generated due to the fact that GAAP is derived from a privately held independent board vs the IRS which is controlled by the government at that time. Items such as Inventory recognition (LIFO or FIFO), Accrual based accounting (recording the revenue with the cost in the same month), or the approach used in the depreciation of assets may all cause these differences. In the attached document we can clearly view the total Revenues, Cost of Goods Sold (and thus the Gross Profit), along with all of the deductions that provides tremendous input into the value, efficiency, future growth potential, and operating costs of the firm which we as a team can support/stand behind.

MAIN DATA-BALTIMORE RESINS CASE--EXHIBITS A-F & 2019 deal stats-companion-guide

Deal Stats provides the comprehensive financial statistics of both privately and publicly held companies (in this case for the plastics and resins industry). The information listed on their platform is utilized in any mergers, buy outs, or selling of a firm. An individual can learn how to navigate their site by reading the “2019 deal stats-companion-guide” which includes definitions to all the charted statistics. The information attached provides a comprehensive breakdown of the sector which will support any comparative analysis to use as a benchmark in evaluation. Specifically, it illustrates the past financial standing of companies that were sold and then provides earning multiples for analysts to make judgements calls based on. In simplistic terms, this platform can be compared to that of a Zillow for the sale of houses. The location of the house, sale date of the house, purchase price of the house, how many rooms in the house and more are real life examples of how this information may be utilized in calculating the value of a firm using these metrics. If an analyst sees that a company in the same industry was sold and valued for more than 10x of their Gross Profit, than this provides a baseline number to use when reviewing BRC’s Gross Profit at 10x. Two items of value are Net Sales and EBITDA numbers. This provides insight into how profitable or efficient a firm may be. For example, if two firms have similar net sales, but very different EBITDA numbers than there is a higher operating cost which should be taken into consideration as well. Essentially it is more expensive to run the same business. Earnings multiples such as the MVIC/PRICE provides insight into what companies are being sold at (selling price divided by the earnings). This is an objective approach to number crunch and apply a weight of each multiple when deriving the final value summation.

WRAP_Large_Scale_HDPE_Recycling_Trial_Report.4328448f.3769

The attached document will be utilized to build upon the teams’ understanding of the industry and the potential growth of the firm (or proof of concept). Although this article does not provide true insight into a number evaluation, it will assist the analyst in understanding the feasibility of the business and thus any barriers to entry in the market (or any deductions/discounts that must be taken into consideration based on the level of effort or Operating costs associated in large scale recycling and potential recycled use (size of market or opportunities)).

32521 Plastic - Resin Manufacturing in the US Industry Report & 42461 Plastics Wholesaling in the US Industry Report

Although the information in this article is more recent and may not have been available at the time, the information contained is a reliable source which depicts and further illustrates the resins industry (“Industry at a Glance”). The article supports an increased valuation of BRC since the industry has recognized steady demand through 2018, however also provides a positive outlook for the industry through 2023. The data visualization charts provide detailed analysis on how the revenue in the resins industry is directly tied to manufacturing, construction, consumer spend, oi prices, and raw material prices. This information will support an objective approach in valuing the growth potential of BRC. With the key external drivers listed, economist project a healthy outlook for construction considering the low interest rates paired with the lowering cost of crude oil. However, as material costs increase, ethylene (derived from natural gas), this cost may be passed on to the customer which may either lower demand or deter future customers. Based on our strong dependency on plastics based on the decline in other raw material prices, from 2018 – 2023 IBIS World expects the industry revenues to rise slightly in our recovery period (again this would not have been known at the time of divorce). In addition, new firms are expected to enter the industry which also must be evaluated as this competitive landscape paired with the high upfront cost to build a factory with heavy machinery could prove to be a barrier to entry. Overall, this article, provides a strong foundation on the industry itself and how an economist may project a value based on these external findings.

VALUATION SPREADSHEET _2018 Goodwill article v1

Used by team member to calculate multiple scenarios and DCF methods in Part 2. This template will be utilized and further defined in Part 2.

NYT article scrap business

In the attached NY Times article by Jake Halpern it is said that “The U.S. produces more garbage than any other nation in the world per capita.” Although this article will not provide much value, the reading is insightful as it may highlight to an outsider the true potential of the industry and how large it is. The article follows a man by the name of Adrian Paisley hunting for raw material such as copper and aluminum or of other items of value who made enough profit to pay for his power boat. Along with this incredible story, the Institute of Scrap Recycling Industries (ISRI), cites that the scrap industry has over 531,500 employees which exceeds the amount of “computer programmers, web developers, chemical engineers and biomedical engineers combined.” Again, to an outsider, this article provides a foundation to the size and market capacity of this industry.

BALT RESINS CASE-COMPILATION OF FINANCIAL DATA & VALUATION METRICS AND WEIGHTS use with DEALSTATS

Both documents provide insight into BRC’s financial statements from 2008 through 2011. The data illustrates Net Sales which provides insight into the revenue streams, strength of sales team/customer base, and the firms growth potential. In addition, Net Income is provided. Net Income is the sales less working capital (or total overhead) which illustrates the financial health of the firm and what has been earned. Finally, Invested Capital is provided. Depending on the method of valuation, invested capital is useful in illustrating the money/spend that is re-invested out of the profits back into the company. The income mid-point and sales mid-point were derived by taking the average sales from 2008-2011 of both the income statement and tax returns. Although, I would have taken the geometric mean of both, utilizing the average can be misleading if one does not understand the drivers of the business (i.e. is there a large contract ending with an ongoing customer and so on?). Per the below, we can see that income does not proportionately increase or decrease with net sales. It appears net income has been decreasing year over year with invested capital & nets sales increasing, thus leading to the argument that, per our professors’ comment, there may be “some cannibalization towards TOWSON RESINS, Inc.” The Metrics tab highlights three SIC codes (SIC 5000, SIC 5100, & SIC 2821). The professor then calculated the weighted multiples of sales, invested capital, and income on each of the three comparable industry codes (at 45%, 45%, & 10%) and multiplied this by the financial data previously mentioned. With these averages the professor then placed a weighted average on each of the financial metrics (sales, income, invested capital, DCF) to arrive at a $1.8M value. This is an example of how we intend to value BRC as a team.

Recycling-of-High-Density-Polyethylene-_HDPE-or-PEHD_

Background information on product and not incredibly useful to this case.

Deal Stats Value Index 2019 Q2

The attached article provides insight into valuation pricing multiplies and profit margins. The data is extensive and includes historic data visualization charts that depicts the median selling price compared to EBITDA, net sales, Gross Profit, Operating Income, and Sellers Discretionary Income per sector or industry. In addition, it includes information on the volume of private firm acquisitions (which demonstrates the appetite/demand for company buyouts/mergers). This information is useful not only for the BRC sector, however we learned in a separate article that the Resins sector is directly affected and correlated to manufacture and construction performance which is provided in these charts.

bvr cost-of-capital-platform-bvu-article

The attached article will not be incredibly useful in valuing this case (BRC), however the below quote was found to be very insightful as it sheds light onto the complex world of valuing firms. There is no one way to calculate the value, but rather an analyst combines all the meaningful information on record and utilizes the objective and subjective information gathered to arrive at a conclusion in which they will need to defend.

“We’ve reached the point where the concept and the inputs to cost of capital have become so complex that the risk of making errors has increased. Finance is not a physical science; it’s a social science. Tools of physical science and mathematics are probably being incorrectly applied, and the process has become too much of a black box of applied mathematics. Mathematics should be used as a tool in practice. It should be a means to an end, not the end itself. Focusing too much on math results in an “illusion of precision” that moves us away from using judgment in the process. You can’t program professional judgment.” -- Michael Crain. Business Valuation UpdateTM (ISSN 2472-3657, print; ISSN 2472-3665, online)

Sources

A. Trugman, G.R. Understanding Business Valuation: A Practical Guide to Valuing Small to Medium Sized Businesses, 5e. New York: American Institute of Certified Public Accountants, Inc., 2017.

2008 - 2009-8%-61%-11%

2009 - 201020%-6%22%

2010 - 201114%-235%17%

SALES (2011 tax return)INCOME (2011 tax return)INVESTED CAPITAL