There are many ways of heating up a chilly Friday
night in
Northern VT, but for 11-year-old Noah there is only
one with
any real interest now that the Red Sox season is
over
— Red Sox Monopoly.
My wife Annie and I were providing D.C.C.P. services
(as in
Designated Child Care Providers) to Noah and his
brother and
sister a couple of weekends ago when he offered to
introduce
us to yet another spin-off of the Sox' most
successful
season in our lifetime. The terminology had
changed
— Boardwalk and Park Place were Fenway Park
and Ted
Williams Way — but the numbers and rules
were all
the same.
Annie and I were a little rusty, but we quickly got
caught up in
Noah's strategy of never passing up a buying
opportunity. He also proved to be a pretty
shrewd trader,
in no time accumulating hotels in the low-rent district
—
Landsdowne Street and Yawkey Way (Mediterranean
and Baltic)
— while we were still trying to buy houses for
our more
upscale properties.
Ultimately, my strategy of concentrating all my
resources on my one color code —
Fenway and
Williams Way — coincided with Noah's
unlucky
landing on Fenway (three houses —
$1,400) to
wipe him out, but not before I had to mortgage
a few of
my properties to stay in the game. Facing the
immediate
potential of four hotels of mine clustered
around "GO," Annie
quickly sized up the situation and retired to her
reading.
In the following week, a couple of client
situations offered
some parallels to Monopoly. In both cases, my
clients
have recognized the limitations of internally-
generated growth,
of adding houses and hotels one color code at a
time.
They're seeking to grow more quickly based on a)
strong
management; b) a history of profitability; c) insight
and
knowledge of their respective industries; and d) a
financeable
balance sheet.
Equally important, they've learned what Noah is just
beginning
to appreciate, something I didn't learn until I was
much older
than he is — that there are key metrics in
the
acquisition game, just as in Monopoly, that you
ignore at your
peril.
In Monopoly, the color code which provides the best
return on
investment is the orange — traditionally, St.
James,
Tennessee, and New York — based on the
probabilities
of going to jail, advancing token to nearest utility,
advancing to
St. Charles Place, etc. You're not a guaranteed
winner if you
control those properties, but you're far more likely
than if you
have the worst set, the green (Pacific, North
Carolina, and
Pennsylvania). (For a complete list of the
probabilities, advance
your token to this
site.)
Similarly with buying companies. Both of my
clients have a
strong sense for how the competition's products and
services
could supplement their own line and what it
might be
worth to fill in a "color code."
The basic determination, however, still comes back
to the
numbers: the only certainties (subject to
due
diligence) are the historical numbers on
the
income statement and balance sheet. To the
extent that
recent results are replicable in future years, a
combination of
yardsticks (see sidebar) can yield a consensus
valuation.
If, as in one client's case, you're buying a
company whose
expertise is largely concentrated in one person, the
bulk of the
value is in the potential, at least some of
which is
attributed to what you, the acquirer, bring to
the table.
In the usual case, this deal is structured as an
earn-out:
the owner(s) of the acquired company are paid
over
2–5 years based on results —
revenues,
margin, profits, return on investment, or a
combination of all,
with the terminology precisely defined.
In my other client's situation, the target product line
is well-established, the market is reasonably stable,
the
principals
want to retire, and the underlying value is
represented by
several designs and trade names. My client knows all
of the
costs, so the challenge is to determine the value
today of
the stream of earnings being added by the
acquisition.
Understood by every MBA student and incorporated
in Excel
software since the earliest versions, the Net Present
Value
calculation is the standard method of doing this.
So as I think about all of my clients and their
opportunities in
The Great Game of Business (with credit to author
Jack Stack),
I revert to the lessons I'm trying to convey to Noah
through
Monopoly:
- Without a strategy, every property looks like
a great
opportunity. You can run through your time and
money
very quickly pursuing every opportunity.
- The railroads and utilities can be useful as
deal
sweeteners, but they're not going to win the game
for you.
Similarly with long-term employment contracts:
guaranteed compensation is seldom accompanied by
guaranteed motivation.
- Life isn't built around winning the Lottery, so
there are
no jackpots for Free Parking. Nor is the value of
a target
company to be predicated on the long-hoped-for Big
Contract
or the projected break-out year.
- Knowing the odds may allow you to trade your
greens
(Pennsylvania et al) for your opponent's
oranges (St.
James et seq) and win the game. Knowing
your
industry's economic model and making it work leaves
you no
worse than even in any negotiating session. You
can
always walk away.
- The only way to avoid risk is to be the
banker
(ref. Howe's
Bayou,
November 2005). I've never been in a Monopoly
game
played by the official rules in which the Bank went
bust.
The next day Noah was back to the Monopoly board,
playing a
game against himself to test the various
strategies. "There's a
kid," his proud grandpa thought to himself, "who's
figured out
how to avoid losing — truly a budding
Monopolist."
