I used to work in the financial institutions group at a buldge bracket bank doing valuation and M&A on the banks team. The thing about bank valuation that's weird, is that it's balance sheet valuation and not income statement valuation. Banks don't sell things, they sell money. The make money off interest earned on loans - their cost of capital (~interest paid on deposits=0) - branch/hr overhead (if they have branches). Anyways, to compare a bank to another company that sells physical goods or widgets is kind of silly to begin with. They are not valued the same way, and they make money completely differently.
I like to think that there are two extremes for valuations.
On one side of the range, the consulting firm, which has no assets, and which value is a pure function of future earnings.
On the other extreme you have an investment fund where the value is purely a function of the value of the assets which are all liquid financial assets. You don't buy the fund at a premium, otherwise you might as well buy the underlying assets yourself.
A bank is somewhere between the two. It has what should be a reasonably reliable accounting value since at the end of the day, all of its assets are financial assets that can be sold and aren't highly specialised like a factory or a hotel building is. But on the other side a large part of the value is not just the balance between assets and liabilities. It has additional earnings (fees, trading activities, etc).
Consulting firms generate revenues. Their assets are mostly human capital, but their value is generally a multiple of current earnings, not "a pure function of future earnings".
Most banks hold a decent amount of highly specialized, illiquid debts that have no active market and could reasonably be compared in terms of liquidity to real estate or capital goods.
I am not sure I understand your point. How is that different from what I wrote.
And no, there are no line in an IFRS balance sheet for "human capital".
[edit] and on your second point, I don't think I agree. You will pretty much always find a buyer for financial assets. Unless they are so rotten that no one thinks they are worth what you have them in your books for (which may be the case for some Italian banks).
Where I think you are right to be careful with banks is with the size. If you need to wind down a massive international bank, you need to find buyers for a awfully large amounts of assets, and that will likely damage their value.
> I am not sure I understand your point. How is that different from what I wrote.
Yeah, we are on the same page, it was just a little nit as it seems weird to me to state that future revenues are the "pure" base for valuation when future is informed by current. Just semantics though.
> You will pretty much always find a buyer for financial assets. Unless they are so rotten that no one thinks they are worth what you have them in your books
At the right price you will find a buyer for anything. I was speaking to your point about liquidity, which is not about price of the asset, but about the quantity of interested buyers and the ease of structuring and executing a transaction with a buyer.
But there are buyers for complex financial instruments. There are many hedge funds around who can do both size and complex products. And other international banks have the teams and system to buy a portfolio.
But size is a problem. When you have 2 trillions $ of assets to sell, even if they are simple vanilla mortgages, it will be a buyer's market.
> but their value is generally a multiple of current earnings, not "a pure function of future earnings".
Not sure what your objection is. The function is something like V = 3 * r, where V is the value of the company and r is the annual revenue. Boom, pure function.
Ok, but if I wanted to buy enough shares to own DB or snapchat (if it were public at its current valuation) I would have to pay more to own Snapchat. So while it doesn't make sense to compare underlying assets/liabilities, it does make sense when you ask the question: how much would I need to pay to own this business?
But Snapchat is not public and that makes a world of difference. Its valuation is based on a group of investors that likely have a totally different risk tolerance and time horizon that the market as a whole. The terms of their investment are also likely totally different than the terms you get as a standard shareholder of a public company. E.g. if they have liquidation preference, that's going to distort the valuation calculated based on their investments.
The article compares DB Market Cap to Snapchat's "valuation" which is based on the terms of its latest funding round. Snapchat doesn't have an Enterprise Value because it's not a public company, so the value of its equity is currently unknown.
As I said before the DB/Snapchat comparison is apples to oranges when you compare balance sheets, but both metrics (market cap, "valuation") are decent proxies for the magnitude and direction of the "true" value of the company.
Market cap is not a decent proxy of the magnitude of the value of the company.
EV in it's simplest form is Mkt Cap less Cash plus Debt. Just b/c a company isn't public doesn't mean the value of the equity is unknown.
If you buy the equity of a $100M company that has $90M in Net cash then you really are only paying $10M for it. Likewise, if the company had $1B in Net debt then you are paying $1.1B for it. Theoretically, DB could issue $10B of debt and buyback $10B of equity tomorrow and that reduces their mkt cap dramatically (their regulators wouldn't be too happy about it, though).
My point is that Banks use leverage so mkt cap is NOT a decent proxy of the value of the bank. When you compare valuation of 2 companies using Market Cap for 1 or the other (or both) is VERY misleading, especially when you have one that has a business model that uses leverage.
The real question: what does Snapchat's equity look like?
You practically need a PhD in finance to value these things, with all the preferences, participation multiples, board seats，drag-along and pro rata rights, etc attached to these shares...
It's the value of the equity (shares); market cap completely ignores debt.
Market cap is a good way to think about what the total value of a company's stock is, but a leveraged (indebted) company may have some of its "company value" "owned" by bondholders as well. EV is the total value, whereas MC is just the shareholders' part.
I feel like this shouldn't be a dumb question, but here it goes:
So, how come people are purchasing equity without paying any attention to debt?
I understand how different classes of shares may be equivalent in scenarios where a company is successful, but very different if it is failing. I also understand that the market has established a price for 0.01% of a company, and not necessarily a price for a much larger share.
Ha, I wonder what the students in that class thought when the instructors were "too dumb" to teach the consensus understanding in corporate finance.
That said, on Hacker News, subjects like company valuations seem to be discussed in terms that are more consistent with economics than what you typically hear from students of finance.
Completely different model, and banks are weighed down by projected losses on bad assets. But the image is still valid, "Look at this formerly formidable mega-bank which has less equity value than a disappearing picture and video app." (Of course it's not a public market valuation, and much of the assets are supported in debt) European banking has been suffering along with Europe.
Perhaps the bigger issue is that when banks get to such a low level of equity relative to debt, they have no cushion to absorb losses. Once the equity hits zero, they become insolvent and that's when the Lehman comparison becomes very valid.
Want proof that this is total mathematical coincidence and irrelevant....if DB were going to sell itself, do you really think they would include SnapChat in the comps table? No.
