Valuation guru Prof. Damodaran details relevance of storytelling to drive growth

By Darshana Abayasingha

Professor Aswath Damodaran

Widely regarded as the Dean of Valuation, Professor Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University was in Colombo last week, where he addressed a gathering hosted by the PricewaterhouseCoopers Academy Sri Lanka. Professor Damodaran is globally regarded as a specialist on capital markets and valuations by corporates, fund managers, analysts and has been widely published. 

During a captivating address in Colombo, Professor Damodaran stressed on the importance of story-telling when placing a value on a company. A good valuation in his opinion is a bridge between stories and numbers – engaging the left and right brains – employing the biases and delusions brought forth by both parties. Number crunchers, he says, are a delusion of precision; adding decimals to make themselves feel better, whereas storytellers can be creative and inspire. 

“A good valuation is never about the numbers. All you have is a collection of numbers in a spreadsheet. You can say the greatest story ever about the business but you cannot put numbers in that story. A good valuation is a bridge between stories and numbers. You need to know the story of a company and that will explain the hundred million dollars behind it. The numbers can be moved by that great story.”

However, when telling the story of your company, first it must not have numbers in it, and then it must be ‘possible, plausible and probable’, he adds. The task thereon is to take every piece of the story and transform it or place a number to it. Damodaran adds that whilst some people would argue it is difficult to place a number on a story, he treats it as a challenge – no matter how creative the story is – to find a number to reflect a part of the story. CEOs mingling with like-minded people tend to like their own valuations, which is natural and pat each other on their backs. Therefore, it is important to do something that makes us all uncomfortable and seek out different people with differing opinions who thinks the least like you; companies must find ways to extract that opinion, he says.

Damodaran accedes that for a deal to be fair, the price that is offered has to be somewhat higher than the real value – taking a little break from the rules. However, this cannot pave the way for impossible valuations. He drew on the example of Tesla, where a venture capital firm placed an estimated perpetual growth rate of 6% every year in USD terms, with little or no information available on cash flows. “Think about it; if Tesla grows 6% very year, sooner or later it’s going to become the global economy whereby we will have to eat and drink even in Teslas. This is an impossible valuation, for which they earned over $ 7 million. I’m willing to see rules being broken, but this cannot work.”

Damodaran explains that in every spreadsheet valuation, every line item has a lifecycle. One in three valuations he sees are implausible he says. But he adds that impossible valuations can be at times given plausible reasons that can at times be extreme. For example, he pointsto a student in the US who had projected 4% constant growth for the National Football League in the US, one of the country’s most celebrated brands and institutions, with no reinvestment in the stadium or its facilities. Upon enquiry by Damodaran, the student had presented the radical alternative of challenging the citizens of the state to pay higher for its upkeep or face the alarm of the NFL moving to a different state. A radical but plausible suggestion that could make the impossible valuation work in such instances. 

A CEO of a company must possess the ability to tell the story of his or her company. If it’s a young company, then they need a great storyteller and visionary, Damodaran adds. As the company matures, then the storyteller must have other skills. “I have the notion of a life cycle of a company, where essentially you move through the lifecycle from start-up to growth company, to a mature company down to decline. The right CEO will actually be different in each stage.”  There are different CEOs who will be great for different stages of the company, which is why transition is impotent and some people need to be pushed out, Damodaran remarks. The story must be told in a relevant manner to suit its stage and be relevant to attract the capital to make it successful for that stage. 

The story and how it is told will make or break a company, and it is essential to bring those changes into valuations. Each cluster tends to over value themselves, Damodaran says, but eventually the truth will come out. This is true with every market, he opines, and points to the online advertising segment where it tends to happen more often than not. Big market delusions, which are easy to be caught up in. The story will impact the value of a company. Using one word over another can impact that value, so you need to be fully in control of your stories Damodaran explains, leading up to his own narrative on Uber. With any valuation, he states he will not explain if others may have paid too much. Damodaran simply says he may not have paid so much based on his story, which merely has a different value.  “The Uber story is fascinating, at it is changing all the time. In 2014, the company was valued at over $ 17 billion. Venture capitalists don’t value a business, they price a company. Uber is not a public company. I’m going to assume that they are going to be able to keep doing what they are doing charging 20% from drivers. I expect Uber to be successful in cities and towns with lots of people, with networking benefits. I assume Uber would attract new users, assuming growing at 6%. In my story, I assume would have local networking benefits in some cities, but not everywhere in the world. My story is driving the number. They get 20% doing nothing if they manage to hold it. High growth at relatively low investment. I gave them a 10% chance of failure. So, for Uber, I arrived at the figure of $ 6 billion when it was priced at $ 17 billion by venture capitalists, which I published on my blog. The story was picked up by numerous sites and viewed in different ways, and the tech guys hated it,” Damodaran explains. “A couple of weeks later, I was contacted by a partner of venture capital firm – an early investor with Uber. He countered my post saying Uber is not a car service company but a logistics company. Notice how words have consequences. We are going to be suburban and rural, we are going to try have global networking where you can connect airlines and credit card companies, and have cabs waiting when you land, he said to me. So, I returned the email and asked ‘would you like me to put a number on your story?’. So, I tripled the number on my spreadsheet and my $ 6 billion became $ 53 billion. He liked it. But the 80-20 mix is going to be history he said, which I already knew, and then the value I end up with is $ 27 billion. If your story changes, then your value is different. Build your own story and brings those changes into your valuation,” Damodaran advices. Everything in a story becomes a number. 

Pix by Upul Abayasekara