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Valuation Challenges During the COVID-19 Pandemic

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Valuation is a combination of facts, data, and assumptions.   As part of the risk assessment process, the valuation analyst must consider contemporaneous conditions and ask “how is the company affected by this?” The COVID-19 pandemic is a highly unusual challenge to valuation professionals, as we don’t know how businesses and certain industries may react once restrictions are lifted and the economy is allowed to resume operations on a “normal” basis.

I have seen companies in the same industry be impacted differently because of decisions made by management.  During this pandemic, we have valued several “essential” businesses in New York City and surrounding areas.  One opted to stay open and service its clientele as other providers in the area closed, but more than half of their employees ended up contracting COVID-19.  Was staying open the right decision?  While there was an initial benefit because similar businesses had closed, it appears that management may not have been prepared to safeguard its staff with adequate personal protective equipment and social distancing practices.  If management of a business neglects to properly address the risks associated with a pandemic and adequately protect its own employees, one may have doubts about its ability to shepherd the business through other uncertain circumstances, and such doubts may have a detrimental effect on the value of the business.

The other business, also in the New York City metropolitan area, had a marked decline in volume. Industry research shows that many of these businesses have seen a reduction in volume due to the shelter in place order.  Reduced volume also results in reduced cash flow and reduced value.  However, management showed its ability to make tough decisions and protect its employees as best it could, and was willing to suffer the temporary consequences of reduced business and cash flow hopeful that it would be better positioned for the future.  Two companies, same industry, different management and different outcomes.  Which management made the better decision?

We are valuing another company that is an “essential” business.  It has seen a marked increase in revenue during the first quarter of 2020 compared to 2019. However, the costs have increased at a higher rate than the increase in revenues, and thus, net profits have actually declined.  In this case, it is important to “get under” the numbers and find out why expenses increased.

In valuation, it is crucial that the analyst understand the numbers, the direction in which the numbers are moving, and management’s strategy for addressing challenging circumstances, in order to factor them into the risk assessment of the future cash flow, which is synonymous with value.  There are many changes occurring in the world due to COVID-19, and we don’t know when the economy will open, when cash flows will normalize, or whether the normal of the future will look anything like the normal of the past.  The analyst must look closely at the subject company, consider the financial wherewithal of the company, the manner in which management is handling the current risks, the valuation date, and more. 

It is important to define the ultimate outcome of the pandemic as a limiting condition that will have an unknown effect on the business going forward.  As always, the value an analyst determines for a company is one’s best assessment, given the known and knowable facts and circumstances, as of the valuation date.

Monica Kaden, Sobel EAC Valuations LLC