Collins The Trend Tracker
by Mike Collins
March 3rd, 2009

The Value of a Troubled Company

Since there are currently a larger than normal number of financially troubled companies in the door and window industry, I thought it would make sense to discuss the drivers of valuation for a troubled company that may seek to be sold. First, though, let’s look at the valuation of a company that is not troubled and is operating normally. The typical way in which companies are valued involves applying a multiple to the company’s Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA). A company’s EBITDA is considered a proxy for cash flow and ignores financing decisions, such as the use of debt. In the door and window industry, EBITDA multiples of 4.0-5.5X are still common for companies with average profitability and fairly stable earnings. As a side note, EBITDA margins (calculated as EBITDA / revenues) are a measure of the portion of each sales dollar that is turned into cash flow. For door and window manufacturers, EBITDA margins of 10 percent are solidly respectable and those of 15 to 20 percent indicate superior performance.When valuing a troubled company with negative EBITDA, though, applying a multiple to EBITDA results in a negative valuation number. As a result, the value of troubled companies is typically a function of the current value of their assets, including accounts receivable, inventory, land and property, plant and equipment. This is not to say that a troubled company’s value will be limited by the value of its assets. Rather, the asset value will tend to provide a floor valuation for a troubled company. To the extent that potential buyers believe the company, while troubled now, has significant potential in the future, they will have to outbid one another with offers that accurately capture that future value. For instance, buyers will place more value on a company whose sales have dropped as a result of decreased purchases on the part of its customers than on a company whose sales decline is a result of the outright loss of large numbers of customers. Other factors that will affect valuation include the quality of the assets being sold. For instance, some buyers place no value on accounts receivable outstanding longer than 60 days. Other examples include real estate with environmental difficulties, which may not only impair the value of the overall business but, if serious enough, may make it nearly impossible to sell a company.

When selling a troubled company, the goal is clear – to maximize the proceeds of the sale in order to pay down debt and leave a residual value that can be distributed to shareholders. By assembling a sufficient number of buyers to bid on a troubled company and sharing with them all the positive characteristics of the company being sold, the owners of troubled companies should be able to capture the appropriate market price for their company.

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