Aggregates Manager Digital Magazine
Issue link: http://read.dmtmag.com/i/742224
AGGREGATES MANAGER / November 2016 31 D etermining whether the quarry described in the classifi ed ad to the left is worth $25 million is critical if you are in the market to expand via an acquisition, or a loan offi cer contemplating a loan. Those of you who read the fi rst installment in this series (Aggregates Manager, July, 2016, p. 26) know the simple an- swer is that value is determined from a forecast of future cash fl ows. Why? Because cash is king. Perhaps you're questioning where to begin. Wonder what information a prospective purchaser needs to review during its due diligence investigations to make such a determination? Apparently, the answer varies considerably from one prospec- tive purchaser to another. For example, you may be surprised to learn that a couple of years ago, after signing a letter of intent, a prospective purchaser was asked how long its due diligence investigations would take. Its answer was an hour or two. Sur- prised? This is a true story. From a seller's perspective, a target sales price should be based upon realistic expectations. For example, most buyers have seen the multi-year hockey stick sales and profi ts forecast. Another example is the instance where annual performance is up signifi cantly over the last couple of years. A typical due diligence starting point is to collect a few years of performance data, reserve information, and equipment lists. Various calculations are made to determine value, often by non-industry experts. Quite frequently, the accuracy of the con- clusions derived from the assessments can be far off the mark. There are many, many possible reasons. In this article, three fairly common, but often overlooked, pitfalls to determining an accurate fair market value will be ex- plored. The fi rst two pitfalls relate to what is termed as "normal- ized earnings," while the third instance relates to the accuracy of forecasts. Each of the cited examples are based upon actual cases where Mid-America had been retained to represent either a seller or prospective purchaser. Impact of a non-recurring event on value A non-recurring event can have a signifi cant impact, positive or negative, on a quarry's normalized fi nancial performance and therefore, its fair market value. As illustrated by Figure 1, one aggregates producer reported an average three-year profi t (EBITDA) of nearly $1,450,000. Most of us might agree that a major hurricane coming ashore within a quarry's market area might qualify as a non-re- curring event. As the frequency of such an event is once every 30 to 40 years, it seems there should be little argument in classifying its impact on sales as a non-recurring event. In this instance, the impact was especially large as this quarry was uniquely capable of supplying the necessary riprap to repair several large man-made dams that were damaged and in danger of failing. Over the ensuing three-year period, ap- proximately 127,000 tons of riprap were shipped at a premium price. In order to estimate the quarry's normalized performance, its reported sales and fi nancial results were recast to eliminate the riprap sales that were directly attributable to the dam sta- bilization projects. As Figure 2 illustrates, reported annual sales and profi ts (EBITDA) were recast downwards by $1,075,000 and $600,000, respectively. These reductions to sales revenues and EBITDA represent decreases of 20 percent and 40 percent, respectively. Impact of excess inventory on value On occasion, a quarry produces and sells a large volume of a high-value fi nished product, such as cement stone, which results in a signifi cant quantity of slow moving byproducts. Over time, this stockpile(s) of byproducts can build to signifi cant volumes representing several years of sales volumes. Another example is the common fi nes pile that is often sold from time to time as aglime. Often, these bloated stockpiles are on the balance sheet, although assigning value to all of the material is questionable. One practical method of determining inventory value is taking the perspective of a prospective purchaser of the quarry. A prospective purchaser's approach to valuing the fi nished $0 $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 $6,000,000 $7,000,000 $8,000,000 Yr1 Yr2 Yr3 Yr4 Figure 1: Reported financial performance Sales EBITDA $0 $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 $6,000,000 $7,000,000 $8,000,000 Yr1 Yr2 Yr3 Yr4 Figure 2: Recast versus reported performance Sales Recast Sales EBITDA Recast EBITDA $0 $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 $6,000,000 $7,000,000 $8,000,000 Yr1 Yr2 Yr3 Yr4 Figure 1: Reported financial performance Sales EBITDA Figure 2: Recast versus reported performance