Sunday, September 21, 2008

Technology companies’ valuation, the credit crunch and keeping an eye on legal issues

There is an argument to be made that the “market value” of a company is some sort of fiction that transforms the whole stock-based valuation in a constant self-sustaining bubble. In the case of technology companies the situation is sometimes quite clear and easier to understand. If you take a company that has a market value of 128 billion dollars and gives a net profit of 4.83 billion dollars, forgetting the business that is buying and selling the stock, you would be crazy to spend such a huge amount of money to get 3.77% annual return. But the market value of the company represents the value that investors are willing to pay with the expectation that the value will increase (quite more than 3.77%) and sell it at a profit. And, as far as the company has a proper business model and some profits that allow it to expand and recruit the best talents, the market value is justified because other people will want to buy the stocks too and the original buyer will see the price of his/her stocks raising, so, while to use 128 billion dollars to buy Google and live out of its net profits would be crazy, to use several thousands, millions or billions to buy its stock is not crazy and it may even be advisable. It is easy to use the example of Google because it has a clear business model that deliver profits consistently and because has not given any reasons to investors to doubt about the future value of their stock, but the idea of the expectations-bubble applies to most technology companies and not all may have the same solidity. Sometimes their business model is good and solid and some even have products to sell and some “hardware” that make part of their valuation, but not paying proper attention to legal issues, even those looking small, may prove fatal.

The issue of the relation between companies’ valuation and legal issues refers to institutional investors, hedge funds and other financial-world wild-animals. Those investors normally use other-people’s money and, although there are big disclaimers telling to that “other-people” that the value of the investment may go either up or down, when it goes down pronouncedly the real owners of the money start to ask questions, and when the losses are substantial (big, huge), those owners are willing to (and normally do) go to court to recover some of the losses they have suffered, allegedly due to the lack of care of the investors. During credit crunches and stock markets meltdowns that type of lawsuits become far too common, which make institutional investors to run away from any stock belonging to a company that even smell of having a legal problem, not because that stock in particular would be the cause of the losses in the portfolio (the losses may be purely due to market conditions and unrelated to the stocks in the fund) but because once the losses have accrued the owners of the money would look for any potential pitfall to take the fund’s administrators to court. Accordingly, the impact that a legal issue may have on the valuation of a company does not relate to the monetary value of the damages that the company may have to pay in case of loosing a lawsuit, but it relates to investors shying away from it due to their need to be protected in case of lawsuits. Thus, in uncertain markets funds administrator give (or should give) as much importance to the analysis of the legal issues surrounding their investments as they give to the financial and economic ones, and become very conservative.

In that context, it seems surprising when big, prestigious and good companies rush products to the market creating the possibility of putting themselves in situations that, due to the particular characteristics of their market valuation and the current financial environment, can hurt them in a way that no product-launch delay could and, on top of that, to not take proper measures to ensure that, if a problem occurs, the situation can be controlled and isolated promptly.

From the past 16 August the new Blackberry Bold is available in UK. Having had Blackberry for a while and having the mobile provider that introduced it to the market, I got mine on August 17th (I did have the machine on the 16th but due to certain issues with the provider they were not able to register it until the 17th). The phone is probably the best thing in the market and for business users the phrase stands without the “probably”. So, it was obviously visible that I was excited of having one in my hands…until things started to happen. The fact that the phone freezes many times without reason and that it fails to check automatically for signal quite often (you are underground without signal and when you go over ground the phone does not check for signal, so you have no signal until you turn it off and on) and things like that are not relevant to this post, so I’ll concentrate into the problems with the battery. Few days after start using the phone, I noticed that the battery life was quite short, even without using it, but I did not worry much until one day while teaching I felt something really hot inside my suit’s internal pocket, which was my phone. I turned the phone off and after the class I turned it on again assuming that it was related to some application not closing properly. Next day, after a full night of charge my battery died near the end of the afternoon and it was warm most of the day. Finally, the following day, and again after a full night of charging, the battery was burning hot for the whole morning until it went flat at noon (four hours after disconnecting it from the charger). With the exception of Toyota or Rolls Royce, lemons do exist in any industry, so I did not worry much and tried to contact the people of Blackberry to see whether it was a known issue and there I had to surprises: the first was that all those issues were the ones perfectly identified in trials and that had delayed the launch; and the second was that I had no way to contact Blackberry directly. The next day I went to my mobile service provider and when I told what had happened, they very promptly replaced the faulty device. So, that should be the end of the story, but it brings us back to the valuation, the credit crunch and legal issues.

Leaving apart the issues with the performance of the phone itself, the battery issue is not a minor one. Batteries not only get discharged early, but they also catch fire and explode, so you would imagine that if you put a new product in the market you are going to make sure that things like that cannot happen and, also, to have in place some sort of early warning system and costumer service to avoid any serious consequence of a failure, which through the mechanism briefly described before can have a severe impact on the valuation and access to finance of your company…delaying a product could be costly but facing a lawsuit for product liability in times of the crunch can cost far far more, so companies that depend on expectation to keep their valuation steady, like most technological companies, in this uncertain times should pay more attention to the lawyers than the financiers and marketers to keep their finances healthy.

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