Recognizing Value Situations - The Asset Play

Recognizing Value Situations - The Asset Play

Sometimes it isn't the growth but the value of current underlying assets that points to value.

Although in the mainstream case, assets are in place only as resources upon which to build business growth and thus aren't valued separately, there will be cases in which the assets themselves create the value. In other words:

• the company owns them, but they aren't involved - or aren't completely involved - in producing the company's revenue and profit stream.
• Or they could be used more effectively somewhere else,
• or they simply aren't valued correctly on the books.

The point is, their actual value exceeds reported value in the business as it is currently defined.

Actual value exceeds reported value usually in one of two forms:

• undervalued assets on the books or
• breakup values that exceed the assets' current value to the business.

Undervalued assets

Both physical and intangible assets can be undervalued, sometimes significantly. Frequently this occurs with nondepreciable assets that have been held for a long time, such as land. Land is often carried on the books at purchase value, which is almost always less than current market value, especially if held for a long time.

The classic example is railroads, which hold millions of acres originally granted for free when they were built. Some of this land is used in the business, but a great majority isn't, especially for western roads. Something like 1 percent of all land in California is owned by just a couple of rail firms. Similar situations occur in oil and other natural resource businesses.

Intellectual property can also be undervalued (although in many cases, especially with acquisitions, it is overvalued, watch out!). Patents and other unique, homegrown know-how can have significant value, although corporate history is littered with companies (Xerox, Bell Labs [Alcatel-Lucent], IBM) that failed to capitalize on the wealth potential.

The key to undervalued asset plays is whether the assets are really that valuable, and what the strategy is for unlocking that value. Railroads until recently have done little to try to realize the value of their land assets. (Now, we're starting to see rail yards converted to downtown plazas, but sometimes at great expense for environmental cleanups.)

Look for companies with million of acres or barrels on the books; examine current market prices; decide for yourself whether there's an opportunity. Then look for evidence that the company itself recognizes the opportunity. Union Pacific Corporation (a railroad parent company) for years not only looked to sell its rail-adjacent land but also to target potential customer companies who would build facilities along its lines and ship by rail. They had a whole real estate subsidiary set up around this idea. It was a good strategy, but so far, it's a drop in the bucket compared to potential.

When the sum of the parts exceeds the whole

Big, stagnant, set-in-their-ways companies sometimes offer hidden opportunities. If they were to break into parts, each part would be free to focus on its core opportunities. Improved focus and reduced corporate bureaucracy can work wonders toward rekindling growth, satisfying customers, and building successful new brands. The classic example is AT&T, whose breakup created billions in new business value (despite the fact that the breakup was far from voluntary).

We see it today in a lot of food companies (such as Kraft Foods) and even Procter & Gamble, which has spun off several important divisions to J.M. Smucker. And although the spinoff didn't go public, the Daimler-Chrysler breakup had a lot of value investors thinking about breakup value.

The key is to identify these companies; then try to visualize what they may look like as individual parts - as individual businesses. It isn't always a successful strategy, because new overhead must be created to run each business, and synergies are lost. A breakup of General Motors may not work because the dealer network and synergies of common parts platforms would be lost.

It makes more sense where multiple, unrelated, or poorly related businesses exist under one corporate umbrella. If the customers are different, technologies are different, or business models are different, separation sometimes leads to value. Hewlett-Packard and Agilent Technologies (one selling technology end products and the other selling ''things that make things work" to other technology companies) made a logical break, but it took a long time for both companies to hit their stride in their marketplaces.

Markets tend to undervalue huge conglomerates. It is hard to appreciate and understand the value of each component in detail, so the investing and analysis public tend to discount what they don't understand.

So put all this together, and you may look at a General Electric or Procter & Gamble and wonder whether there is more value than meets the stock pages. Listen to rumors, picture the transition, look for clues that management may be thinking along the same lines (a few small divestitures may be an experiment). This is an area where professional analysts can provide good information on which companies are "in play" and what their breakup vlaue may be.


Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors