Paul,
I pretty much agree with everything you say. R&D is necessary
to develop the next generation of technology. Must invest
in new technology, etc., etc., if I paraphrase you correctly.
I doubt any rational person, or anyone on this board, would disagree.
But I would ask you to reconsider what I called the subtle point:
"*all other things being equal*, a business which does not need
heavy R&D and capital expenditures is more valuable. "
The all other things being equal is important. Consider a world
with two Intels, Intel-A and Intel-B. They have the same earnings,
revenue, earnings growth, etc. Intel-A invests 40% of cash flow
in R&D, capital expenditures, etc. Intel-B only needs
to invest 10% to produce the same results. Which is more valuable?
Intel-B, I believe.
The question of what Intel should do with its cash (i.e.
should it spend it on further capital improvements/R&D?) is related
to the ROA numbers ably discussed by Andrew Chow.
I have been working on a little parable:
A brilliant inventor owns patents on two machines that produce donuts out
of thin air. He offers to sell you a franchise to use one of the machines
to make donuts. Both franchises are located next to a police station so
you are guaranteed to sell all the donuts you can produce.
Machine A breaks down every year, so every year you must have it refit.
Each refit costs 20% more than the previous, but, for the first twenty
years, the refit models produce 20% more donuts each year. After 20 years
donut production cannot be improved further.
Machine B runs forever without breaking down, but always produces the same
quantity of donuts.
Machine A costs $100, produces $20 worth of donuts the first year, and the
first refit costs $20. Machine B also costs $100, and produces $20 worth
of donuts every year.
How much is each franchise worth (assuming you could invest the money
elsewhere at 7%)?
Answer: Franchise A is worth $130. Franchise B is worth $186. Despite
the fact that B has zero earnings growth, it spins off more free cash
because it doesn't have the constant capital investment requirements of the
first franchise.
Math:
A = 20 * 1.13^20 - 100
B = 20/.07 - 100
Of course I fixed the numbers to make my point. But I believe
the analogy is useful.
--joel |
