Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Biotech / Medical : Biotech Valuation -- Ignore unavailable to you. Want to Upgrade?

To: Icebrg who wrote (5503)	1/22/2002 10:17:39 AM
From: Biomaven	Respond to of 52153

<MRK> Note also that there are rumors of serious FDA manufacturing issues at Merck's West Point, PA vaccine manufacturing facility. Peter

To: Icebrg who wrote (5503)	1/29/2002 3:40:38 AM
From: Icebrg	Respond to of 52153

Well perhaps not biotech, but definitively valuation. How to expect the unexpected Companies should accept the inherent uncertainties of business, not mask them with superficially rigorous accounting, says Peter Martin Published: January 28 2002 18:06 \| Last Updated: January 28 2002 18:16 At its heart, business is a gamble. The peasant farmer who plants a crop to sell next year and the semiconductor boss who commits his company to a $2bn chip plant are both placing the same bet: that there will be enough customers, at the right price, for what they produce. Most of the time the gamble pays off. But sometimes it fails. And when it does, disaster ensues. This fundamental uncertainty at the centre of business is so unsettling that most of the time we choose to ignore it. We have developed techniques to analyse and manage the risks it implies and we tell ourselves that these have made the gamble go away. They have not. There is a more disturbing twist. The techniques that we have invented can themselves distort or conceal the underlying risks. And, exploited to the full, as at Enron, they can produce businesses that are concealed time-bombs. This is a good moment, therefore, to remember the gamble inherent in business activity and to explore how the techniques we use to mitigate it can themselves lead us into danger. Take a routine business calculation. Every day, hundreds of thousands of managers all over the world attempt to calculate the value of an investment by placing a value today on all the cash it is likely to generate over its life. To do this there are any number of technical approaches and much scope for disagreement over which is best. The arguments miss the point. The techniques are fine. But all of them rely on the ability to predict cash flows years into the future. Yet - as the problems of Energis, the UK-based alternative telecommunications network, reveal - we sometimes cannot predict cash flows even a few weeks ahead. Energis is having to renegotiate with its bankers after sales fell short of predictions and it risked breaching banking covenants agreed as recently as December. Inability to guess the future is only part of the problem. A much bigger drawback is the temptation to invent the future we want. It is all too easy to manipulate future estimates to produce a desirable present value. One big chemical company told me this month that it had stopped using discounted cash flow calculations to put a value on technological innovations because its scientists had got too good at "gaming the system": adjusting the forecasts to produce the present value needed for project approval. In that case excessive optimism merely resulted in new technologies that never quite lived up to their promise. Sometimes it can be much more serious. When company collapse comes out of the blue, the cause is often wishful thinking about future income streams or an underestimate of the future costs of present obligations. Atlantic Computers, a UK computer leasing firm, went bankrupt in 1990 because the resale value of computers it had leased to customers turned out to be much less than it had expected and their eagerness to escape leases much greater. In Ireland, GPA Group borrowed huge sums of money to buy new jet aircraft to lease to airline customers. But it underestimated the impact of a recession on the creditworthiness of its customers and had to be rescued in 1993 by GE Capital. Equitable Life promised guaranteed annuity returns to some of its policyholders, assuming that the future obligations thus created were trivial because interest rates would never fall to today's levels. The painful consequences are visible today. And everywhere the nuclear power industry underestimated the future costs of long-term waste management obligations that it had cheerfully accepted on our behalf. Enron seems to have been an extreme case. It did not just use estimates of future cash flow for internal purposes; it sold them. Enron and Blockbuster set up a partnership that was no more than a pilot scheme to supply video on demand to a thousand homes. The Wall Street Journal says Enron sold its future earnings from the partnership to a bank in return for $115m in finance - then booked the money as profit. Enron made a routine of capturing future earnings as current profit. That made its results look better every year. Investors then performed their own alchemy on the company's future, by assuming that these profits would continue to rise and applying a multiple to reflect that. Between them, Enron and its investors valued the same future earnings twice - once in the company's calculation of profits and once in the multiple the stock market applied to them. Of course, there was no guarantee that those earnings would ever materialise. They certainly will not now. Just vowing not to misuse the techniques we use to measure and manage risk is not enough. Even scrupulous caution will not save us if we place too much faith in techniques that are inherently limited. The solution is not to invent ever more sophisticated measures of risk or ever more elaborate means of parcelling it out to others. It is to face up to the inherent riskiness of business activity and to understand where the vulnerabilities lie. Simpler calculations of the value of an investment will, in the end, work better if they expose the factors that will make the difference between success and failure. Adopting simplicity as the test will have the side benefit of offering protection against those business ventures that are too complicated to be easily comprehensible. The underlying challenge, though, is to accept the inherent uncertainty of business activity, rather than covering it up with a layer of apparently rigorous calculation. That is not easy. A few free-market zealots apart, most human beings have spent their lives attempting to escape economic uncertainty, not relishing it. In developed countries, these attempts have paid off in clean food, safe transport, secure savings, stable employers and predictable careers. But they have not eliminated uncertainty altogether. And - as Equitable's policyholders and Japan's bank depositors are discovering - apparently certain guarantees are good only as long as they last. Business is a gamble. We can choose between bigger and smaller risks but we cannot eliminate the uncertainty altogether. Trying too hard to do so may expose us to still greater dangers, by placing too much faith in analysis that will always be vulnerable to wishful thinking or outright manipulation. news.ft.com