Are go­ing-out com­pa­nies pay­ing too much?

China Daily (USA) - - BUSINESS - By DAVID BLAIR Con­tact the writer at david­blair@chi­nadaily.com.cn

In the late 1980s, Ja­pan had over-in­flated stock and prop­erty mar­kets. Its com­pa­nies, flee­ing the lack of op­por­tu­ni­ties in Ja­pan it­self, vastly over­paid for all man­ner of US as­sets. I of­ten dreamed that some Ja­panese in­vestor would over­pay for the house I owned at the time.

The rate of Chi­nese com­pa­nies mak­ing over­seas in­vest­ments has more than dou­bled since last year. They of­ten have a busi­ness model de­signed to bring tech­nol­ogy and for­eign busi­ness prac­tices to the huge do­mes­tic Chi­nese mar­ket— a much bet­ter-de­fined plan than the Ja­panese, who were mostly purely fi­nan­cial in­vestors, ever did. But, still I worry that they are pay­ing too much.

Let’s take a look at a re­cent deal. Bei­jing-based LeEco Global Ltd an­nounced last Tues­day that it agreed to pay $2 bil­lion cash for Vizio Inc, a Cal­i­for­nia-based man­u­fac­turer of in­ex­pen­sive tele­vi­sion sets and sound bars. This at a time when the dol­lar is high rel­a­tive to the yuan. LeEco ar­gued that Vizio will en­able it to gain mar­ket share in the com­ing in­ter­net-of-things tech­nol­ogy that links all kinds of smart prod­ucts to­gether. And, it cer­tainly may turn out in that LeEco made a smart move in the long run. But, I still won­der about the pric­ing.

Vizio filed ini­tial pub­lic of­fer­ing pa­pers with the US Se­cu­ri­ties and Ex­change Com­mis­sion in July of 2015, but never ac­tu­ally car­ried out the IPO. Ac­cord­ing to ac­count­ing data in the SEC fil­ing, Vizio’s prof­its were $44.96 mil­lion in 2014 and $31.35 mil­lion in the first half of 2015.

Since Vizio is pri­vately held and de­cided not to go through with the IPO, sub­se­quent data are not avail­able. But these num­bers im­ply a profit of roughly $56 mil­lion in 2015, as­sum­ing that Vizio makes slightly more than half of its prof­its in the first half, as it did in 2014. Vizio has not been a growth com­pany — its sales and prof­its in 2014 were about the same as in 2010 and were lower in the years in be­tween.

Vizio’s busi­ness in the US is in bru­tally com­pet­i­tive mar­kets. Most con­sumers in theUS con­sider tele­vi­sion sets to be al­most un­dif­fer­en­ti­ated com­modi­ties — they buy the cheap­est one. Vizio has be­come the big­gest-sell­ing brand of TVs in the US by fol­low­ing a low-price strat­egy. But, this strat­egy leads to very low mar­gins — prof­its have av­er­aged less than 3 per­cent of sales.

Vizio’s TVs are con­nected to the in­ter­net, so the com­pany re­ceives po­ten­tially valu­able data on what shows its cus­tomers are watch­ing. But, the com­pany so far has not been able to reap prof­its from this in­for­ma­tion. In any case, Wil­liam Wang, the cur­rent CEO and ma­jor­ity owner of Vizio, will re­tain 51 per­cent own­er­ship of the In­sight di­vi­sion, which will own this data.

The bot­tom line is that LeEco has agreed to pay about 35 times earn­ings for a pro­ducer of near-com­mod­ity prod­ucts in a highly com­pet­i­tive busi­ness. This com­pares with Ap­ple Inc, which cur­rently trades for 11 times earn­ings, Google Inc at 30, and Sam­sung Elec­tron­ics Co at 3.3.

If Vizio had com­pleted its IPO and re­ceived 10 times earn­ings, which seems about right for a low­mar­gin com­pany, it would have had a mar­ket value of $600 mil­lion. Even at the cur­rent his­tor­i­cally high av­er­age Dow In­dus­tri­als price-to-earn­ings ra­tio of about 20, which is too high for a com­pany in such a com­pet­i­tive mar­ket, Vizio would be worth $1.2 bil­lion.

China Daily re­ported that Jia Yuet­ing, founder and CEO of LeEco, said that the pur­chase of Vizio is part of a “big bang plan” to en­ter the US mar­ket.

It may get ac­cess to Vizio’s dis­tri­bu­tion chan­nels to sell its phones and other prod­ucts — but, Vizio sells its TVs through big box stores, such as Best Buy Co Inc, which in­sist on pay­ing low-mar­gin prices to their sup­pli­ers.

It may be able to use its LeEco sys­tem to add value to the TVs, but Vizio made its name through low prices — prov­ing that cus­tomers are re­luc­tant to pay more for so­phis­ti­cated TVs. Just about ev­ery merger or ac­qui­si­tion is jus­ti­fied on the ba­sis of “syn­er­gies”, but few ac­tu­ally pay off.

Com­pa­nies spend­ing their own money have more in­cen­tive to get it right than does an out­side an­a­lyst like­my­self. But, I do hope the cur­rent wave of Chi­nese com­pa­nies go­ing-out are not pay­ing too much.

FOR CHINA DAILY

LeEco CEO Jia Yuet­ing, left, and Vizio Inc CEO Wil­liam Wang shake hands at a news con­fer­ence in Los An­ge­les, where it was an­nounced that LeEco had ac­quired Vizio for $2 bil­lion.

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