Recently I ran into a company which was contemplating buying one of their competitors – not an uncommon conversation as Bessemer sometimes finances these types of transactions.
The company I was talking to is on a tear, growing at 150% annually, flirting with profitability, and has a best in class technology. For reference, let’s say the acquiror is around $7 million in revenues. To complete the picture, the business they’d like to buy is a stodgier business, has been around for the last decade or so, and has some decent customers, but the product isn’t that great and they are going to get beat by their competitor in the future unless something changes. The target is around $21 million in revenues, with $5 million in profits, and 5% growth.
So, which would you rather own: a company 1/3 the size, with no profits, but strong growth and what appears to be a much better product? Or, a solidly profitable company (which you could put debt on), which has been around the block and is 3x the size? Which is worth more?
The answer is that if the company growing at 150%/year is growing for the right reasons (a truly better product, better customer acquisition strategy), and those reasons also point to it being the better long term bet, then it’s very feasible the fast growth will continue and quickly make it a larger company, and thus worth more today. And so, the smaller company buying the “larger” one makes sense.
This somewhat analogous situation sparked an interesting conversation with one of my colleagues over the value of the US relative to China (if you were to think of them as two different companies – although I’m not sure either will be buying each other out anytime soon).
For those unfamiliar with the numbers, the US has a $14.6 trillion GDP (or $2 trillion in taxes, which is more akin to revenues), 2-3% growth, huge losses each year (trade deficit of $500 billion in 2010 alone), and a horrible balance sheet ($14 trillion in debt, here is a scary site: http://www.usdebtclock.org/).
China is growing at 10% per year, with $5.7 trillion in GDP ($1 trillion in taxes), a $185 billion trade surplus, and a balance sheet that includes $1+ trillion in US treasuries alone.
Of course, there are a thousand other metrics, both economic (unemployment rate, hourly wages, industries driving growth), and social (education, cultural values), but I think the above gives a decent picture, just as the revenues/profit and growth of the two companies give us a quick picture of what is going on with their relative values.
The US growth may have slowed a bit, but we are still 3x the size of China, have loads of talent and the infrastructure to support growth. We can essentially borrow at will (cost of US debt is still well below 4%). And, some none economic factors like a culture more suited for innovation, the world’s best equipped military, and 100 other things make me think the US is still the right bet to make. It’s interesting to think about nonetheless. Maybe someone should create an exchange where you can essentially bet on countries (or maybe that’s what a combination of country focused ETFs and the rates market already is).
I’ve been doing such country comparison for a while ever since learning about the currency fluctuations in the economics class. One thing I think you missed is how tightly interconnected China and US (and just about any other big economy) are. The recent example is how the Japan disaster is shaking the US and european markets. So it’s one of those cases where if you look at those countries without each other the valuations may change significantly.
An exchange for betting on countries is what forex should be, but countries have a number of mechanisms to protect their currency from gaming (and obviously for many other reasons too). Every now and then these mechanisms break. One of the most famous cases is how George Soros made his fortune http://t.co/GVdSZ8z .