My buddy Nick Woulf from BSchool recently forwarded this article from WSJ talking about how Donald Trump really valued his empire and calculated his net worth. Perhaps Nick was hinting on how we need to value ourselves 😉 but nevertheless I found it funny and worth commenting on. Especially because it literally debunks the basic theories of finance and questions all the research that financial pundits have put in over so many years.
So what is it all about? In a gist Donald Trump is suing Timothy O’Brien, the author of “TrumpNation: The Art of Being the Donald” , for quoting anonymous business associates as pegging his net worth at $150 million to $250 million — less than one-tenth the $2.7 billion figure that he deems a conservative estimate.
So how does Trump really value his empire and his net worth –
and the answer is he uses “mental projections”. Well, you might say that any valuation is based on projections and assumptions. We assume the market conditions, how much money a company can make, approximate our cost of debt & equity to finally calculate our free cash flow which ultimately leads us to our valuation. So a change in any variable in our formula (which is highly possible) can skew our valuation, right? However, the fact is that the assumptions at least consider most risks and base these numbers off past scenarios, current realities and conservative future projections, therefore lending some credibility to the valuation. Additionally, in case of private companies the investors have to agree with each other on the valuation and in case of public companies, the valuation is determined by the market through the stock price (although public companies may have an internal valuation that is totally different from the market). Moreover, there is a clear definition of the percentage of equity each person owns in the corporation (on paper) that helps us calculate individual wealth.
In Trump’s world, it looks like this whole theory turns upside down. There is no concept of debt, no free cash flow (there is just cash), and equity is based purely on perception (with no cost of course and you can choose whatever ownership percentage you like). For example just licensing your name (with zero investment) entitles you to 50% equity, managing someone else’s entity (with zero investment) probably entitles you to 50% equity again and so on. The net worth just keeps adding and it does not matter whether the concerned investors or the market agrees or not. Moreover, none of this is on paper. It is all in the beautiful mind. Nice, isn’t it?
How would this change the theory of valuations? Any company that licenses its technology or brand name to another ends up owning 50% of that other company or that particular division. For example ARM would own more than 50% of the iPhone franchise since it is rumored that the phone uses about 6 – 8 processor cores in it (licensed from ARM). Imagine what would that do to ARM’s valuation. Similarly any private wealth manager would own 50% of the wealth he/she is managing (Madoff who was believed to have managed $14 Billion would probably be worth $7 Billion).
I think the biggest trap of Trump’s way of valuation is over-leveraging oneself. If I think I am worth more, I’ll borrow more (after convincing the smart bankers of course). And I am guessing that is what Trump ended up doing. Warren Buffet had this to say about Donald Trump in his speech in 1991 which is very apt for anyone even today…
He [Donald Trump] owes, perhaps, $3.5 billion now, and, if you had to pick a figure as to the value of the assets, it might be more like $2.5 billion. He’s a billion in the hole, which is a lot better than being $100 in the hole because if you’re $100 in the hole, they come and take the TV set. If you’re a billion in the hole, they say “hang in there Donald.”
The two biggest weak links in my experience: I’ve seen more people fail because of liquor and leverage – leverage being borrowed money. Donald Trump failed because of leverage. He simply got infatuated with how much money he could borrow, and he did not give enough thought to how much money he could pay back.
Obviously, if I am worth $4 Billion based on my most conservative mental projections even though in reality it is $250 million on paper, I can easily borrow $2 Billion and also guarantee that it will be paid, right?
All in all I think the takeaway from Trump is that “If you really believe in something then it would turn true for sure”. He believes he is worth more and he keeps getting there because the investors/media also believe it and keep pouring in more. Don’t you agree? Why do you need to care about others agreeing with your estimates or using complex formulas. Isn’t the current financial mess a great example where despite using the most complex calculations, risk considerations and projections everyone got into a hole. The financial analysts might as well have used mental projections like Trump rather than spend so much time justifying what they did with numbers. I am starting to believe I am worth at least serveral Millions too. Don’t ask me how because it is all in my mind and it makes me feel good right now :). Whack the WACC and invest in me!