False precision hurts investors
Most deals are either worth a lot more or a lot less
In the S4 filing by Tesla following the purchase of Solarcity Lazard admitted to an error when calculating the value for Solarcity. Lazard was hired as independent advisor to Solarcity to evaluate the deal. The mistake is nothing tragic and the filing says that the valuation of Solarcity still holds, even after accounting for the mistake.
However, the episode shows some serious flaws in the current financial system. The problem is not Lazard making a mistake. The problem is people thinking that it matters. The belief that we can precisely calculate the value of a company and then argue about digits after the comma is wrong.
Most deals are either worth a lot more or a lot less. That is a fact and there is nothing wrong with that. The financial markets are a reflection of reality and reality is messy, volatile and full of surprises. Valuations are an attempt to put a price on something which will for sure change shape. Therefore valuations are inherently mistaken. In other words, mistakes are the norm. We should not make a bid deal out of them.
The narrative in M&A deals should not be about precise numbers but about the potential and reasoning for a deal. Shareholders should commit to a deal not because a bank says so but because they believe in the rationale for the deal.
To illustrate this I will use a somewhat unusual analogy. The US revolution of 1776. If people where asked in 1776 how much the US revolution is worth or put a price on a potential new country called the USA, they would have been allover the place. One thing is for sure, they would have been wrong. Even people like George Washington or Alexander Hamilton would have been wrong. But what matters with those two individuals is that their motivations, reasoning and actions made sense. That is what you should bet on, not their precise evaluation of the situation.
If people where asked to value the Walt Disney company after they released Snow White or Apple after the first computers…Well, again, it’s futile. You have to take a leap of faith in such matters, you cannot rely on precise numbers. But what you can do is listen to the narrative of the people in charge. If they make sense to you, follow them. If not, leave. Don’t listen to numbers, listen to words.
The false precision in finance is a nuisance and a sign of our still surprisingly deterministic society. We simply can’t accept the fact that life is volatile and outcomes highly uncertain. That’s why we fool ourselves with numbers and false precision. We should let go of that.