Useful Fools

This lesson addresses property valuation in the context of nationalization, and specifically the Allende attempts to nationalize copper mines. It is a simplified approach to give the ideas behind property evaluation, and is not meant to be complete. I am not an accountant.

In the case of Chile and copper mines, compensation for nationalization was proposed by the government with a formula that did not attempt to estimate the value, but was instead apparently based on some odd socialist idea of value - a “social justice” formula. The copper companies appropriately rejected this, but then (according to Marc Cooper) joined the coup against Allende, which was very wrong - companies should not get involved in violence.

So how do you value a property? The value is affected by the following major factors:

1. The net present value of the future cash flow. This just means the current value, where the cash flow is discounted by the cost of money.
2. The risk - the likelihood of achieving that cash flow. This includes how volatile the market is, the probability that taxes will rise, the stability of the government, the nature of the labor force, and all sorts of other variables. Hence risk estimation is quite tricky and not precise.
3. The value of salvagable assets and outstanding debt - if you stopped operating the company, how much money could you get out of it by selling its capital assets and paying off its debts

A simple way to look at it is to add the salvage value to the net present value, and then adjust the result for the risk. A simple formula for the net present value (given typical non-insane cost of money) is 7 years of profit. This is sort of a quick rule of thumb, if the assumptions are correct and the risk is relatively low.

The only accurate way to set a value is to sell on the open market, and see how much it brings. That amount, whatever it is, is the precise value of the company at that time, by definition. Note that past profit and investment are irrelevant (except as they created a cash excess - a salvageable asset, or debt).

In the case of nationalization, another factor comes into play: did the company acquire the assets dishonestly? In other words, did it use government coercion or bribery to not pay full value? This is a social justice issue that can be demagoged but must be considered.

This is similar to the concept of “odious debt,” where an illegitimate government runs up a large debt, and then leaves the following government to pay it. The best example is Iraq, where Saddam ran up huge debts, mostly to France and Russia. These are odious debts because they were not used for legitimate purposes. Furthermore, France and Russia knew that and hence acquired that debt through immoral means. In such a case, it is sometimes appropriate to renege on the debts.