LTA’s, DCF’s & OPP

Best Experienced With: Naughty By Nature; OPP

(please right click on the link below to open the suggested music to this evening’s treatise in a new browser window. Ah yes, army with harmony up in The Attic. “Dave…..drop a load on them”

http://www.youtube.com/watch?v=mJgFU3U4X_Y

Have been fortunate to sit on both sides of the table in various business adventures, both as the seller and the buyer. Would strongly suggest to all those new to the business world to wear both sets of shoes as you meander through your own business adventures. Have lots and lots of tools in your toolbox as you roll through the business world.

As a lifelong avoider of most things long term, am a firm believer in long term business agreements. Have heard the arguments from random purchasing folks on my team for years. “We have to keep that company honest.” “What if they go out of business?” “Why would you want to put all the eggs in one basket?” Blah, blah, blah. If you choose your strategic partners (seller or buyer) correctly, you never have to worry about any of those questions. Just like marriage. If you feel the need to check your spouse’s cell phone while they are asleep, you chose the wrong spouse. If you feel the need to compare your strategic partner’s price against everyone else every two months, you chose the wrong strategic partner.

Regardless of your table side, it is always easier to row out into the middle the lake, throw both oars into the lake and figure out the business relationship together as a team. Just like marriage.

LTA’s

You and I own a marsupial farm in West Virginia and have been recently approached by the senior management team at Harrods, Ltd in the United Kingdom. The Harrods there on Brompton Road in London. It seems that Harrods marketing department has determined that from 2011 through 2016, most of the women in the United Kingdom will forsake their purses and handbags and choose to instead purchase a hopping marsupial to carry all their purse and handbag stuff. High fashion is sometimes like that.

We meet with Harrods and qualify the opportunity (e.g. price is not in their “top five” decision making factors, they pay their bills on time, they are the type of people we will enjoy doing business with) properly. They choose to sample a few of our wallabies to rave reviews and we start developing a great relationship with Marketing and R&D. The investigation period comes to a close after ninety days and we eagerly await Harrods’ decision, swilling moonshine and playing banjos.

Fortunately, our marsupial line has some of the highest quality wallabies on earth and we are Harrods’ first choice. The true decision makers (Marketing and R&D) tell us that we are the marsupial company of choice for Harrods. Their purchasing department then gets into the mix and tells us “you are too expensive” and “three hundred other marsupial companies quoted and we like them just as well as we like you” and “did you know that the human head weighs eight pounds”. Harrods’ Marketing and R&D departments tell the purchasing department that their title is not “making the decision and purchasing” it is restricted to “purchasing” and instruct the purchasing folks to place their first order with our marsupial company. West Virginia is thrilled and we get a key to the state and front row seats at all Marshall football games.

Offering a long term agreement at the beginning of our Harrods relationship would be as unseemly as meeting someone attractive near the fruits and vegetables section of the grocery store and immediately proposing marriage. We must chill and allow the relationship to evolve naturally. Build trust and relationships on both sides. All dating lessons are business lessons and all business lessons are dating lessons. Right around day number 126, we are going to have a serious argument with Harrods.

Perhaps one of our wallabies acted up at the opera and maimed a theater patron. Perhaps Harrods was late on an invoice or returned a dozen perfectly good wallabies because they needed to make a quarterly earnings call to “the street” and needed to reduce inventory. Getting along is easy, especially at the beginning when each half of the relationship is rolling around in the salad days like a dog rolling around in seaweed at the beach. When we can figure out how to disagree with Harrods, resolve the conflict, and hug it out rapidly, then we can start talking LTA.

After we have delivered a few hundred wallabies, have the process down relatively well, and have learned to argue properly, we choose to offer a long term wallaby supply agreement (LTWSA) to Harrods. We discuss Harrods’ five year wallaby forecast, their quarterly delivery expectations, and how much incremental revenue each of us can earn if we work together to drive down costs and market price. We approach it like a true partnership because the more wallabies Harrods sells in the UK, the happier West Virginia is. Because meth is illegal and cannot be counted as part of West Virginia’s GDP.

We sign a five year LTWSA with Harrods nine months into our relationship and each side wins. Harrods has a guaranteed supply of wallabies for five years with a predictable cost structure and annual price increases linked to an agreed upon index. Moreover, we have provided additional discounts when Harrods exceeds their forecast in a given twelve months. You and I have mandatory minimum quarterly wallaby shipments and a five year contractual revenue stream. This allows us to streamline our operation and drive our wallaby cost down. As we drive our costs down and pass on some of the savings to Harrods, they are able to gobble up more market share.

LTA’s between trusting partners with similar cultures allow each side to grow top line revenue more rapidly in any market space. Life is easier and your business is more profitable with LTA’s and there is significant value in LTA’s for both the buyer and the seller.

NPV’s of DCF’s

If you really want to see what a potential LTA is truly worth to you and your company take off those slippers and put on a different pair. As long as Warren Buffet is still breathing, every company out there is theoretically for sale. Let’s take a look at what our venture with Harrods would look like to a potential suitor.

We sign the contract and three months later Mr. Buffet’s plane makes an emergency landing in Charleston, WV. While at dinner with the governor, Mr. Buffet asks if West Virginia has an exportable product other than meth and the governor tells him about our marsupial company.

We need to calculate the value of this five year contract and to be precise we want to discount the cash flows back to today’s dollars. Since our product can die in shipment and might hop away rapidly during the warranty period, we have a high risk premium of 20%. We run a model on the numbers and come up with this:


		2010	2011	2012	2013	2014	2014

# Wallabies			234	536	1,983	3,496	12,313

Wallabie Price			6,238	5,999	4,732	3,981	3,209
Wallabie Cost			2,900	2,800	2,600	2,500	2,300

Revenue			1,459,692	3,215,464	9,383,556	13,917,576	39,512,417
COGS		-450,000	678,600	1,500,800	5,155,800	8,740,000	28,319,900
Gross Profit			781,092	1,714,664	4,227,756	5,177,576	11,192,517

Blah, blah, balh		-500,000	300,000	350,000	500,000	700,000	900,000

EBITDA		-950,000	481,092	1,364,664	3,727,756	4,477,576	10,292,517


Discount Rate	20%

NPV		$7,376,263

The multiple on marsupial companies in the open market is two times cash flow. Mr. Buffet loves the wallaby potential in the UK with Harrods and we are skillful negotiators. We command a four times multiple and we sell the company immediately for $28,000,000. Moreover, because our marsupial raising skills are beyond compare we each get a three year contract to stay on board to run the company properly.

That is how you and I roll. We each buy a pony and donate the balance of the $28M to Street of Dreams in San Diego and Project Haiti in Aitken, MN.

OPP

There are four songs in the universe that no one should ever choose for karaoke. One of these is OPP by Naughty by Nature. No one should ever choose to sing this song during karaoke. You will ruin this song and die on stage as people laugh like hyenas if you choose OPP for karaoke. Do not choose OPP for karaoke.

Seriously. Only Naughty by Nature can sing this song at karaoke. You cannot sing OPP by Naughty by Nature. None of us can. You especially cannot even come close to the part that goes “It’s not a front….F to the R to the O to the N to the T” Go ahead and recue up the song there above on You Tube and click on the 58^th second. Now go ahead and please try to rhyme along with just this part: “It’s not a front….F to the R to the O to the N to the T”. See? Well beyond all of our talents. Choose something from the Grease soundtrack instead. You’d look good singing something from the Grease soundtrack.

You are welcome. Thanks for joining this evening. Nice shoes.