From a static EVA to a dynamic MVA: Divergent tendencies in Firms

Markets are sniffy about a pallid current performance and a metric like EVA makes a scathing attack on the firm’s ability to muster two conflicting requirements, the ability to return capital to investors while simultaneously being able to fuel the capital needs of a growing business. Companies, that are growing fast and have to fuel their expansions with borrowed money, have a harrowing time with EVA. The good thing is that the market understands the nuances and there are other measures like MVA.

I am intrigued further on this topic and two of the recent books I have read, the seminal ‘Value & Capital’ by John Hicks and ‘Liquidity: Inside & Outside’ by Jean Tirole gives me some ammunition to take my thinking forward.

Hicks used the ‘dynamic economy’ for the first time in Economics while Tirole has been a Titan in the field of Industrial Economic Theories, where he dealt on the topic of multiple liquidity shocks when firms expand as large doses of capital injection happens. While on the topic of EVA, we cannot exclude the role played by liquidity shocks for firms in high demand of capital under different convergent scenarios of capital constraints during expansion. These liquidity shocks have market fall outs and strategies must be re-oriented to deal with them. MVA is a good measure to understand how firms are dealing with the future cash flows with the current strategies.

These topics are relevant for a company that is growing at a frenetic pace as it embarks on an expansion curve on the back of fixed nature of capital investment. To be able to return capital while on its ascendancy becomes a crucial point of challenge and market measures like EVA could be very punishing.

EVA per se is on a static economy; it takes one snapshot and gives the information of past performance. Market value added on the other hand is dynamic; it gives the NPV of future cash flows or the Net present value of future EVAs.

Take for example a company with an EVA as (about) negative $1 Billion, and Market Value added is currently (about) negative $2 Billion. These two numbers would make me delve deeper into the static Vs the dynamic values. For this company the market makes a judgment that the company based on its current performance and future projections would not be able to improve on its EVA going forward, thus the present value of its future EVAs is far worse than the EVA of its last performance year.

But how does the market judge the future, it has only the current treadmill with the current performance? Well, it also has the recent trends to look at. Alcoa offers a classic example.

Alcoa EVA was negative $700 Million last year, but it has a $1Billion positive MVA. This swing in valuations stem from its very positive portfolio transformation program that it could sell at the market place.

I compared Alcoa, where the static vs the dynamic is rather better, where the dynamic moved to the positive territory versus the static. And what stood out is that their very current actions on portfolio transformation made the market look at the future much more positively, taking the valuation several notches up.

Contrary to what we expect, currency of events has a far higher influence on the dynamic measure as well, as in this example. So when companies are saddled with debt and liquidity and their current EVAs are way behind the expectations, there is considerable thought and actions to be diverted towards building of a credible strategic direction that the market would believe which is doable. And this has to be followed through with actions.

Amazon, which had been growing at a frenetic pace, had the same problem, it was never EVA positive, but it always had a positive MVA. Their strategy was followed through with actions and the market believed that the rise in revenues were in line with the guidance, which Amazon never missed.

On the other hand there are other examples where current performance on the EVA makes the firm narrow down its window of opportunity for the future be dented with actions that cut down revenue streams which if actually pursued could have given them the right support for garnering positive sustainable space that is profitable. Selecting a mix of alternatives, one that increases the share of the pie, against one that reduces, is never a straightforward decision. Sometimes the impact of this decision on the MVA could be very large, while it could have a positive small impact on the EVA.

The divergent tendencies include the travails of the resource rich companies with a debt overhang and they are stuck in the middle. The solution lies in looking at the revenue side of the problem, than the cost side. What is cost could be a revenue earning opportunity; that is where the mystery of the MVA lies.

And that is where the winners are separated from the losers.