The Basics of Business Storytelling: How Narrative Influences Valuation?

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This is the second post in the Basics of Business Storytelling, you can read the first post here.

The year was 2015, this company had the crème-de-la-crème board that included notable former US secretaries of state such as George Shultz and Henry Kissinger, former Secretaries of Defense James Mattis and William Perry, and ex-US Senators Bill Frist and Sam Nunn. It was touted as the “the Apple of Healthcare.”

The founder was a Stanford drop out with her venture funded by marquee investors. At its high point, valued at $ 9 billion with the founder’s net worth alone at $4.5 billion. It all came crashing by Oct 2015 when the WSJ opened the pandora’s box. The company I am talking about is Theranos, and the founder is Elizabeth Holmes.

The year is 2020, this company is a greenfield telecom startup which had managed to put established telecom operators out of business with its predatory pricing model. The promoter calls it a platform instead of a communication service provider.

With the potential to disrupt entertainment to e-commerce, investors believe this startup is all set to be the next big thing. Over the past five weeks, it has attracted investments from Facebook to PE players such as Silver Lake, General Atlantic, Vista Partners and KKR.

You might have guessed the company now – it is Jio part of the Reliance Group and the man behind it is Mukesh Ambani.

How did Elizabeth Holmes and Mukesh Ambani get their companies valued at a premium and attracted investments from the who’s who? The answer is in their narratives. They were able to tie their narrative to the numbers, i.e. their business story drove their valuation.

New York University’s Prof. Aswath Damodaran, an authority in corporate valuation says, “In a good valuation, the numbers are bound together by a coherent narrative and storytelling is kept grounded with numbers.”

When an entrepreneur is pitching for an investment, the narrative that goes behind the numbers is more important. That is what gave premium valuation and attracted investors to Theranos and Jio.

Founders of all the leading companies Amazon, Tesla or Apple, have a consistent story that aligns with their decisions.

Consistent narratives build trust and provide investor confidence. That is the reason why Amazon is valued at $ 1.23 Trillion at a forward P/E of 98.04in comparison to Walmart’s forward P/E of 25.19. The following is what Jeff Bezos said in his 1997 letter to shareholders.

“We first measure ourselves in terms of the metrics most indicative of our market leadership: customer and revenue growth, the degree to which our customers continue to purchase from us on a repeat basis, and the strength of our brand. We have invested and will continue to invest aggressively to expand and leverage our customer base, brand, and infrastructure as we move to establish an enduring franchise. Because of our emphasis on the long term, we may make decisions and weigh trade-offs differently than some companies.”

For the last 23 years, Amazon still retains this narrative. Jeff Bezos always talks about having a dominant market share in whichever segment they operate in, investing back into the business for long term growth and focussing on customer experience.

Whether you are a retail investor trying to value a company before investing in its shares or you are an investor evaluating a startup for potential investment, you must have an investment thesis behind your decision.

To make the valuation story better, Prof. Damodaran suggests a five-step process. It is about weaving numbers into narratives and having every narrative backed up by numbers.

Five-step process for weaving narratives with numbers
Source: Prof. Aswath Damodaran’s Blog

Step 1 is about the story you say about the business.

What story you tell for the business will drive the valuation. In the above reference, I consider Amazon as a retailer and compare it against Walmart. You might have a different narrative for Amazon, which is fine. Your narrative will influence your valuation.

The founder’s narrative will play a key role, based on how persuasive, consistent, and credible their story is, both public and private investors will believe or not believe in them. It will influence investment decisions.

Step 2 is about how the narrative holds good against history, common sense, and reality.

Theranos story will fail against common sense and reality. There could be disruption in technology or business model which may be against historical cases, but it still needs to pass through common sense and reality filter. Common knowledge rides on principles of economics and mathematics. Prof. Damodaran asks investors to test if the narrative is possible, plausible and probable.

When Holmes said she could do 100+ tests with two droplets of blood all at a very competitive price, she was telling a runaway story. Everyone wants to believe this type of story. Unfortunately, no one questioned the numbers behind it or use common sense to understand how blood-testing works. That is what led to massive wealth erosion for the investors in Theranos.

Step 3 is about tying narratives to different levers that drive business.

You break down the big picture narrative into individual narratives. For example, how competitive advantage in the business story gives better margins, how scale gives pricing power, how the asset-light model results in lower Capex and easy scaling, etc. This step is more about narratives than numbers.

Framework to tie narratives to different levers that drive business

Step 4 is about connecting the different levers to come up with the valuation (the end goal).

This step is more about numbers than about narratives. Those of who familiar with valuation know the DCF (Discounted Cash Flow) model where you discount the future value of cash flow to the present value and arrive at the intrinsic value of the share. Based on the intrinsic value and the current market price, you either take a call to invest or not to invest.

Step 5 is more to fine-tune than the valuation process itself.

By keeping with times, one may want to relook at some of the narratives you had built-in for the business. You can do this by tweaking the narrative to the changing nature of the business and by being open to feedback from different market players.

This is where you say, Amazon is not just retail business but also cloud service provider which has a higher growth rate and you plug those numbers. By doing that, you can also open up a range of valuation starting from how a pure-play retail player is valued to how a company that encompasses streaming services to cloud services to e-book & audiobook readers to pay wallets to the smart assistant is valued. Different segments come with different risk, growth, and profit margins.

Are you a numbers person or a narratives person? The future will belong to those who can craft narratives with numbers.

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