A license to operate
Understanding what underpins your company’s valuation
A “license to operate” can be defined as the gap between where a business should trade, based on its profitability and growth profile, and where it actually trades.
This license is granted by the confluence of the market’s collective view of a company’s risk and by the aggregate of investor sentiment. On average, holistic, fundamental operating metrics typically explain at least two-thirds of valuation. However, the remaining third reflects either perceived risk or genuine mispricing, and therefore it is critical that companies develop significant agency in how they address that residual value.
In this paper, we take a closer look at a company’s license to operate analyzing a series of factors relating to the license, identifying whether these factors are directly or indirectly within management’s control, the importance of each metric, and the timeframe over which they have influence. We also place the market-centric nature of the license to operate in a broader context.
Markets are a meeting place for capital and ideas. Management teams create and articulate those ideas, and investors decide which ideas to support and how to value them. These interactions create opportunities for both sides. For the providers of capital, there is the possibility of capturing excess returns by investing in great businesses or by opportunistically trading shares. For companies, access to investors’ capital enables their ideas to be turned into cash flows and then to have those cash flows valued at an attractive level.
But this confluence of ideas and capital does not happen without friction. Access to capital at the right price and ensuring that operating cash flows are valued appropriately requires considerable management time and effort. Investors have significant choice as to where to deploy capital, therefore companies need to create an attractive story with appropriate amounts of risk to attract them. Getting buy-in from investors enhances a management team’s ability to invest, grow and execute its strategy – enhancing its license to operate.
Since the license to operate is granted at the point where capital meets ideas, we can use capital markets metrics to clearly assess the state of a company’s license. In this paper we identify a number of those metrics, what they mean, how to measure them and – where possible – how management teams can control them.