The Big Question Behind NTA

When buying stocks at a discount to NTA, it's important to assess what the firms NTA consists of, that it's not over-stated, and that there are no contingent claims on the assets.

The proposed management buyout of NatSteel Ltd's assets at a deep discount to its net tangible assets (NTA) has ignited market debate as to the fairness of the deal. This week, lets look at what goes into NTA in general. And specifically, what NatSteels NTA consists of. Well also discuss why some stocks trade below their NTA and others many times above. Just some quick statistics. Almost 40 per cent of the 370 stocks listed on the Singapore Exchange are trading below their NTA, while 56 stocks trade two times above their NTA. We'll discuss briefly if there are justifications for these share prices relative to NTA. First, the definition. A companys NTA is its total assets minus intangible asset and total liabilities. Technically, its what would be left over for shareholders if the firm were to sell all its tangible assets at the prices recorded in its books and repay all its debts. The question, of course, is how accurately the book values of the assets reflect their market value.

In accounting, the key principles used to identify and value assets are historical cost and conservatism. Under the historical cost principle, assets are recorded at their original cost. Conservatism, meanwhile, requires that asset values be revised downward if fair value is less than the cost. These two principles ensure that managements estimate of a firm's resources is not overstated. As a result, asset values reported on the balance sheet can be normally considered the lower boundary of the value of future benefits. But we are not living in normal times. In the past few years, the emergence of various technologies has revolutionized the way we do business. The roles played by layers of middlemen have been reduced. In addition, the entry of China into the global marketplace has expanded the worlds production capacity significantly. Chinas low cost base has put a dampener on product prices worldwide. This has been compounded by weak demand as a result of anaemic economies. So a plant that cost $100 million to build two years ago may not be worth even $50 million if the price of the products it makes has plunged 50 per cent. This has been the case for NatSteel. Due to capacity glut, steel prices have declined to a 20-year low. Steel producers around the world have gone bankrupt and many more are bleeding, including NatSteel. In such a scenario, the fall in the market value of the fixed assets is faster than the accounting depreciation. Thus, conservatism requires that a company write down the net book value of the assets. Meanwhile, stocks or inventories carried by the company may not be sold at even cost-price. So a write-down in inventory is also required. If the write-down carried out by management is less than the fall in the market value of the assets, then NTA will be over-stated and the share price will trade below the NTA per share.