The Frozen Corporation, A thought Experiment and case for good management.
- Grover Grafton
- Nov 5, 2024
- 2 min read
Updated: Apr 7
By: Grover Grafton
When making investment decisions, what really matters? What is it that we're really doing? This post is meant to get at the crux of that very problem and get you thinking.
Lets meet Mr. Frozen Co. and get to know him?
Frozen Co. :
makes 1B per year in revenue.
150M in Operating Profit (15% OP Margin)
80M Net (8% Net Margin)
It will grow revenues at 5% for the next 20 years, at which point it will cease to exist.
With Operating Margin, Net Margin, and Return on Capital Employed remaining steady over the period.
But:
The company can't pay Dividends, Buy Back Shares, Sell Itself, or otherwise liquidate.
Hence the frozen bit.
Meet Mr. Froze Co.
So... whats Froze Co. worth? Really Think!
The Answer?
The answer has to be nothing, $0.
In spite of its great fundamental prospects, this business isn't worth anything, not even a dollar.
What does this make the case for?
Honest shareholder-minded management. You might think this is merely a thought experiment, but Frozen Companies do exist. The problem is they are rarely recognized as such, and often management has an interest in obscuring the degree to which they are frozen.
Why might they do this?
In the example above, while to shareholders the Frozen Co. is worth exactly $0, it is perfectly capable of paying large salaries to its management. Placing their interests with the company, in that they want to keep the golden goose alive but misaligned with the shareholders (the actual owners).
Fundamentally, a business is only worth to shareholders what it can pay out to them, and this requires an honest management that runs a business for its shareholders and not just the employees.
Modern example:
Fannie Mae, whose Shareholder Equity (as stated on the balance sheet) of 86B trades in the market at 1.62B (As of 11/5/2024). Why? It's in conservatorship, and all capital is either retained or paid to the government, leaving shareholders with a frozen company.
Many successful Japanese companies are run with extremely low ROEs, as culturally they are more often run for the employees and less for the shareholders. EXP. Tokyo Stock Exchange-listed companies have an ROE of 9.6%, currently up from 6.4% in 2017, while the S&P 500 has a current ROE of 19.94%.
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