ShmoopTube

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principles of finance a la shmoop mitigating risk so the pieces of this

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drone puzzle are starting to come together but you catch it eight how on [hand places puzzle onto drone]

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earth do I reduce the risk in this business at least in this deal

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well you recall reconnecting with a few buds from big school who went to work [women working near jet engine]

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for General Electric in their jet engine division when GE wanted to reduce risk

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while it reduced the price five percent of the engines and pre-sold a forward

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ten years worth of jet engines to Boeing or whoever well the result was a great [jet engine with 5% off tag]

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partnership that took all of the exogenous stress out of the very

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difficult task of building jet engines let alone building jet engines when the [man building jet engine]

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seller didn't know whether or not there'd be any buyers of the engines by

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the time they were finished years later but in this Blade Runner nano drone LBO

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well you have a consumer item with fickle consumers in a highly volatile [toddler screaming]

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non must-have area like you think about must-have products like milk and clean

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water and heat and you rationalize Netflix but that might not fly with [woman watching netflix]

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partners reviewing your case well nano drones are not must-haves

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neither are blade runner's so if the whole world stopped buying them well not [man sleeping]

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much would change so what can you do to mitigate company risk here is there an

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advance ten years or even three years forward buyer in the GE Boeing vein who

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could pre buy and say a million units so that they had them for ten years well it

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would guarantee at least locking in most of your production costs and leave

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upside to the base case set of free cash flow numbers what deal with the devil

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are you going to do with an advanced pre-sale like this like what terms would [woman sitting beside man with horns in fire]

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you have to give while having never done one before in your vast 27 years of life

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even the voice in your head is queasy thinking about that notion but hey you

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say it's worth exploring anyway so through your partner's rolodex system a

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big part of your value-add as a private equity shop you get to the buyer at

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Walmart she knows your product and well it isn't even yours yet but if it were [woman answers phone]

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you posit how might Walmart think about pre purchasing for ten years forward and

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yeah it's a combination of laughter and [woman laughing on phone]

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wonderings that somehow reality TV is taping the phone call so you hang up

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with Walmart after she does there's no tenure advance by risk

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mitigating partner in that form in the future of be rnd ain't gonna happen but

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you know that's Walmart kind of oldie worldly debt but what about Amazon yeah

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well that call goes a bit differently Amazon actually thinks drones are a [woman gasps on phone call]

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great seller and that they'll be around for a long time Amazon actually uses

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drones to deliver their crap all over the world so they really know the

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industry and the technology and they actually really like your idea and you

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get excited and then Amazon asks if you could make them a million units and your [woman bouncing in excitement]

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head is almost ready to explode and then Amazon finishes the sentence for five

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hundred dollars or less each so the earth stops again you look at BR n DS

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various unit pricing lines and quickly realize that at five hundred dollars a

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unit well the company would make about ten dollars per unit and have to sell

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like super quadrillion of them just to equal the amount you were making by

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selling them on your own off your own website so without making eye contact

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you stare at the ground and slowly back out of the Amazon room in Seattle and [woman walks away]

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fly home more questions you mumble other than pre-selling what else could you do

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here to mitigate risk well what about OMA or original equipment manufacturing

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drones to be private labeled for Apple and low margin a la Amazon you mumble

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correctly at $500 a unit this whole deal isn't worth doing and they'll

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cannibalize most or all of the $2000 sales you rely on for profits to drive [drone appears in amazon search bar]

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the business forward is there an overseas player to pre-buy

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like to co market / share marketing costs you know the way movies and

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McDonald's or coke team-up mmm well no nothing obvious Europe they're not that

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crazy about drones we are here well you spend a [drones exploding]

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mind-numbing set of brain cycles trying to figure out how to answer the oldest

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firm partners question when he undoubtedly will ask about reducing risk

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and you keep mumbling about this problem if you stand in the corner of the giant [woman mumbling in room of people]

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hallways of the San Jose Convention Center which is hosting drone world over

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the phone you chat with your secretary and are overheard to have said I have to

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figure out a big way to cut costs if nothing else and then a man confronts

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you he's smoking a cigarette indoors here as he leans on the no smoking sign [man smokes cigarette]

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I got you he says he nods walk with me and zombie-like you do this is normal

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behavior for geeky convention goers you want cut costs I have way you're in with

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drone maker right and you not yes and he says guidance system I have one just as

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good one fourth price you license big you have big really can I see how it [man discussing guidance system]

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works what do you have he nods over to my booth and way over in the far corner

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there's a tiny booth you don't fear for your physical safety but someone clearly

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did not get the no-smoking memo here as his partners jump back when you approach [men smoking in booth]

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from the clouds they're making well he opens the guts of a guidance system you

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spent enough time with blade runner's guts in this lbo process to know the

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layout your electoral engineering major in college also helped the non bloody [electrical engineering certificate on a wall]

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drone guts you're staring at seemed eerily identical to those of blade

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runners yeah some foreign lettering stamped above them is that Chinese

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Arabic Russian well one of the smoker man's partners asked you about batteries [smoking partners smoking in booth]

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they can make those also at 1/4 the price and as you're taking all this in

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you mumble how's that and you hear the phrase gallium arsenide and there's a [woman mumbles]

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crushing blade that feels like it's coming down on the paper work cycles

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you've put into this LBO these guys clearly steal the electronic

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architecture of guidance systems and make them cheaply overseas with what [person building guidance system]

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looks like prison labor and yeah you note on the little notes scrawled on the

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side of the drone casing saying help get me out of here with GPS coordinates on

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them as well these guys then apparently sell product for less and just in case

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you didn't hear clearly well you asked them to repeat in broken English you

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catch it clearly the second time gallium arsenide

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equals arsenic equals poison that's how they make the baseboards and structured

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semiconductors for the guidance system so cheap

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they itch silicon with arsenic poison and well just dump it in the river and [silicon etching with arsenic]

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as you imagine the three headed children down river in some foreign country [woman appears with three headed baby]

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you've never visited or maybe even ever heard of you hand the guidance guts back

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to the smoker and beat it out of there with a flurry of questions at costing

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you is this gray / black / stolen market a big part of the drone world there in

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the back corner here so it can't be that big can it would be would they sell to [smoke appears from corner of room]

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Amazon on the five hundred dollars a unit deal is there anything I could or

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would do about it if I called the cops what would happen why didn't I go to med [cops talking on the street]

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school well the bottom line is that it sounds like there is simply no real

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ethical way to mitigate risk in this deal so what does that mean to the math

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of the financial engineering bigger discount rate on the discounted cash

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flow model remember that thing that you'll put together for your partners [man discussing cash flow model]

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well the last dying embers of risk mitigation are about just having an exit

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door ie someone to sell the whole company to and this is a very bad

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alternative when you have a lot of debt if things should not go well three years

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in you might still have 750 million dollars of debt in a company whose total

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value declined say 40 percent from the one point three or four billion it

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started at and in that case on a sale of 750 million bucks well the only ones

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made whole are the banks which loaned the lbo the money that equity piece [piggy bank forms back to normal]

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remember the hundred fifty million that you put in and then also the hundred

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fifty million that management put in yeah that'd be worth gonzo zero nuked

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well what do you do then hint it rhymes with driving for shmoo BRR [woman driving car and man in the back appears smoking]

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