Unallocated Equity and Value of the Cooperative to the Member
Phil Kenkel
Bill Fitzwater Cooperative Chair
One of my on-going research projects is estimating the value of cooperatives. In the accounting
literature there are two models for valuing a firm. One is based on the present value of the future
free cash flows of the firm. Free cash flows represent all of the funds left over after operating
expenses, loan payments and infrastructure re-investment are made. The other model is based on
pay-out and represents the present value of all future cash patronage plus equity retirement
payments. We have been using my cooperative financial simulator to estimate those cash flows
and pay outs. We use historical financial information and information on the equity structure to
model the future cash flows, patronage and equity retirement. One question which we can answer
is whether the value of the cooperative is greater than the value of the stock held by the
members.
The valuation results obviously vary across cooperatives. The payout value, that is the value that
the member actual receives, is also heavily influenced by how profits are distributed. Not
surprisingly, higher cash patronage increases the valuation of the cooperative when it is based on
the payout method. Retaining member profits as unallocated reserves decreases the payout
valuation.
As an example, one case study cooperative, which as an average return on assets of 7.5% has a
free cash flow valuation of 3.3 times the value of the members’ stock. That is good news
because it implies that the members’ equity is being invested in assets which are generated future
cash flows worth more several times the stock value. That particular cooperative has been
retaining a high portion (around 40%) of member profits in the form of unallocated equity during
the last four years. That results in a payout based valuation of 73% of the members’ stock value.
If the cooperative continued the same retention practices the members would actually be
financially better off to sell their equity as face value rather than continue to patronize the
cooperative and receive cash patronage and eventually receive an equity retirement payout. If
the cooperative reverted to its traditional mix of cash and qualified stock the payout value would
be 2.5 times the current stock value while if the cooperative transitioned to non-qualified stock
the payout based valuation would be 3.5 times stock value.
In most cooperatives members rarely, if ever, consider selling off the cooperative. When those
issues arise, I’m sure it is based on much more that projections of future payouts. The simulation
results strongly suggest that Oklahoma cooperatives are creating value. They also suggest that
our choices in profit distribution directly affect the extent to which the member captures that
value.