Entrepreneurial Finance: Valuation Finance II 24092… · Multiples: Ryanair case (8/10) Finance II...

Alice Rossi

Finance II 2018/2019Prof. Silvio Vismara

Management engineering - Unibg

Entrepreneurial Finance:

Valuation

Agenda

Finance II

Introduction▪ What does valuation mean?▪ When to valuate?▪ What is value?Core valuation techniques▪ Multiples▪ DCF Methodology▪ Enterprise DCFWhatsApp case▪ Overview▪ WhatsApp valuation: Multiples▪ WhatsApp valuation: DCF▪ Additional commentsEquity crowdfunding with WeAreStarting case▪ WeAreStarting – Equity Crowdfunding based platform▪ 5 methods to value a startupReferences

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Introduction▪ What does valuation mean?

▪ When to valuate?

▪ What is value?

What does valuation mean? (1/2)

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▪ Valuation is about evaluating how much a company is worthy now based on expectedfuture performance

▪ Valuation is based on bringing future cash flows back into the present in order to givea price of the company now taking into account its future development and risks

▪ There are two important valuation techniques which we are going to focus on, whichare multiples and Discounted Cash Flow methodology

▪ One methodology doesn’t exclude the other, it is advisable to rely on both of themwhen valuating a company

4

What does valuation mean? (2/2)▪ The basic idea of valuation refers to Net Present Value (NPV) principle

▪ In NPV analysis, money (cash flows) expected in the future need to be discounted at RRRin order to have a present estimation of how the investment is expected to go

▪ In enterprise valuation, future expected cash flows need to be discounted at WACC

▪ The discount rate is a quantitative way to translate the concept that “money now are morevaluable than in the future”

NPV Enterprise valuation

Single investment Box of investments

Required Rate of Return (RRR)

Weighted Average Cost of Capital (WACC)

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When to valuate? (1/1)

Some examples of when you need money

▪ Merger and Acquisition (M&A)

▪ Initial Public Offering (IPO)

▪ Equity crowdfunding

Some examples of when you want to invest money

▪ Venture capital

▪ Money manager

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What is value? (1/2)

▪ Value is defined as the sum of present value of future expected cash flows

▪ Value is a measure of performance because it takes into account the long-term interests ofall the stakeholders in a company, while value creation is the change in value due tocompany performance

Principle of value creation

“Companies create value by investing capital they raise from investors to generate future cashflows at rates of return exceeding the cost of capital”

▪ The faster companies can increase revenues and deploy more capital at attractive rates ofreturn, the more value they create

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What is value? (2/2)

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Conservation of value

▪ “Anything that doesn’t increase cash flows doesn’t create value”

▪ As a consequence, “the value of a company shouldn’t be affected by changing the structure of debt and equity ownership unless overall cash flows change”(F., Modigliani & M.H., Miller, “The Cost of Capital, Corporation Finance and the Theory of Investment” American Economic Review 48,3(1958):261–297)

▪ Stock market isn’t easily fooled when companies undertake actions to increase reported accounting profit without increasing cash flows, i.e. share repurchases, acquisitions and financial engineering. All these actions create value if and only if cash flows increase

FOCUS ON CASH FLOW IS PARAMOUNT

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Take home messages

Finance II

▪ We want to evaluate how much a company is worthy now based on expected futureperformance

▪ There are different methodologies:- Multiples- Discounted Cash Flow

▪ We consider cash flows as they are linked to the value of the enterprise

▪ We have to discount future expected cash flows at a discount rate

9

Core Valuation Techniques▪ Multiples

▪ DCF Methodology

▪ Enterprise DCF

Multiples (1/10)

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▪ A multiple is a ratio between a measure of the (estimated) value of an asset and a specificitem on the financial statements or a non-financial statistic

▪ Multiples analysis is about comparing a company’s multiples with those of similarcompanies → multiples are relative valuation tools

▪ Multiples analysis is a way to get an approximation of the company size

▪ Two important things are needed:a) Consider more than one multipleb) Use the right peer (benchmark) group

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Multiples (2/10)

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a) Consider more than one multiple

The most common financial multiples are:

▪ Enterprise value divided by next year’s projection of revenue (EV/revenues)▪ Enterprise value divided by Earnings Before Interest, Taxes, Depreciation and Amortization

(EV/EBITDA)▪ Enterprise value divided by Earnings Before Interest, Taxes and Amortization (EV/EBITA)

▪ EBITA and EBITDA are related to company’s operating earnings → company’s operatingprofitability

▪ They focus on enterprise value, rather than share price▪ They do not look at the company’s capital structure

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Multiples (3/10)

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Multiples may be based on non-financial data

▪ It is about comparing the enterprise value with one or more non-financial statistics

▪ It is especially useful when valuing young companies with negative profitability and greatuncertainty surrounding potential market size, profitability and required investments

▪ Nonfinancial multiples should be used only when they provide incremental explanatorypower above financial multiples

▪ Depending on the situation, one multiple may lead to better valuation than another

▪ Relying on more than one multiple gives you a more complete overview on company’s valuation

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Multiples (4/10)

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b) Use the right peer group

▪ A peer group (or benchmark group) is a set of companies which are supposed to have very similar multiples due to similar business characteristics, size and age.

▪ Production methodology, distribution channels and R&D are also relevant aspects to consider.

▪ Sometimes, the peer group can be built relying on the list provided in company’s annual report

▪ If the company doesn’t disclose its competition, you can rely on an industry classification system such as Standard Industrial Classification (SIC) codes

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Multiples (5/10)

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When working with multiples, ask yourself the following questions:

▪ Why are the multiples different across the peer group?

▪ Do certain companies in the group have superior products, better access to customers, recurring revenues, or economies of scale?

▪ How do they generate revenue and profits?

▪ How do they grow?

▪ What products they sell?

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Multiples: Ryanair case (6/10)

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▪ Low fares airline from 1985

▪ 2,000 daily flights from 86 bases across Europe and North Africa, connecting over 215airports in 37 countries with 400 new boeing aircrafts and 13,000 skilled professionals(September 2018)

▪ On 29th May 1997 Ryanair becomes a public company on the Dublin, London and NASDAQStock Exchanges

▪ How can we estimate the value of Ryanair?

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Finance II

Alitalia Lufthansa Ryanair

Employees 12,428 123,287 10,926

Clients 22.1 109 106

Pilots 1,556 5,400 3,424

Clients/seatsratio

76.20% 79.10% 93%

Employees cost (€m)

613 7,354 585

Revenues (€m) 3,312.40 31,660 6,500

EBIT (€m) -199.1 +1,776 +1,240

▪ We choose market capitalization(unit stock price × total number ofstocks) as an estimate of equity value

▪ Peer group: firms in the same market,Alitalia and Lufthansa

▪ Alitalia is valued zero on the market,so it is not a good base to computemultiples

ALITALIA LUFTHANSA

Market Capitalization (€m) 0 10,757

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Source: repubblica.it, April 2017

Source: bloomberg.com, September 2017


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▪ We consider four different multiples▪ The first estimations of Ryanair value with multiples are quite far from market valuation▪ We try to use different multiples derived from the data to search which driver is more

representative of Ryanair market valuation

Market capitalization of Ryanair15,032 €m

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Lufthansa multiplesRyanair Equityestimation (€m)

E/Revenues 0.34 2,207

E/EBIT 6.05 7,506

E/Clients 98.62 10,454

E/Employee 0.09 953

𝐸𝐿𝑢𝑓𝑡ℎ𝑎𝑛𝑠𝑎

𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠𝐿𝑢𝑓𝑡ℎ𝑎𝑛𝑠𝑎× 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠𝑅𝑦𝑎𝑛𝑎𝑖𝑟 = 𝐸𝑅𝑦𝑎𝑛𝑎𝑖𝑟

10,750 €𝑚

31,660 €𝑚× 6,500€𝑚 = 2,207 €𝑚

0.34Lufthansa multiple



Finance II

ALITALIA LUFTHANSA RYANAIR𝑬𝑹𝒚𝒂𝒏𝒂𝒊𝒓

𝑬𝑳𝒖𝒇𝒕𝒉𝒂𝒏𝒔𝒂

Market Capitalization (€b)

0 10.76 15.03 1.40

▪ 1.40 is the ratio between the two market capitalization and so it represents also thetarget ratio between of the driver that best represents the market valuation. If therevenues were representative of the relationship which links the equity values of thetwo companies, the ratio would be 1.40.

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𝐸𝐿𝑢𝑓𝑡ℎ𝑎𝑛𝑠𝑎

𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠𝐿𝑢𝑓𝑡ℎ𝑎𝑛𝑠𝑎× 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠𝑅𝑦𝑎𝑛𝑎𝑖𝑟 = 𝐸𝑅𝑦𝑎𝑛𝑎𝑖𝑟

𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠𝑅𝑦𝑎𝑛𝑎𝑖𝑟

𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠𝐿𝑢𝑓𝑡ℎ𝑎𝑛𝑠𝑎=

𝐸𝑅𝑦𝑎𝑛𝑎𝑖𝑟

𝐸𝐿𝑢𝑓𝑡ℎ𝑎𝑛𝑠𝑎=15,032

10,757= 1.40


Finance II

RYANAIR LUFTHANSARYANAIR/

LUFTHANSA RATIOS

Employees 10,926 123,287 0.09

Clients (mln) 106 109 0.98

Pilots 3,424 5,400 0.63

Employees cost (mln) 585 7,354 0.08

Revenues (mln) 6,500 31,660 0.21

EBIT (mln) 1,240 1,776 0.70

EBIT/Revenus 0.19 0.06 3.40

EBIT/Clients 11.65 16.29 0.72

Clients/Pilots 0.03 0.02 1.54

Revenues (€m) / Employees cost (€m)

11.10 4.31 2.58

▪ Clients/Pilots ratio seams to be agood driver to estimate Ryanairvalue from Lufthansa figures

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Source: repubblica.it, April 2017

Take home messages

Finance II

▪ Multiples are ratio between an estimation of the value of an asset and a financial or non-financial indicator

▪ Multiples are relative valuation tools

▪ Different multiples may bring to different results

▪ We want to use more than one multiples to have a more complete overview

▪ We want to choose a proper peer (benchmark) group

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DCF Methodology (1/10)

Finance II

▪ Discounted Cash Flow (DCF) methodology relies on the forecasting and the actualizationof future cash flows of the firm that is going to be evaluated

▪ Methodology assumption: stable debt-to-equity-ratio

▪ Measure: Free Cash Flow

▪ Two main different approaches with the same result: Enterprise DCF and Equity DCF

▪ Two different kind of Cash Flow related to the two different techniques: Free Cash Flow toFirm (FCFF) and Free Cash Flow to Equity (FCFE)

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Finance II

What is a Free Cash Flow?

▪ Free Cash Flow is a measure of a company's financial performance

▪ FCF represents the cash that a company is able to generate after spending the money requiredto maintain or expand its asset base

▪ FCF in Discounted Cash Flow methodology has to be discounted, i.e. brought back into thepresent, at a constant discount rate

TIMENOW FCF FCF FCF FCF

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Finance II

▪ In this section we are going to show some examples of the main steps of the DCFMethodology and the comparison between different valuations

▪ To this purpose we will use the case of Home Depot, one of the world’s largest retailerof home improvement products (McKinsey). Data are taken from 2006 to 2008,forecasting starts from 2009

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Finance II

Free Cash Flows to Firm (FCFFs)

▪ Free Cash Flow to Firm are the cashflows available to all investors at theWACC, the weighted average capitalcost, meaning the blended cost for allinvestors

▪ FCFF is calculated as the cash flowgenerated by the company’s operationsless any reinvestment back into thebusiness

▪ Alternatively, FCFF can be computed asgross cash flow minus gross investment

Free Cash Flows to Equity (FCFEs)

▪ Free Cash Flow to Equity are the cash flowsavailable to the shareholders at the 𝑘𝑒, thecost of equity

▪ FCFE is calculated as net income plus non cashexpenses minus investments in working capital,fixed assets and nonoperating assets. Finally,the variation in debt and other nonequityclaims is added/subtracted

▪ Alternatively, FCFE can be computed asdividends plus share repurchases minus newequity issues. The two methods generateidentical results

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Finance II

FCFEs calculationFCFFs calculation

Non-cash expenses

Fixed assets

Nonoperating assets

Debt variation

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Finance II

A

E

D

Enterprise DCF

Equity DCF▪ Use FCFFs discounted at weighted cost of capital (WACC) to estimate the Value of the Operations (VO):

VO = σ𝐹𝐶𝐹𝐹𝑛

(1+𝑊𝐴𝐶𝐶)𝑛

▪ Estimate enterprise value (EV) = Value of the Operations (VO) + Non Operating assets

▪ 𝐸 = 𝐸𝑉 − 𝐷

▪ Estimate directly equity value

▪ Use FCFEs discounted at the cost of equity (𝑘𝑒)

𝐸 =𝐹𝐶𝐹𝐸𝑛

(1 + 𝑘𝑒)𝑛

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EV

ASSETS

EQUITY

DEBT


Finance II

Enterprise DCF

▪ Use of Free Cash Flow to Firm

▪ Value of the operations (VO): sum ofdiscounted FCFF

VO= σ𝐹𝐶𝐹𝐹𝑛

(1+𝑊𝐴𝐶𝐶)𝑛

▪ Add non operating-assets to obtainthe Enterprise Value (EV)

▪ Finally obtain the value of Equity (E)by subtracting the value of Debt (D)and non-equity asset from the EV

▪ 𝐸 = 𝐸𝑉 − 𝐷

Equity DCF

▪ Use of Free Cash Flow to Equity

▪ Value of Equity (E): sum of discounted FCFE

𝐸 =𝐹𝐶𝐹𝐸𝑛

(1 + 𝑘𝑒)𝑛

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Finance II

Enterprise DCF Equity DCF

VALUE OF OPERATIONS

VALUE OF NON-OP. ASSETS

VALUE OF DEBT

ENTERPRISE VALUE

EQUITY VALUE

ENTERPRISE VALUE

+

-

=

=

𝐹𝐶𝐹𝐹𝑛

(1 +𝑊𝐴𝐶𝐶)𝑛

VALUE OF OPERATIONS

𝐹𝐶𝐹𝐸𝑛

(1 + 𝑘𝑒)𝑛

EQUITY VALUE

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Finance II

EQUITY VALUE

NUM SHARES

VALUE PER SHARE

/ =

▪ The last step for both methods is to divide the obtained value of Equity for the number of shares of the company in order to find the value of a single share:

▪ Example: Home Depot’s value per share

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DCF Methodology: (10/10)

Finance II

▪ So far, we presented the general features of DCF methodology with the main differencesbetween Enterprise DCF and Equity DCF

▪ Although the Equity DCF seems to be easier because it goes directly to the Equity Value, itis a model that mixes together operating performance and capital structure in calculatingthe cash flows, easily leading to mistakes

▪ For this reason, equity cash flow valuation model is not used, except when valuing banksand other financial institutions, where capital structure is an inextricable part ofoperations

▪ From now on we go into deeper detail of the Enterprise DCF method

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Enterprise DCF: Principles of forecasting FCFFs (1/12)

Finance II

In order to discount the Free Cash Flows to Firm to the present date, we have to forecastthem. Let’s focus on how the way we forecast FCFFs changes depending on the time span weconsider.

First we have to decide the length and detail of the forecast.

There are three periods you need to distinguish in the forecast, each of them characterized bya different length and level of detail

Forecast line-by-lineComplete data

Usually 5 → 7 years

Focus on few important variables

Constant rate of revenue growth with constant reinvesting in the business

TIME

EXPLICIT FORECAST 10 → 15 years PERPETUITY FORMULA

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Enterprise DCF: Principles of forecasting FCFFs (2/12)

Finance II

EXPLICIT FORECAST 10 → 15 years

1. Analyse historical financial resultsUnderstanding a company’s past is essential to forecast its future → robust analysis ofhistorical performances.Look back as far as possible (at least 10 years)2. Build the revenue forecastRevenue is usually the leading driver to the forecast so we need to do an accurate forecastingof it. There are two different approaches to the revenue forecast:▪ Top-Down: from the market view to the single forecast▪ Bottom-Up: forecast based on the demand of existing customers3. Forecast the income statementIndividual line items of the income statement are forecasted and so FCFFs for each year areobtained4. Actualization of the FCFFs

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Enterprise DCF: Continuing Value (3/12)

Finance II

PERPETUITY FORMULA

▪ The principles seen in the previous slide are valid for the first years of forecast

▪ As time passes, information decreases and our ability to forecast the future is lessaccurate

▪ At a certain point in time, the prediction becomes too far from the day of valuation’sperspective and so a perpetuity formula is needed

▪ The perpetuity formula gives the so called Continuing Value (CV) that is the value at timet of the Cash Flows from the year t later on

▪ Continuing Value has to be considered as a FCFF at time t, so it has to be actualized

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Enterprise DCF: WACC (4/12)

Finance II

To actualize the FCFFs and CV we need to estimate the Weighted Average Cost of Capital(WACC)

▪ WACC is defined as the opportunity cost that investors face for investing their funds in oneparticular business instead of others with similar risk

▪ WACC is decomposed as follows:

𝑊𝐴𝐶𝐶 =𝐷

𝐷 + 𝐸𝑘𝑑 1 − 𝑇𝑚 +

𝐸

𝐷 + 𝐸𝑘𝑒

▪ 𝑘𝑑 = Cost of debt, 𝑘𝑒 = Cost of equity

▪𝐷

𝐷+𝐸= Target level of debt to enterprise value using market-based values,

𝐸

𝐷+𝐸= Target level

of equity to enterprise value using market-based values

▪ 𝑇𝑚 = Company’s marginal income tax rate

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Finance II

WACC

(1) COST OF EQUITY

(2) COST OF DEBT AFTER TAX

(3) TARGET LEVELS DEBT AND EQUITY

▪ RISK-FREE RATE▪ MARKET RISK PREMIUM▪ COMPANY SPECIFIC RISK

ADJUSTMENT (beta)

▪ CURRENT CAPITAL STRUCTURE

▪ COMPARABLES COMPANIES

▪ MANAGEMENT APPROACH

YIELD TO MATURITY + TAX SHIELDS

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𝑘𝑑 1 − 𝑇𝑚

𝐷

𝐷 + 𝐸

𝑘𝑒


Finance II

Cost of equity


𝐷 + 𝐸𝑘𝑑 1 − 𝑇𝑚 +

𝐸

𝐷 + 𝐸𝑘𝑒

▪ Capital Asset Pricing Model (CAPM) is the method used to estimate the cost of equity

▪ The cost of equity is estimated as the expected stock’s return, i.e. the sensitivity to the stockmarket

▪ The expected rate of return of an equity security, taking into account the risk, is affected bythree elements: risk free rate, factor beta and the market risk premium

𝑘𝑒 ∼ 𝐸 𝑅𝑖 = 𝑟𝑓 + ß𝑖 𝐸 𝑅𝑚 − 𝑟𝑓RISK FREE

RATEMARKET RISK

PREMIUM

BETA

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Finance II

RISK FREE RATE 𝑟𝑓

▪ The best approximation for the risk free rate is a high liquid, long term security governmentrate with the same currency as FCFF stream

▪ Each FCFF should be discounted using a government bond with the same maturity as theFCFF but usually only one single yield to maturity that best matches the entire FCFF streamis used (use government STRIPS for US and German Eurobond for UE companies)

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Finance II

BETA ß𝑖

▪ ß is a factor standing for how much the enterprise’s stock market and the entire marketmove together

▪ In order to estimate company’s ß, perform a linear regression where ß is the slope of theobtained curve which relates company’s stock return with market return

▪ Companies in the same industry face similar operating risks, so they should have similar ß→ industry ß can be used as a reference when 𝑅𝑖 of the company is not available

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𝑅𝑖 = α + ß𝑅𝑚 + ε𝑅𝑖= Stock return𝑅𝑚=Market return


Finance II

MARKET RISK PREMIUM 𝐸 𝑅𝑚 − 𝑟𝑓

▪ It is the premium for holding equity rather than debt and it has been estimated to be around4.5/5.5% (historical market risk premium)

▪ Adjust the historical market risk premium for econometric issues

▪ You can also estimate the market risk premium and compare the result with the historicalmarket risk premium

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Finance II

After tax cost of debt


𝐷 + 𝐸𝑘𝑑 1 − 𝑇𝑚 +

𝐸

𝐷 + 𝐸𝑘𝑒

▪ For companies with an investment grade (BBB or better), the best estimation of the cost ofdebt is the yield to maturity of the company’s long-term option-free bonds, despite yieldto maturity is the promised return and not the return itself

▪ In the following explanation we focus only on companies with an investment grade

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Finance II

▪ Solve the following formula for yield to maturity (YTM)

𝑃𝑟𝑖𝑐𝑒 =𝐶𝑜𝑢𝑝𝑜𝑛

1 + 𝑌𝑇𝑀+

𝐶𝑜𝑢𝑝𝑜𝑛

1 + 𝑌𝑇𝑀 2+⋯+

𝐹𝑎𝑐𝑒 + 𝐶𝑜𝑢𝑝𝑜𝑛

(1 + 𝑌𝑇𝑀)𝑁

▪ YTM must be related to a liquid, option-free, long-term debt bond

▪ When a company only has short-term bonds or rarely trade bonds, an indirect method mustbe used:

1) company’s credit rating on unsecured long-term debt2) examine YTM on a similar portfolio of long-term bonds with the same rating

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Finance II

Capital structure


𝐷 + 𝐸𝑘𝑑 1 − 𝑇𝑚 +

𝐸

𝐷 + 𝐸𝑘𝑒

1) Estimate current capital structure▪ When debt and equity are publicly traded, multiply each security with the most recent price▪ Take into account debt, debt-equivalent claims and equity

2) Reviewing capital structure of comparable companies▪ Compare the capital structure with those of similar companies▪ Median level of debt-to-value▪ Analysis of long term trend

3) Reviewing management’s financing philosophy

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Take home messages

Finance II

Enterprise DCF Equity DCF

General approach EV → E=EV-D E

MeasureFree Cash Flow to Firm (FCFF)=cash flow

generated by company operations –reinvestment back into the business

Free Cash Flow to Equity (FCFE)=net income + noncash expenditures – investment in working capital – fixed assets – non operating expenses +/- variation in debt

and equity

Discount factor Weighted Cost of Capital (WACC) Cost of equity (𝑘𝑒)

Discount factor calculation 𝑊𝐴𝐶𝐶 =

𝐷

𝑉𝑘𝑑 1 − 𝑇𝑚 +

𝐸

𝑉𝑘𝑒 𝑘𝑒 = 𝑟𝑓 + ß𝑖 𝐸 𝑅𝑚 − 𝑟𝑓

Actualizationformula

VO = σ𝐹𝐶𝐹𝐹𝑛

(1+𝑊𝐴𝐶𝐶)𝑛𝐸 =

𝐹𝐶𝐹𝐸𝑛(1 + 𝑘𝑒)

𝑛

44

▪ Assumption: stable debt-to-equity ratio▪ We prefer to use Enterprise DCF as Equity DCF mixes operating performance with capital

structure

WhatsApp case▪ Overview

▪ Why WhatsApp?

▪ WhatsApp valuation: Multiples

▪ WhatsApp valuation: Enterprise Discounted Cash Flow

▪ Additional comments

Overview (1/3)

Finance II

19$bLARGEST

FACEBOOK

ACQUISITION

19th FEBRUARY 201446

Overview (2/3)

Finance II

▪ Add-free mobile instant messaging application with the mission of allowing people tocommunicate without any barriers all over the world

▪ 19$ billion price-tag acquisition on the 19th February 2014 (more than Iceland GDP andone tenth of Facebook market value)

▪ Acquired by Facebook through a mixed acquisition, 4$ billion cash and about 184 millionsshares of Facebook Class A common stocks

▪ Launched in 2009 → it was acquired when it was a 5 years old company

▪ Founders Jan Koum and Brian Acton are still into the business and WhatsApp is still runningits operations completely independently

47

Overview (3/3)

Finance II

▪ Facebook has acquired 72 companies

▪ WhatsApp is the largest Facebook acquisition, 20 times larger than Instagram acquisition

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Acquisition date Company Business Value ($m)

2014 WhatsApp Mobile messaging 19,0002014 Oculus VR Virtual reality technology 2,0002012 Instagram Photo sharing 1,0002014 LiveRail Publisher Monetization Platform 4502012 Face.com Face recognition platform 1002018 Redkix Team Messaging via E-Mail 1002013 Atlas Solutions Atlas advertiser suite 1002013 Parse Mobile app backends 852011 Snaptu Mobile app developer 702015 Pebbles Computer vision, augmented reality 60

Source: Wikipedia, September 2018

Overview: why WhatsApp? (1/7)

Finance II

▪ Apparent revenue source at the time of the acquisition: each user was charged 0.99$ forsubscription

▪ According to Forbe’s estimation, WhatsApp annual revenue was about 20$ million in 2014→ not enough to justify 19$ billion price tag

Why WhatsApp?

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Finance II

1) USER SIZE AND USER GROWTH

▪ Facebook wanted to enhance its customers and market power level within the GlobalInternet Media Industry → a large number of users attract more users (network effects)

▪ Monthly active WhatsApp users, as in December 2013, were 450 million against the 1.3billion Facebook users. However only 556m are mobile active users

▪ Moreover, Facebook Messanger (Facebook chat service, similar to WhatsApp) had only 120million monthly active users

2 1 3


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Finance II

▪ What Facebook wasparticularly interested in wasthe extraordinary WhatsAppusers growth

▪ Buying WhatsApp, Facebookmay be able to benefit fromthis high diffusion rateexploiting new usersworldwide

▪ WhatsApp grew much fasterthan Facebook did whenFacebook was the same age!


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Finance II

2) SYNERGIES

▪ Synergy is when the value of two combined entities is greater than the sum of the twoseparated companies

▪ Synergies may be related to revenue enhancement, cost reduction, capital tax gains orcombining talent and technologies

▪ In our case, Facebook had the ambition to combine talent and technologies, i.e. goodwill,brand recognition and intellectual property

▪ Furthermore, WhatsApp could offer Facebook a high fixed revenue stream over the years


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Finance II

𝑠𝑦𝑛𝑒𝑟𝑔𝑦 = 𝑣𝑎𝑙𝑢𝑒𝑤+𝑓 − 𝑣𝑎𝑙𝑢𝑒𝑤 + 𝑣𝑎𝑙𝑢𝑒𝑓

𝒂𝒄𝒒𝒖𝒊𝒔𝒊𝒕𝒊𝒐𝒏 𝒑𝒓𝒊𝒄𝒆 = 𝒗𝒂𝒍𝒖𝒆𝒘 + 𝒂𝒄𝒒𝒖𝒊𝒔𝒊𝒕𝒊𝒐𝒏 𝒑𝒓𝒆𝒎𝒊𝒖𝒎

𝑊ℎ𝑎𝑡𝑠𝐴𝑝𝑝 𝑔𝑎𝑖𝑛 = 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 = 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑝𝑟𝑖𝑐𝑒 − 𝑣𝑎𝑙𝑢𝑒𝑤Acquisition premium>0 in order to have a positive gain for WhatsAppThe larger the acquisition premium, the larger the gain for WhatsApp

𝐹𝑎𝑐𝑒𝑏𝑜𝑜𝑘 𝑔𝑎𝑖𝑛 = 𝑠𝑦𝑛𝑒𝑟𝑔𝑦 − 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚Acquisition premium < synergy in order to have a positive gain for Facebook

The larger the difference between real synergy and acquisition premium, the larger the gain for Facebook

Constraint: 0 < acquisition premium < synergy


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Finance II

▪ In order to determine the tag-price Facebook should pay for WhatsApp, it is bothimportant to correctly valuate WhatsApp and estimate synergies

▪ The overestimation of WhatsApp value and synergies makes Facebook to pay too much,the underestimation works on the other way round

▪ The acquisition can create value for Facebook only if the WhatsApp’s performanceimproves by more than the value of the premium over the target’s intrinsic value thatFacebook had to offer for WhatsApp in order to persuade its shareholders to part with it


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Finance II

3) NEW BUSINESS: Mobile Money Transfer

▪ Facebook looks for other ways of making moneythrough WhatsApp, i.e. mobile money transfer

▪ WhatsApp as a channel for digital payments

▪ WhatsApp seems to be the right tool to beintegrated with money transaction, more thanFacebook, due to its efficiency and immediacy

▪ What about the opportunity to associate moneyto WhatsApp messages?


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WhatsApp valuation: Multiples (1/9)

Finance II

Multiples: Comparable companies

▪ Multiples analysis is about comparing a company’s multiples with those of similarcompanies → relative valuation tool

▪ Multiples can be both the starting point of a valuation and an auxiliary tool in checking DCFresults

▪ Multiples have a short-term nature since they are based on historical data or short termforecasts so they might be distorted for long term perspectives

▪ Good for fast growing companies like WhatsApp

▪ We want to compare WhatsApp with similar companies whose valuation enterprise value isknown (companies trading on a stock exchange which values them in real-time)

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Finance II

▪ More than one multiple is used in order to valuate WhatsApp enterprise value

▪ Since WhatsApp is almost totally financed by equity investors, debt is almost neglectableand Equity value is very close to Enterprise Value (𝑬 ≅ 𝑬𝑽)

▪ Let’s consider as multiples EV/Revenues (financial multiple) and EV/user (non financialmultiple)

▪ Valuation of the same company may differ under different multiples

▪ When choosing which multiple to trust the most, it is important to consider the industry thecompany belongs to and try to give weight to the different factors influencing company’senterprise value

▪ Benchmark group: main companies belonging to Global Internet Media Industry

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Finance II

EV ($m) Revenues ($m) Users/month (m) EV/Revenues EV/Users

Facebook 160,090 7,870 1,230 20.34 130.15

Linkedin 19,989 1,530 277 13.06 72.16

Twitter 18,790 665 243 28.26 77.33

Pandora 7,150 665 73 10.75 97.41

Groupon 5,880 2,440 43 2.41 136.74

Netflix 25,380 4,370 44 5.81 576.82

Yelp 5,790 233 120 24.85 48.25

Opentable 1,500 190 14 7.89 107.14

Zynga 2,930 873 27 3.36 108.52

Average 12.97 150.50

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Finance II

EV/Revenues

EV/Revenues = 12.97WhatsApp revenue at the time of the acquisition = 20$mWhatsApp enterprise value = 20$m x 12.97 = 0.26$b << 19$b

▪ Knowing that WhatsApp was acquired for 19$b, EV/Revenues suggests that WhatsApp wasovervalued

▪ Are the value of the synergies enough to justify a 19$b price-tag? Rememberthat 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑝𝑟𝑖𝑐𝑒 = 𝑣𝑎𝑙𝑢𝑒𝑤 + 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚

▪ As a buyer you would like to pick this multiple for valuation since you are interested inmultiples which give you the lowest valuation

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Finance II

EV/Users

EV/Users = 150.50WhatsApp users at the time of acquisition = 450 millionWhatsApp enterprise value = 450 million x 150.50 = 67.7$b >> 19$b

▪ Knowing that WhatsApp was acquired for 19$b, EV/Users suggests that WhatsApp wasundervalued

▪ As a seller you would like to pick this multiple for valuation since you are interested inmultiples which give you maximum valuation

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Finance II

Multiples: Comparable transactions

▪ Based on comparing similar companies transactions

▪ Now we compare acquisition prices throughmultiples

▪ We look for acquisitions made by the same acquirer,Facebook

▪ We choose as a comparable transaction theacquisition of Instagram by Facebook in 2012

▪ Acquired companies are both mobile applicationsand they share some similar functionalities

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Finance II

▪ Let’s use as a multiple Acquisition price/User

▪ WhatsApp monthly active users at acquisition were 450 million

▪ WhatsApp acquisition price = 450 million x 33.33 = 15$b < 19$b

▪ The result is quite close to the real price-tag paid by Facebook to acquire WhatsApp

▪ However, basing on this multiple, WhatsApp seems to have been a little overvalued

▪ In order to obtain exactly 19$b, WhatsApp multiple should have been 42.22

Acquisition price ($m)Monthly users at acquisition (m)

Acquisition price/user

Instagram 1,000 30 33.33

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Finance II

▪ In order to reach a more accurate evaluation, it is preferable to rely to more comparabletransactions → we stay with the same multiple Acquisition price/user while we expandthe benchmark group

▪ Benchmark group: Companies with similar business and financial model being acquired

Year Acquirer Acquisition price ($m)Users at acquisition

($m)Acquisition price/user

Instagram 2012 Facebook 1.0 30 33.33

Tumbrl 2013 Yahoo 1.1 40 27.50

Snapchat (offer) 2013 Facebook 2.5 27.5 90.91

Average 50.58

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Finance II

▪ Computing the mean among the benchmark group, the multiple is higher than the previouscase in which only Instagram acquisition was considered

▪ WhatsApp monthly active users at acquisition were 450 million

▪ WhatsApp acquisition price = 450 million x 50.58 = 22.76$b > 19$b

▪ Again, the result is quite close to the real price-tag paid by Facebook to acquire WhatsApp

▪ However, considering the multiple built from the benchmark group, WhatsApp seems tohave been a little undervalued

▪ Comparing similar transactions seams to lead to estimations closer to the effective price-tagthan comparing similar companies

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WhatsApp valuation: Enterprise DCF (1/9)

Finance II

▪ Good for WhatsApp since it is a simple firm with a very simple project

▪ Capital structure can be considered constant → The project does not have identifiableincremental debt, the company is mostly financed by equity

▪ Enterprise DCF methodology is adopted → direct calculation of enterprise value bydiscounting Free Cash Flows to Firm (FCFF) at the weighted cost of capital (WACC)

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Finance II

1) WACC estimation

▪ A good estimation of WACC is trivial since the actualization formula is very sensitive to itsparameters

▪ A too low discount rate may lead to an overvaluation in the value of the company while atoo high discount rate is the other way round

▪ Since the WhatsApp is almost totally financed by equity investors we use as discountedfactor the cost of equity

𝑊𝐴𝐶𝐶 = 𝑘𝑒𝑊𝐴𝐶𝐶 =𝐷

𝑉𝑘𝑑 1 − 𝑇𝑚 +

𝐸

𝑉𝑘𝑒

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Finance II

▪ In order to estimate the cost of equity Capital Asset Pricing Model (CAPM) is used, based onthe following formula:

𝑘𝑒 = 𝑟𝑓 + ß𝑖 𝐸 𝑅𝑚 − 𝑟𝑓

▪ Risk free rate 𝑟𝑓 is market data whose value can be found on Bloomberg Market

Rates&Bonds data searching for U.S. February 2014 long term security government rate →𝑟𝑓 = 2.74%

▪ Market return 𝐸 𝑅𝑚 can be also found on Bloomberg Market data searching for February2014 → 𝐸 𝑅𝑚 = 10.17%

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Finance II

RISK FREE RATE (rf)

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Finance II

▪ ß𝑖 is a factor standing for how much the stock market and the entire market move together

▪ Create a set of 20 WhatsApp comparables, i.e. companies with similar characteristics andbelonging to the same industry

▪ Compute an arithmetic average among the selected companies → ß𝑖 = 0.94 → WhatsAppstock market and the entire market have similar behaviour

▪ WACC= 𝑘𝑒 = 2.74%+0.94(10.17%-2.74%) = 9.72%

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Finance II

2) FCFF estimation and actualization

▪ We want to estimate future Free Cash Flows to the Firm

▪ For the first 10 years (explicit period), revenue is estimated year by year basing on the userbase expansion. Each expected FCFF is discounted to the present.

▪ From the eleventh year, g is assumed to be constant at the 5% value → perpetuity formulacan be applied and continuing value (CV) at t=10 is obtained, which is in turn discounted tothe present

▪ According to experts forecast, WhatsApp is going to experience a very fast growingexpansion in the next ten years due to geographic spread in those under developedcountries which are gaining internet access in the next few years, while in the long-term thegrowth is expected to stabilize

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Finance II

Assumptions:Users continue to pay annual 0.99$ feeAs time passes, user base grows→ An increase in users lead to a more or less proportional increase revenue

▪ During the explicit period of 10 years, FCFF are discounted one by one while after theexplicit period the terminal value calculation is performed

▪ Value of oper𝑎𝑡𝑖𝑜𝑛𝑠 = σ𝑛=110 𝐹𝐶𝐹𝐹𝑛

(1+𝑊𝐴𝐶𝐶)𝑛+

𝐹𝐶𝐹𝐹10

𝑊𝐴𝐶𝐶−𝑔×

1

(1+𝑊𝐴𝐶𝐶)10

▪ Non operating assets and liabilities are not considered since they are assumed to be aneglectable percentage of the enterprise value

DISCOUNTED CONTINUING VALUE

DISCOUNTED FCFF

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Finance II

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 CV

Year 0 1 2 3 4 5 6 7 8 9 10+

Active users 450 719 982 1218 1431 1623 1795 1950 2090 2216 2339

Revenue ($M) 20 143.80 343.70 685.13 1,180.58 1,846.16 2,513.00 3,290.63 4,180.00 5,179.90 6,288.30

FCFF ($M) -0.47 -2.64 78.56 202.23 389.34 615.45 877.64 1187.48 1545,11 1,950.12 39,002.40

PV FCFF ($M) -0.47 -2.40 64.93 151.94 265.92 382.15 495.40 609.37 720,81 827.04 16,540.82

WACC 9.72%

g 5%

EV ($M) 20,055.51

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Finance II

▪ Enterprise DCF valuation leads to 20$b which is quite close to 19$b real price-tag

▪ If all the assumptions taken would correspond to the future reality, WhatsApp seems to be a little undervalued

▪ However, we know that WhatsApp is a totally free service from year 2016, without any fee for the users to pay

▪ As a consequence, valuating the WhatsApp enterprise value on revenue from users annual fee couldn’t have worked nowadays when WhatsApp revenue model is completely different from the time of the acquisition (2014)

▪ As a conclusion we can say that as information changes, estimate of an enterprise may change a lot and also is necessary to rely on different methodologies

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Additional comments (1/4)

Finance II

Financing the deal

▪ An acquisition can be performed through three different types of payment: all-cashacquisition, all-stock acquisition or both of them

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Finance II

▪ There are many pros and cons related to different strategies of acquiring a deal

▪ Facebook decided to buy WhatsApp mainly in stocks

▪ Facebook perceived itself to be overvalued → By widely swelling the value of its stocks,Zuckerberg was able to save money from the overall transaction outlay

▪ When a company seems to pay too much or people may think that the target company isoverpriced by the takeover firm, the overprice is easier to hide for the latter if it is paidbasically by stocks

▪ By paying almost in stocks, Facebook allowed WhatsApp to avoid capital tax gains and toshare future gains, so that target shareholders can participate in future stock’s priceappreciation

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Finance II

What about now…

▪ Most popular messaging appsworldwide as in January 2017, basedon number of monthly active users (m)

76Source: Statista.com, September 2017


Finance II

Possible concerns

▪ Competition leads a company to continue improvement efforts and to strive forcontinuously innovate itself in order to differentiate from its competitors

▪ Facebook bought its main competitor and there are no any other app able to offer thesame service → without any rivals, is there any risk that Facebook would suffer from this?

▪ Will Facebook be able to efficiently integrate WhatsApp into Facebook?

▪ If WhatsApp is now totally free of charge for the users, how does it make money?

▪ We know from recent reports that WhatsApp is currently working on “WhatsApp Business”which is a version of the app aimed to better manage clients (to launch in India) → IsWhatsApp paving the way for monetization?

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Equity CrowdfundingWeAreStarting case study▪ WeAreStarting – Equity Crowdfunding based platform

▪ 5 methods to value a startup

WeAreStarting – Equity Crowdfunding

Finance II

▪ WeAreStarting is a Italian equity crowdfunding platform where professional and non professional investors can invest directly in startups and SME (Small Medium Enterprise).

▪ When a company decide to lunch a campaign on the platform it has to compute a valuation of its business

▪ WeAreStarting uses different methods to evaluate the plausibility of the valuation

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1 - The Scorecard method

Finance II

▪ The scorecard method is often used for startups because it compares them to other already funded companies taking also into account the differences

▪ The first step is to determine the average pre-money valuation of companies in the same business sector as the target company and possibly in the same growth stage

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1 - The Scorecard method

Finance II

▪ The weight of these factors in the final valuation ranges from 0 to 100%. The factors are then given a score based on a comparison with similar businesses

▪ After you have assigned weights and scores for each comparison, you can calculate the factors by multiplying the range by the score of the company

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2 - The Checklist method

Finance II

▪ The checklist, created by Dave Berkus, is similar to the scorecard method. However, the checklist method has fixed value amounts attached to each of the elements

▪ The checklist valuation method considers a startup individually, without taking into account market or competitive environment

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3 - The DCF method with Multiples

Finance II

▪ The discounted cash flow method with multiples is based on a multiple of the earnings before interest, taxes, depreciation and amortization (EBITDA)

▪ The multiple is based on the average multiple of companies comparable to the one you are analysing. Generally, comparable companies are (in this order of priority):▪ Direct competitors▪ Indirect competitors▪ Companies with the same business model▪ Companies in the same industry

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PRESENT VALUE = σ1𝑛 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑡

(1+𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑟𝑎𝑡𝑒)𝑡

3 - The DCF method with Multiples

Finance II

VALUATION = PRESENT VALUE + TERMINAL VALUE

TERMINAL VALUE= 𝐸𝐵𝐼𝑇𝐷𝐴𝑛×𝐸𝐵𝐼𝑇𝐷𝐴𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑒

(1+𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑟𝑎𝑡𝑒)𝑛

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4 - The DCF method with Long-Term Growth

Finance II

▪ The underlying assumption behind this method is that cash flows will continue to grow consistently at an estimated long-term growth rate

▪ The basic formula for the terminal value using the DCF with Long-Term Growth is the same of DCF with Multiples and differs for the terminal value formula:

▪ The growth rate is the rate you believe the company will grow at. Typically it is near to the estimated growth of the market where the company is operating

TERMINAL VALUE= 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑛 ×(1+𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒)

(𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 −𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒)

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5 - The VC method

Finance II

▪ The venture capital (VC) method is one of the most adopted rule-of-thumb approaches for valuing innovative early stage companies

▪ The difference between the VC method and the other valuation approaches is that the valuation is an example of reverse engineering. The model is based on the estimation of the exit value of the company and its subsequent discount for a high year-on-year return on investment (ROI)

▪ This method assumes an exit value of the company and then discounts it back using the return rate that the VC firm desires

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5 - The VC method

Finance II

POST MONEY VALUATION = TERMINAL VALUE ÷ ROI

ROI = TERMINAL VALUE ÷ POST MONEY VALUATION

PRE MONEY VALUATION = POST MONEY VALUATION - INVESTMENT

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References

Finance II

IntroductionCore valuation techniques

▪ VALUATION, Measuring and Managing the Value of Companies” FIFTH EDITION Tim Koller, Marc Goedhart and David Wessels, McKinsey&Company - theoretical reference

WhatsApp case

▪ “Case study preparation: the WhatsApp acquisition from Facebook”, Francesco Cosentino, NOVA School Of Business & Economics – Financial statement data

Equity crowdfunding with WeAreStarting case

▪ HOW TO VALUE A BUSINESS: https://www.equidam.com/how-to-value-a-business/

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Any questions?

Alice [email protected]

Thank you!

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