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Can European Unicorns Defend the High Valuations?

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Can European Unicorns Defend the High Valuations? Norwegian School of Economics Bergen, Spring 2018 Can European Unicorns Defend the High Valuations? A challenge of the post-money valuation approach Kristian Hansen Lomheim & Ola Thune Øritsland Supervisor: Nataliya Gerasimova Master thesis in Financial Economics NORWEGIAN SCHOOL OF ECONOMICS This thesis was written as a part of the Master of Science in Economics and Business Administration at NHH. Please note that neither the institution nor the examiners are responsible − through the approval of this thesis − for the theories and methods used, or results and conclusions drawn in this work. 2 Abstract We apply a DCF-based R-model on a sample of 12 European unicorns to show that post- money valuations overstate the fair value of VC-backed companies. At best, the initial result suggests that the majority of the sample is overvalued whereas some firms are slightly undervalued. The median overvaluation of the sample is 25%. When we increase the conservative cost of capital estimates with one percentage point, all firms are overvalued with a median overvaluation of 75% in the sample. Our results indicate that many of the firms will need an abnormal operational improvement toward steady state in addition to significantly outperform the peer group and industry forecasts in order to generate cash flows that are sufficient to defend the post-money valuation. 4 Contents 1. INTRODUCTION .......................................................................................................................8 1.1 PURPOSE & BACKGROUND OF THE STUDY ................................................................................8 1.2 LITERATURE REVIEW ..............................................................................................................10 1.3 STRUCTURE OF THE THESIS .....................................................................................................11 2. VENTURE CAPITAL ...............................................................................................................12 2.1 DEFINITION .............................................................................................................................12 2.2 FINANCING ROUND ..................................................................................................................12 2.3 CONTRACTUAL TERMS ............................................................................................................12 2.4 TRENDS IN EUROPEAN VC MARKET ........................................................................................14 3. VALUATION METHODS – UNDERLYING THEORY AND EVALUATION ................17 3.1 PRESENT VALUE METHODS ......................................................................................................18 3.1.1 An evaluation of the present value methods ................................................................18 3.1.2 Enterprise DCF ............................................................................................................19 3.2 RELATIVE VALUATION ............................................................................................................20 3.2.1 An evaluation of the relative valuation methods ..........................................................21 3.2.2 EV/Revenues ................................................................................................................22 3.3 ASSET-BASED METHODS .........................................................................................................22 3.3.1 An evaluation of the asset-based methods ...................................................................22 3.4 CONTINGENT CLAIM VALUATION ............................................................................................23 3.4.1 Real Option Valuation (ROV) ......................................................................................23 3.4.2 Contractual term valuation ..........................................................................................24 3.5 VENTURE CAPITAL METHOD ....................................................................................................24 3.6 CHOICE OF VALUATION METHOD ............................................................................................25 4. DATA & METHODOLOGY ...................................................................................................26 4.1 DATA ......................................................................................................................................26 4.1.1 Unicorn sample ............................................................................................................26 4.1.2 Data sources ................................................................................................................27 4.2 METHODOLOGY ......................................................................................................................28 4.2.1 R-model ........................................................................................................................28 4.2.2 Relative valuation ........................................................................................................44 5. ANALYSIS .................................................................................................................................46 5.1 SPOTIFY ..................................................................................................................................46 5.1.1 Summary of the valuations ...........................................................................................47 5.1.2 R-model ........................................................................................................................48 5.1.3 Relative valuation ........................................................................................................55 5.2 THE HUT GROUP .....................................................................................................................56 5.2.1 Summary of the valuations ...........................................................................................57 5.2.2 R-model ........................................................................................................................58 5.2.3 Relative valuation ........................................................................................................64 5.3 BREWDOG ...............................................................................................................................65 5.3.1 Summary of the valuations ...........................................................................................65 5.3.2 R-model ........................................................................................................................66 5.3.3 Relative valuation ........................................................................................................71 6. FINDINGS ..................................................................................................................................73 6.1 INITIAL RESULT .......................................................................................................................74 6.2 INITIAL RESULT WITH WACC SENSITIVITY .............................................................................74 6.3 EV/REVENUES GROUPS ...........................................................................................................77 6.4 INDUSTRY GROUPS ..................................................................................................................78 7. CONCLUSION ..........................................................................................................................80 REFERENCES .....................................................................................................................................81 APPENDIX ...........................................................................................................................................87 5 List of Figures Figure 2.1 – Capital invested and number of deals closed in the period 2006 to Q1 2018 ................................ 14 Figure 2.2 – Median deal size in the European VC market from 2007 to Q1 2018 ........................................... 15 Figure 2.3 – Median time from founding to exit in the European VC market .................................................... 15 Figure 3.1 – Valuation methods .......................................................................................................................... 17 Figure 3.2 – FCFF equation ................................................................................................................................ 19 Figure 4.1 – FCFF equation ................................................................................................................................ 29 Figure 4.2 – The Hut Group’s valuation scenarios ............................................................................................. 31 Figure 4.3 – Spotify’s revenue growth scenarios ................................................................................................ 34 Figure 4.4 – Forecast of NWC/Revenues when historical levels show no trend ................................................ 37 Figure 4.5 – Forecast of NWC/Revenues when historical levels show a decreasing trend ................................ 37 Figure 4.6 – Forecast of NWC/Revenues when historical levels show a flat trend ...........................................
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