Entrepreneurial Finance: Valuation
Alice Rossi
Finance II 2018/2019 Prof. Silvio Vismara Management engineering - Unibg Agenda Introduction ▪ What does valuation mean? ▪ When to valuate? ▪ What is value? Core valuation techniques ▪ Multiples ▪ DCF Methodology ▪ Enterprise DCF WhatsApp case ▪ Overview ▪ WhatsApp valuation: Multiples ▪ WhatsApp valuation: DCF ▪ Additional comments Equity crowdfunding with WeAreStarting case ▪ WeAreStarting – Equity Crowdfunding based platform ▪ 5 methods to value a startup References
Finance II 2 Introduction ▪ What does valuation mean? ▪ When to valuate? ▪ What is value? What does valuation mean? (1/2)
▪ Valuation is about evaluating how much a company is worthy now based on expected future performance
▪ Valuation is based on bringing future cash flows back into the present in order to give a 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, which are multiples and Discounted Cash Flow methodology
▪ One methodology doesn’t exclude the other, it is advisable to rely on both of them when valuating a company
Finance II 4 What does valuation mean? (2/2) ▪ The basic idea of valuation refers to Net Present Value (NPV) principle NPV Enterprise valuation Single investment Box of investments Required Rate of Return Weighted Average Cost of (RRR) Capital (WACC)
▪ In NPV analysis, money (cash flows) expected in the future need to be discounted at RRR in 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 more valuable than in the future”
Finance II 55 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
Finance II 66 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 of all the stakeholders in a company, while value creation is the change in value due to company performance
Principle of value creation
“Companies create value by investing capital they raise from investors to generate future cash flows at rates of return exceeding the cost of capital”
▪ The faster companies can increase revenues and deploy more capital at attractive rates of return, the more value they create
Finance II 77 What is value? (2/2)
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
Finance II 8 Take home messages
▪ We want to evaluate how much a company is worthy now based on expected future performance
▪ 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
Finance II 9 Core Valuation Techniques ▪ Multiples ▪ DCF Methodology ▪ Enterprise DCF Multiples (1/10)
▪ A multiple is a ratio between a measure of the (estimated) value of an asset and a specific item on the financial statements or a non-financial statistic
▪ Multiples analysis is about comparing a company’s multiples with those of similar companies → 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 multiple b) Use the right peer (benchmark) group
Finance II 11 Multiples (2/10)
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 operating profitability ▪ They focus on enterprise value, rather than share price ▪ They do not look at the company’s capital structure
Finance II 12 Multiples (3/10)
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 great uncertainty surrounding potential market size, profitability and required investments
▪ Nonfinancial multiples should be used only when they provide incremental explanatory power 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
Finance II 13 Multiples (4/10)
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
Finance II 14 Multiples (5/10)
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?
Finance II 15 Multiples: Ryanair case (6/10)
▪ Low fares airline from 1985
▪ 2,000 daily flights from 86 bases across Europe and North Africa, connecting over 215 airports 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 NASDAQ Stock Exchanges
▪ How can we estimate the value of Ryanair?
Finance II 16 Multiples: Ryanair case (7/10)
Alitalia Lufthansa Ryanair ▪ We choose market capitalization (unit stock price × total number of stocks) as an estimate of equity value
▪ Peer group: firms in the same market, Employees 12,428 123,287 10,926 Alitalia and Lufthansa Clients 22.1 109 106 ALITALIA LUFTHANSA Pilots 1,556 5,400 3,424 Clients/seats 76.20% 79.10% 93% Market Capitalization (€m) 0 10,757 ratio Source: bloomberg.com, September 2017 Employees cost 613 7,354 585 (€m) ▪ Alitalia is valued zero on the market, Revenues (€m) 3,312.40 31,660 6,500 so it is not a good base to compute EBIT (€m) -199.1 +1,776 +1,240 multiples Source: repubblica.it, April 2017
Finance II 17 Multiples: Ryanair case (8/10)
퐸퐿푢푓푡ℎ푎푛푠푎 Ryanair Equity × 푅푒푣푒푛푢푒푠푅푦푎푛푎𝑖푟 = 퐸푅푦푎푛푎𝑖푟 Lufthansa multiples 푅푒푣푒푛푢푒푠퐿푢푓푡ℎ푎푛푠푎 estimation (€m) 10,750 €푚 E/Revenues 0.34 2,207 × 6,500€푚 = 2,207 €푚 31,660 €푚 E/EBIT 6.05 7,506
0.34 E/Clients 98.62 10,454 Lufthansa E/Employee 0.09 953 multiple
Market capitalization of Ryanair 15,032 €m Source: bloomberg.com, September 2017 ▪ 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
Finance II 18 Multiples: Ryanair case (9/10)
퐸퐿푢푓푡ℎ푎푛푠푎 × 푅푒푣푒푛푢푒푠푅푦푎푛푎𝑖푟 = 퐸푅푦푎푛푎𝑖푟 푅푒푣푒푛푢푒푠퐿푢푓푡ℎ푎푛푠푎
푅푒푣푒푛푢푒푠푅푦푎푛푎𝑖푟 퐸푅푦푎푛푎𝑖푟 15,032 = = = 1.40 푅푒푣푒푛푢푒푠퐿푢푓푡ℎ푎푛푠푎 퐸퐿푢푓푡ℎ푎푛푠푎 10,757
푬푹풚풂풏풂풊풓 ALITALIA LUFTHANSA RYANAIR 푬푳풖풇풕풉풂풏풔풂
Market Capitalization 0 10.76 15.03 1.40 (€b)
▪ 1.40 is the ratio between the two market capitalization and so it represents also the target ratio between of the driver that best represents the market valuation. If the revenues were representative of the relationship which links the equity values of the two companies, the ratio would be 1.40.
Finance II 19 Multiples: Ryanair case (10/10)
RYANAIR/ RYANAIR LUFTHANSA LUFTHANSA RATIOS Employees 10,926 123,287 0.09 Clients (mln) 106 109 0.98 ▪ Pilots 3,424 5,400 0.63 Clients/Pilots ratio seams to be a Employees cost (mln) 585 7,354 0.08 good driver to estimate Ryanair Revenues (mln) 6,500 31,660 0.21 value from Lufthansa figures 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) / 11.10 4.31 2.58 Employees cost (€m) Source: repubblica.it, April 2017
Finance II 20 Take home messages
▪ 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
Finance II 21 DCF Methodology (1/10)
▪ Discounted Cash Flow (DCF) methodology relies on the forecasting and the actualization of 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 to Firm (FCFF) and Free Cash Flow to Equity (FCFE)
Finance II 22 DCF Methodology (2/10) 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 required to maintain or expand its asset base
▪ FCF in Discounted Cash Flow methodology has to be discounted, i.e. brought back into the present, at a constant discount rate
TIME NOW FCF FCF FCF FCF
Finance II 23 DCF Methodology (3/10)
▪ In this section we are going to show some examples of the main steps of the DCF Methodology and the comparison between different valuations
▪ To this purpose we will use the case of Home Depot, one of the world’s largest retailer of home improvement products (McKinsey). Data are taken from 2006 to 2008, forecasting starts from 2009
Finance II 24 DCF Methodology (4/10) Free Cash Flows to Firm (FCFFs) Free Cash Flows to Equity (FCFEs)
▪ Free Cash Flow to Firm are the cash ▪ Free Cash Flow to Equity are the cash flows flows available to all investors at the available to the shareholders at the 푘푒, the WACC, the weighted average capital cost of equity cost, meaning the blended cost for all investors ▪ FCFE is calculated as net income plus non cash expenses minus investments in working capital, ▪ FCFF is calculated as the cash flow fixed assets and nonoperating assets. Finally, generated by the company’s operations the variation in debt and other nonequity less any reinvestment back into the claims is added/subtracted business ▪ Alternatively, FCFE can be computed as ▪ Alternatively, FCFF can be computed as dividends plus share repurchases minus new gross cash flow minus gross investment equity issues. The two methods generate identical results
Finance II 25 DCF Methodology (5/10)
FCFFs calculation FCFEs calculation
Non-cash expenses
Fixed assets Nonoperating assets
Debt variation
Finance II 26 DCF Methodology (6/10) EV Enterprise DCF ▪ Use FCFFs discounted at Equity DCF weighted cost of capital (WACC) to estimate the E ▪ Estimate directly equity Value of the Operations value (VO): EQUITY ▪ Use FCFEs discounted at the cost of equity (푘푒) 퐹퐶퐹퐹 A VO = σ 푛 ASSETS (1+푊퐴퐶퐶)푛 퐹퐶퐹퐸푛 퐸 = 푛 D (1 + 푘푒) ▪ Estimate enterprise value DEBT (EV) = Value of the Operations (VO) + Non Operating assets ▪ 퐸 = 퐸푉 − 퐷
Finance II 27 DCF Methodology (7/10) Enterprise DCF Equity DCF
▪ Use of Free Cash Flow to Firm ▪ Use of Free Cash Flow to Equity
▪ Value of the operations (VO): sum of ▪ Value of Equity (E): sum of discounted FCFE discounted FCFF 퐹퐶퐹퐹푛 VO= σ 퐹퐶퐹퐸푛 (1+푊퐴퐶퐶)푛 퐸 = 푛 (1 + 푘푒) ▪ Add non operating-assets to obtain the Enterprise Value (EV)
▪ Finally obtain the value of Equity (E) by subtracting the value of Debt (D) and non-equity asset from the EV ▪ 퐸 = 퐸푉 − 퐷 Finance II 28 DCF Methodology (8/10)
Enterprise DCF Equity DCF
퐹퐶퐹퐹푛 퐹퐶퐹퐸푛 푛 푛 (1 + 푊퐴퐶퐶) (1 + 푘푒)
VALUE OF OPERATIONS EQUITY VALUE
VALUE OF VALUE OF NON-OP. ENTERPRISE OPERATIONS + = ASSETS VALUE
ENTERPRISE VALUE OF EQUITY VALUE - DEBT = VALUE
Finance II 29 DCF Methodology (9/10)
▪ 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:
EQUITY / NUM = VALUE PER VALUE SHARES SHARE
▪ Example: Home Depot’s value per share
Finance II 30 DCF Methodology: (10/10)
▪ So far, we presented the general features of DCF methodology with the main differences between Enterprise DCF and Equity DCF
▪ Although the Equity DCF seems to be easier because it goes directly to the Equity Value, it is a model that mixes together operating performance and capital structure in calculating the cash flows, easily leading to mistakes
▪ For this reason, equity cash flow valuation model is not used, except when valuing banks and other financial institutions, where capital structure is an inextricable part of operations
▪ From now on we go into deeper detail of the Enterprise DCF method
Finance II 31 Enterprise DCF: Principles of forecasting FCFFs (1/12) In order to discount the Free Cash Flows to Firm to the present date, we have to forecast them. Let’s focus on how the way we forecast FCFFs changes depending on the time span we consider.
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 by a different length and level of detail EXPLICIT FORECAST 10 → 15 years PERPETUITY FORMULA
TIME
Forecast line-by-line Focus on few important Constant rate of revenue growth with constant Complete data variables reinvesting in the business Usually 5 → 7 years
Finance II 32 Enterprise DCF: Principles of forecasting FCFFs (2/12) EXPLICIT FORECAST 10 → 15 years
1. Analyse historical financial results Understanding a company’s past is essential to forecast its future → robust analysis of historical performances. Look back as far as possible (at least 10 years) 2. Build the revenue forecast Revenue is usually the leading driver to the forecast so we need to do an accurate forecasting of 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 customers 3. Forecast the income statement Individual line items of the income statement are forecasted and so FCFFs for each year are obtained 4. Actualization of the FCFFs
Finance II 33 Enterprise DCF: Continuing Value (3/12)
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 less accurate
▪ At a certain point in time, the prediction becomes too far from the day of valuation’s perspective and so a perpetuity formula is needed
▪ The perpetuity formula gives the so called Continuing Value (CV) that is the value at time t 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
Finance II 34 Enterprise DCF: WACC (4/12) 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 one particular business instead of others with similar risk ▪ WACC is decomposed as follows: 퐷 퐸 푊퐴퐶퐶 = 푘 1 − 푇 + 푘 퐷 + 퐸 푑 푚 퐷 + 퐸 푒
▪ 푘푑 = Cost of debt, 푘푒 = Cost of equity
퐷 퐸 ▪ = Target level of debt to enterprise value using market-based values, = Target level 퐷+퐸 퐷+퐸 of equity to enterprise value using market-based values
▪ 푇푚 = Company’s marginal income tax rate Finance II 35 Enterprise DCF: WACC (5/12)
▪ RISK-FREE RATE (1) COST OF ▪ MARKET RISK PREMIUM 푘 EQUITY ▪ COMPANY SPECIFIC RISK 푒 ADJUSTMENT (beta)
(2) COST OF DEBT YIELD TO MATURITY + TAX WACC 푘 1 − 푇 AFTER TAX SHIELDS 푑 푚
▪ CURRENT CAPITAL (3) TARGET LEVELS STRUCTURE 퐷 DEBT AND EQUITY ▪ COMPARABLES COMPANIES 퐷 + 퐸 ▪ MANAGEMENT APPROACH
Finance II 36 Enterprise DCF: WACC (6/12) Cost of equity
퐷 퐸 푊퐴퐶퐶 = 푘 1 − 푇 + 푘 퐷 + 퐸 푑 푚 퐷 + 퐸 푒
▪ 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 stock market ▪ The expected rate of return of an equity security, taking into account the risk, is affected by three elements: risk free rate, factor beta and the market risk premium BETA
푘푒 ∼ 퐸 푅𝑖 = 푟푓 + ß𝑖 퐸 푅푚 − 푟푓 RISK FREE MARKET RISK RATE PREMIUM Finance II 37 Enterprise DCF: WACC (7/12)
RISK FREE RATE 푟푓
▪ The best approximation for the risk free rate is a high liquid, long term security government rate with the same currency as FCFF stream
▪ Each FCFF should be discounted using a government bond with the same maturity as the FCFF but usually only one single yield to maturity that best matches the entire FCFF stream is used (use government STRIPS for US and German Eurobond for UE companies)
Finance II 38 Enterprise DCF: WACC (8/12)
BETA ß𝑖
▪ ß is a factor standing for how much the enterprise’s stock market and the entire market move together
푅𝑖 = α + ß푅푚 + ε 푅𝑖= Stock return 푅푚=Market return
▪ In order to estimate company’s ß, perform a linear regression where ß is the slope of the obtained 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 푅𝑖 of the company is not available
Finance II 39 Enterprise DCF: WACC (9/12)
MARKET RISK PREMIUM 퐸 푅푚 − 푟푓
▪ It is the premium for holding equity rather than debt and it has been estimated to be around 4.5/5.5% (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 historical market risk premium
Finance II 40 Enterprise DCF: WACC (10/12)
After tax cost of debt
퐷 퐸 푊퐴퐶퐶 = 푘 1 − 푇 + 푘 퐷 + 퐸 푑 푚 퐷 + 퐸 푒
▪ For companies with an investment grade (BBB or better), the best estimation of the cost of debt is the yield to maturity of the company’s long-term option-free bonds, despite yield to maturity is the promised return and not the return itself
▪ In the following explanation we focus only on companies with an investment grade
Finance II 41 Enterprise DCF: WACC (11/12)
▪ Solve the following formula for yield to maturity (YTM)
퐶표푢푝표푛 퐶표푢푝표푛 퐹푎푐푒 + 퐶표푢푝표푛 푃푟𝑖푐푒 = + + ⋯ + 1 + 푌푇푀 1 + 푌푇푀 2 (1 + 푌푇푀)푁
▪ 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 must be used:
1) company’s credit rating on unsecured long-term debt 2) examine YTM on a similar portfolio of long-term bonds with the same rating
Finance II 42 Enterprise DCF: WACC (12/12) Capital structure
퐷 퐸 푊퐴퐶퐶 = 푘 1 − 푇 + 푘 퐷 + 퐸 푑 푚 퐷 + 퐸 푒
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
Finance II 43 Take home messages
▪ Assumption: stable debt-to-equity ratio ▪ We prefer to use Enterprise DCF as Equity DCF mixes operating performance with capital structure
Enterprise DCF Equity DCF
General approach EV → E=EV-D E
Free Cash Flow to Equity (FCFE)=net income + noncash Free Cash Flow to Firm (FCFF)=cash flow expenditures – investment in working capital – fixed Measure generated by company operations – assets – non operating expenses +/- variation in debt reinvestment back into the business and equity
Discount factor Weighted Cost of Capital (WACC) Cost of equity (푘푒) Discount factor 퐷 퐸 푊퐴퐶퐶 = 푘 1 − 푇 + 푘 푘 = 푟 + ß 퐸 푅 − 푟 calculation 푉 푑 푚 푉 푒 푒 푓 𝑖 푚 푓 퐹퐶퐹퐸 Actualization 퐹퐶퐹퐹푛 퐸 = 푛 VO = σ 푛 푛 formula (1+푊퐴퐶퐶) (1 + 푘푒)
Finance II 44 WhatsApp case ▪ Overview ▪ Why WhatsApp? ▪ WhatsApp valuation: Multiples ▪ WhatsApp valuation: Enterprise Discounted Cash Flow ▪ Additional comments Overview (1/3) 19$b LARGEST FACEBOOK ACQUISITION 19th FEBRUARY 2014
Finance II 46 Overview (2/3)
▪ Add-free mobile instant messaging application with the mission of allowing people to communicate without any barriers all over the world
▪ 19$ billion price-tag acquisition on the 19th February 2014 (more than Iceland GDP and one tenth of Facebook market value)
▪ Acquired by Facebook through a mixed acquisition, 4$ billion cash and about 184 millions shares 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 running its operations completely independently
Finance II 47 Overview (3/3)
▪ Facebook has acquired 72 companies
▪ WhatsApp is the largest Facebook acquisition, 20 times larger than Instagram acquisition
Acquisition date Company Business Value ($m) 2014 WhatsApp Mobile messaging 19,000 2014 Oculus VR Virtual reality technology 2,000 2012 Instagram Photo sharing 1,000 2014 LiveRail Publisher Monetization Platform 450 2012 Face.com Face recognition platform 100 2018 Redkix Team Messaging via E-Mail 100 2013 Atlas Solutions Atlas advertiser suite 100 2013 Parse Mobile app backends 85 2011 Snaptu Mobile app developer 70 2015 Pebbles Computer vision, augmented reality 60 Source: Wikipedia, September 2018
Finance II 48 Overview: why WhatsApp? (1/7)
▪ Apparent revenue source at the time of the acquisition: each user was charged 0.99$ for subscription
▪ According to Forbe’s estimation, WhatsApp annual revenue was about 20$ million in 2014 → not enough to justify 19$ billion price tag Why WhatsApp?
Finance II 49 Overview: why WhatsApp? (2/7) 1) USER SIZE AND USER GROWTH
▪ Facebook wanted to enhance its customers and market power level within the Global Internet 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 1.3 billion Facebook users. However only 556m are mobile active users
▪ Moreover, Facebook Messanger (Facebook chat service, similar to WhatsApp) had only 120 million monthly active users
2 1 3
Finance II 50 Overview: why WhatsApp? (3/7)
▪ What Facebook was particularly interested in was the extraordinary WhatsApp users growth
▪ Buying WhatsApp, Facebook may be able to benefit from this high diffusion rate exploiting new users worldwide
▪ WhatsApp grew much faster than Facebook did when Facebook was the same age!
Finance II 51 Overview: why WhatsApp? (4/7) 2) SYNERGIES
▪ Synergy is when the value of two combined entities is greater than the sum of the two separated companies
▪ Synergies may be related to revenue enhancement, cost reduction, capital tax gains or combining 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
Finance II 52 Overview: why WhatsApp? (5/7)
푠푦푛푒푟푔푦 = 푣푎푙푢푒푤+푓 − 푣푎푙푢푒푤 + 푣푎푙푢푒푓
풂풄풒풖풊풔풊풕풊풐풏 풑풓풊풄풆 = 풗풂풍풖풆풘 + 풂풄풒풖풊풔풊풕풊풐풏 풑풓풆풎풊풖풎
푊ℎ푎푡푠퐴푝푝 푔푎𝑖푛 = 푎푐푞푢𝑖푠𝑖푡𝑖표푛 푝푟푒푚𝑖푢푚 = 푎푐푞푢𝑖푠𝑖푡𝑖표푛 푝푟𝑖푐푒 − 푣푎푙푢푒푤 Acquisition premium>0 in order to have a positive gain for WhatsApp The larger the acquisition premium, the larger the gain for WhatsApp
퐹푎푐푒푏표표푘 푔푎𝑖푛 = 푠푦푛푒푟푔푦 − 푎푐푞푢𝑖푠𝑖푡𝑖표푛 푝푟푒푚𝑖푢푚 Acquisition 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
Finance II 53 Overview: why WhatsApp? (6/7)
▪ In order to determine the tag-price Facebook should pay for WhatsApp, it is both important 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 performance improves by more than the value of the premium over the target’s intrinsic value that Facebook had to offer for WhatsApp in order to persuade its shareholders to part with it
Finance II 54 Overview: why WhatsApp? (7/7) 3) NEW BUSINESS: Mobile Money Transfer
▪ Facebook looks for other ways of making money through WhatsApp, i.e. mobile money transfer
▪ WhatsApp as a channel for digital payments
▪ WhatsApp seems to be the right tool to be integrated with money transaction, more than Facebook, due to its efficiency and immediacy
▪ What about the opportunity to associate money to WhatsApp messages?
Finance II 55 WhatsApp valuation: Multiples (1/9) Multiples: Comparable companies
▪ Multiples analysis is about comparing a company’s multiples with those of similar companies → relative valuation tool
▪ Multiples can be both the starting point of a valuation and an auxiliary tool in checking DCF results
▪ Multiples have a short-term nature since they are based on historical data or short term forecasts 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 is known (companies trading on a stock exchange which values them in real-time)
Finance II 56 WhatsApp valuation: Multiples (2/9) ▪ 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 neglectable and Equity value is very close to Enterprise Value (푬 ≅ 푬푽)
▪ Let’s consider as multiples EV/Revenues (financial multiple) and EV/user (non financial multiple)
▪ 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 the company belongs to and try to give weight to the different factors influencing company’s enterprise value
▪ Benchmark group: main companies belonging to Global Internet Media Industry
Finance II 57 WhatsApp valuation: Multiples (3/9)
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 Source: Wikipedia, September 2017
Finance II 58 WhatsApp valuation: Multiples (4/9) EV/Revenues
EV/Revenues = 12.97 WhatsApp revenue at the time of the acquisition = 20$m WhatsApp enterprise value = 20$m x 12.97 = 0.26$b << 19$b
▪ Knowing that WhatsApp was acquired for 19$b, EV/Revenues suggests that WhatsApp was overvalued
▪ Are the value of the synergies enough to justify a 19$b price-tag? Remember that 푎푐푞푢𝑖푠𝑖푡𝑖표푛 푝푟𝑖푐푒 = 푣푎푙푢푒푤 + 푎푐푞푢𝑖푠𝑖푡𝑖표푛 푝푟푒푚𝑖푢푚
▪ As a buyer you would like to pick this multiple for valuation since you are interested in multiples which give you the lowest valuation
Finance II 59 WhatsApp valuation: Multiples (5/9)
EV/Users
EV/Users = 150.50 WhatsApp users at the time of acquisition = 450 million WhatsApp enterprise value = 450 million x 150.50 = 67.7$b >> 19$b
▪ Knowing that WhatsApp was acquired for 19$b, EV/Users suggests that WhatsApp was undervalued
▪ As a seller you would like to pick this multiple for valuation since you are interested in multiples which give you maximum valuation
Finance II 60 WhatsApp valuation: Multiples (6/9) Multiples: Comparable transactions
▪ Based on comparing similar companies transactions
▪ Now we compare acquisition prices through multiples
▪ We look for acquisitions made by the same acquirer, Facebook
▪ We choose as a comparable transaction the acquisition of Instagram by Facebook in 2012
▪ Acquired companies are both mobile applications and they share some similar functionalities
Finance II 61 WhatsApp valuation: Multiples (7/9) ▪ Let’s use as a multiple Acquisition price/User
Monthly users at Acquisition price ($m) Acquisition price/user acquisition (m) Instagram 1,000 30 33.33 Source: Wikipedia, September 2018 ▪ 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$b, WhatsApp multiple should have been 42.22
Finance II 62 WhatsApp valuation: Multiples (8/9) ▪ In order to reach a more accurate evaluation, it is preferable to rely to more comparable transactions → we stay with the same multiple Acquisition price/user while we expand the benchmark group
▪ Benchmark group: Companies with similar business and financial model being acquired
Users at acquisition Acquisition Year Acquirer Acquisition price ($m) ($m) price/user Instagram 2012 Facebook 1.0 30 33.33 Tumbrl 2013 Yahoo 1.1 40 27.50 Snapchat (offer) 2013 Facebook 2.5 27.5 90.91 Average 50.58 Source: Wikipedia, September 2017
Finance II 63 WhatsApp valuation: Multiples (9/9) ▪ Computing the mean among the benchmark group, the multiple is higher than the previous case in which only Instagram acquisition was considered
▪ WhatsApp monthly active users at acquisition were 450 million
▪ WhatsApp acquisition price = 450 million x 50.58 = 22.76$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 to have been a little undervalued
▪ Comparing similar transactions seams to lead to estimations closer to the effective price-tag than comparing similar companies
Finance II 64 WhatsApp valuation: Enterprise DCF (1/9)
▪ 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 identifiable incremental debt, the company is mostly financed by equity
▪ Enterprise DCF methodology is adopted → direct calculation of enterprise value by discounting Free Cash Flows to Firm (FCFF) at the weighted cost of capital (WACC)
Finance II 65 WhatsApp valuation: Enterprise DCF (2/9) 1) WACC estimation
▪ A good estimation of WACC is trivial since the actualization formula is very sensitive to its parameters
▪ A too low discount rate may lead to an overvaluation in the value of the company while a too high discount rate is the other way round
퐷 퐸 푊퐴퐶퐶 = 푘 1 − 푇 + 푘 푊퐴퐶퐶 = 푘 푉 푑 푚 푉 푒 푒
▪ Since the WhatsApp is almost totally financed by equity investors we use as discounted factor the cost of equity
Finance II 66 WhatsApp valuation: Enterprise DCF (3/9)
▪ In order to estimate the cost of equity Capital Asset Pricing Model (CAPM) is used, based on the following formula: 푘푒 = 푟푓 + ß𝑖 퐸 푅푚 − 푟푓
▪ Risk free rate 푟푓 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 → 푟푓 = 2.74%
▪ Market return 퐸 푅푚 can be also found on Bloomberg Market data searching for February 2014 → 퐸 푅푚 = 10.17%
Finance II 67 WhatsApp valuation: Enterprise DCF (4/9)
RISK FREE RATE
(rf)
Source: bloomberg.com, September 2017 Finance II 68 WhatsApp valuation: Enterprise DCF (5/9)
▪ 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 and belonging to the same industry
▪ Compute an arithmetic average among the selected companies → ß𝑖 = 0.94 → WhatsApp stock market and the entire market have similar behaviour
▪ WACC= 푘푒 = 2.74%+0.94(10.17%-2.74%) = 9.72%
Finance II 69 WhatsApp valuation: Enterprise DCF (6/9) 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 user base expansion. Each expected FCFF is discounted to the present.
▪ From the eleventh year, g is assumed to be constant at the 5% value → perpetuity formula can be applied and continuing value (CV) at t=10 is obtained, which is in turn discounted to the present
▪ According to experts forecast, WhatsApp is going to experience a very fast growing expansion in the next ten years due to geographic spread in those under developed countries which are gaining internet access in the next few years, while in the long-term the growth is expected to stabilize
Finance II 70 WhatsApp valuation: Enterprise DCF (7/9)
Assumptions: Users continue to pay annual 0.99$ fee As 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 the explicit period the terminal value calculation is performed
퐹퐶퐹퐹 퐹퐶퐹퐹 1 ▪ Value of oper푎푡𝑖표푛푠 = σ10 푛 + 10 × 푛=1 (1+푊퐴퐶퐶)푛 푊퐴퐶퐶−푔 (1+푊퐴퐶퐶)10 DISCOUNTED DISCOUNTED CONTINUING FCFF VALUE ▪ Non operating assets and liabilities are not considered since they are assumed to be a neglectable percentage of the enterprise value
Finance II 71 WhatsApp valuation: Enterprise DCF (8/9)
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
Finance II 72 WhatsApp valuation: Enterprise DCF (9/9) ▪ 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
Finance II 73 Additional comments (1/4) Financing the deal
▪ An acquisition can be performed through three different types of payment: all-cash acquisition, all-stock acquisition or both of them
Finance II 74 Additional comments (2/4) ▪ 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 is overpriced by the takeover firm, the overprice is easier to hide for the latter if it is paid basically by stocks
▪ By paying almost in stocks, Facebook allowed WhatsApp to avoid capital tax gains and to share future gains, so that target shareholders can participate in future stock’s price appreciation
Finance II 75 Additional comments (3/4) What about now…
▪ Most popular messaging apps worldwide as in January 2017, based on number of monthly active users (m)
Source: Statista.com, September 2017 Finance II 76 Additional comments (4/4) Possible concerns
▪ Competition leads a company to continue improvement efforts and to strive for continuously innovate itself in order to differentiate from its competitors
▪ Facebook bought its main competitor and there are no any other app able to offer the same 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) → Is WhatsApp paving the way for monetization?
Finance II 77 Equity Crowdfunding WeAreStarting case study ▪ WeAreStarting – Equity Crowdfunding based platform ▪ 5 methods to value a startup WeAreStarting – Equity Crowdfunding
▪ 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
Finance II 79 1 - The Scorecard method
▪ 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
Finance II 80 1 - The Scorecard method ▪ 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
Finance II 81 2 - The Checklist method
▪ 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
Finance II 82 3 - The DCF method with Multiples
▪ 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
Finance II 83 3 - The DCF method with Multiples
VALUATION = PRESENT VALUE + TERMINAL VALUE
퐶푎푠ℎ 푓푙표푤 PRESENT VALUE = σ푛 푡 1 (1+푑𝑖푠푐표푢푛푡푒푑 푟푎푡푒)푡
퐸퐵퐼푇퐷퐴 ×퐸퐵퐼푇퐷퐴 푚푢푙푡𝑖푝푙푒 TERMINAL VALUE= 푛 (1+푑𝑖푠푐표푢푛푡푒푑 푟푎푡푒)푛
Finance II 84 4 - The DCF method with Long-Term Growth
▪ 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:
(1+푔푟표푤푡ℎ 푟푎푡푒) TERMINAL VALUE= 퐶푎푠ℎ 푓푙표푤 × 푛 (푑𝑖푠푐표푢푛푡 푟푎푡푒 −푔푟표푤푡ℎ 푟푎푡푒)
▪ 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
Finance II 85 5 - The VC method
▪ 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
Finance II 86 5 - The VC method
ROI = TERMINAL VALUE ÷ POST MONEY VALUATION
POST MONEY VALUATION = TERMINAL VALUE ÷ ROI
PRE MONEY VALUATION = POST MONEY VALUATION - INVESTMENT
Finance II 87 References
Introduction Core 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/
Finance II 88 Thank you! Any questions?
Alice Rossi [email protected]