Valuation Entrepreneurial Finance: Alice Rossi Finance II 2018/2019 Prof. Silvio Vismara - UniBg

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
 Source: repubblica.it, April 2017
 multiples

Finance II 17

Multiples: Ryanair case (8/10)
 ℎ Ryanair Equity
 × = Lufthansa multiples
 ℎ estimation (€m)
 10,750 € E/Revenues 0.34 2,207
 × 6,500€ = 2,207 € 
 31,660 € 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)
 ℎ 
 × = 
 ℎ 

 15,032
 = = = 1.40
 ℎ ℎ 10,757

 ALITALIA LUFTHANSA RYANAIR
 
 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 , 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)

 Enterprise DCF
 EV
 ▪ Use FCFFs discounted at Equity DCF
 weighted cost of capital
 (WACC) to estimate the
 Value of the Operations
 E ▪ Estimate directly equity
 value
 (VO): EQUITY ▪ Use FCFEs discounted at the

 σ
 
 A cost of equity ( )
 VO = ASSETS
 
 (1+ ) 

 ▪ Estimate enterprise value
 D
 DEBT
 =෍
 (1 + ) 

 (EV) = Value of the
 Operations (VO) + Non
 Operating assets
 ▪ = − 

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
 
 VO= σ 
 (1+ ) =෍
 (1 + ) 
 ▪ 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
 ▪ = − 
Finance II 28

DCF Methodology (8/10)
 Enterprise DCF Equity DCF
 
 ෍ ෍
 (1 + ) (1 + ) 

 VALUE OF
 OPERATIONS
 EQUITY
 VALUE

 VALUE OF
 VALUE OF ENTERPRISE
 OPERATIONS + NON-OP. = VALUE
 ASSETS
 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:
 
 = 1 − + 
 + + 

 ▪ = Cost of debt, = Cost of equity

 ▪ = Target level of debt to enterprise value using market-based values, = Target level
 + + 
 of equity to enterprise value using market-based values

 ▪ = Company’s marginal income tax rate
Finance II 35

Enterprise DCF: WACC (5/12)

 ▪ RISK-FREE RATE
 (1) COST OF ▪ MARKET RISK PREMIUM
 ▪ COMPANY SPECIFIC RISK 
 EQUITY
 ADJUSTMENT (beta)

 (2) COST OF DEBT YIELD TO MATURITY + TAX
 WACC SHIELDS 1 − 
 AFTER TAX

 ▪ CURRENT CAPITAL
 (3) TARGET LEVELS STRUCTURE 
 DEBT AND EQUITY ▪ COMPARABLES
 COMPANIES + 
 ▪ MANAGEMENT APPROACH

Finance II 36

Enterprise DCF: WACC (6/12)
 Cost of equity

 = 1 − + 
 + + 

 ▪ 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
 ∼ = + ß − 
 RISK FREE MARKET RISK
 RATE PREMIUM
Finance II 37

Enterprise DCF: WACC (7/12)

 RISK FREE RATE 

 ▪ 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 ß 

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

 = α + ß + ε
 = Stock return
 =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 of the company is not available

Finance II 39

Enterprise DCF: WACC (9/12)

 MARKET RISK PREMIUM − 

 ▪ 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

 = 1 − + 
 + + 

 ▪ 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)

 + 
 = + 2
 +⋯+
 1 + 1 + (1 + ) 

 ▪ 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

 = 1 − + 
 + + 

 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 ( )
 Discount factor 
 = 1 − + = + ß − 
 calculation 
 Actualization 
 VO = σ =෍
 formula (1+ ) (1 + ) 

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
 19 FEBRUARY 2014
 th

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)

 = + − + 

 = + 

 ℎ = = − 
 Acquisition premium>0 in order to have a positive gain for WhatsApp
 The larger the acquisition premium, the larger the gain for WhatsApp

 = − 
 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 ( ≅ )

 ▪ 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

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

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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
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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

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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

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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

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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)

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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

 = 1 − + = 
 
 ▪ Since the WhatsApp is almost totally financed by equity investors we use as discounted
 factor the cost of equity

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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:
 = + ß − 

 ▪ Risk free rate 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 →
 = 2.74%

 ▪ Market return can be also found on Bloomberg Market data searching for February
 2014 → = 10.17%

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WhatsApp valuation: Enterprise DCF (4/9)

 RISK FREE RATE
 (rf)

 Source: bloomberg.com, September 2017

Finance II 68

WhatsApp valuation: Enterprise DCF (5/9)

 ▪ ß 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 → ß = 0.94 → WhatsApp
 stock market and the entire market have similar behaviour

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

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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

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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

 10 1
 ▪ Value of oper = σ10
 =1 + ×
 (1+ ) − (1+ )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

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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

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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

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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

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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

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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

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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?

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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

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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

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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

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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

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3 - The DCF method with Multiples

 VALUATION = PRESENT VALUE + TERMINAL VALUE

 ℎ 
 PRESENT VALUE = σ1
 (1+ ) 

 × 
 TERMINAL VALUE=
 (1+ ) 

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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+ ℎ )
 TERMINAL VALUE= ℎ ×
 ( − ℎ )

 ▪ 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

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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

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5 - The VC method

 ROI = TERMINAL VALUE ÷ POST MONEY VALUATION

 POST MONEY VALUATION = TERMINAL VALUE ÷ ROI

 PRE MONEY VALUATION = POST MONEY VALUATION - INVESTMENT

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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
alice.rossi@unibg.it