Thursday, September 29, 2016

The Case for Twitter: Private Equity et. al or Apple can do

Recent reports on a Twitter (NYSE:TWTR) sale skim through the facts and misinterpret suitors . Why No one should buy Twitter (@Slate).

Twitter is a unique media property with loyal users. The user base of Twitter is organic, limited. (very different than the Facebook platform). As far as demographics go, Twitter users have more buying power than FB users have by and large.

I've done a back of the envelope LBO model where a private sponsor "PE" buyout of Twitter at a $28 Bn price today (a 21.7% premium) where Twitter though COGS and SG&A synergies. Twitter turns profitable in my Year 3 with a $32.56 MM EBITDA (Assumptions: equity contibution: 30%, blended interest cost: 30%, enterprise multiple, 7.8). More on that later1.

As a strategic tech buyer for Twitter, a see Apple doing wonderfully owning a unique news platform. Twitter’s board hired Goldman Sachs(NYSE:GS) and Allen & Co. LLP to explore strategic options. Are major suitors getting into a bidding war for TWTR ?

Monday, September 19, 2016

Venture Capital valuation methods: the basics

There's been some talk about Andreessen Horowitz returns lagging other prominent venture capitalists such as Sequoia, Benchmark and Founders Club.

In response, Scott Kupor of A16Z published a rebuttal outlining valuation methods used in the industry. Kupor differentiates between the "marks" (quarterly snapshot of realized and unrealized gains ) from the actual cash and stock distibutions (which constitute the returns). Generally speaking, VCs require companies to get an independent 409A FMV valuation. A 409(A) Primer is available at Axiom Valuation. Accordingly the methods used to value investments are:

  1. Last Round Valuation Waterfall.
  2. Comparable Company Analysis. For example, if a portfolio company is generating $100 million of revenue and its “comparable” set of companies are valued in the public markets at 5x revenue, a venture firm would then value the company at $500 million ($100 million*5x) ". A  firm will then also apply what’s known as a DLOM (a discount for lack of marketability) to reduce the carrying value of the company described as often 20-30%.
  3. Option Pricing Model. OPM uses Black-Scholes to value a portfolio company as a set of “call options  whose strike prices are the different valuation points at which employee options and preferred shares all convert into common stock." Kupor points out Black-Scholes is the method his firm widely uses. If a firm has raised Series C at $5.00/share, OPM using Black-Scholes will assign a value to the Series A and B that is a substantial discount to the $5 per share price assigned to the Series C. Adding those up gives the company value. " (Kupor).  The strike price of an option here corresponds to the other(s) equity values reached (but it could have been the liquidation preferences on each preferred series). Calculate the incremental value of each option based on the option's strike prices. Of course the common class participation percentage would be multiplied by the incremental value of the call options, them sum them all up.

Thursday, September 15, 2016

Private Equity Funds Returns: The Basics

PE use borrowed funds to buy companies, so typically these investments are riskier than the public markets and are mostly illiquid.

Private equity cash flows are typically described by the “J-Curve ”, with investments generally being made in years 1-5 (negative returns) and realizations generally occurring in years 4-11 (positive). The years when a partnership is closing to new investors are called vintage years.

But what about returns from PE investments? The returns are the excess IRRs or alphas.

Alpha is the increment to market rate that equates the out-of-pocket cost of the investment to the Present Value of its gross return. Studies have shown that PE excess IRRs are between 5-8%, even (and more particularly so) in a down economy.

Excess returns are calculated after correction for the leverage effect.

0=Sum CFi (1+r)^-i,

The IRR is the return (discount rate) that will equalize the present value of all invested capital with the present value of all returns, or where the net present value of all cash flows (positive and negative) is zero; CFi is the cash flow for period i (negative for takedowns, positive for distributions).

The targeted IRRs may hover around 25%, which can be a decent investment.

• Cumulative IRR
• Cumulative Realization Multiples (DPI and RVPI, and their Sum)
• Time Weighted Return
• Investment Horizon Return
• Public Market Comparables – Index method
• DPI = Distributions / Paid-In Ratio, a.k.a. realized multiple
• RVPI = Residual Value / Paid-In Ratio, a.k.a. unrealized multiple

More on Alphas at Morgan Stanley, PE K@Wharton

What makes for an attractive investment (in general)?

Tuesday, September 6, 2016

Tech Unicorns: More like Rhinos [The ugly truth about Billion Dollar Private Companies]

For the first time this summer in Silicon Valley and beyond I've seen people looking hard at what I call "the ugly rhino truth" of tech industry's superstars, the $1 Bn+ "unicorn" companies and even the "decacorns"($10 Bn+).

The academic world took the lead at it

Those hyper valuations appear more hype than science, in fact as Professor Ilya Strebulaev of Stanford Graduate School remarked at SVOD, fair market values may be 33 to 70% lower than the advertised (purported) post money valuation unicorns love to taut.

The San Francisco Chronicle already in May 2015 first wrote about those +1Bn valued companies, citing a Fenwick & West study:

  • in May 2015, 35% of the companies Fenwick &West analyzed had valuations in the $1-1.1 billion dollar range,
  • in the 4th quarter of 2015, 50% of the unicorns were in $1-1.1 Bn range
  • , indicating that the companies may have negotiated specifically to attain the unicorn level.

It's Barbarians at the Gates with these rhinos.

That study also found investors were given 100% protection for subsequent down rounds if acquired, while only 30%  were protected for post-IPO down rounds. Thus it can be reasonably inferred the unicorns were lowering investors protections for going public scenarios, knowing they could easily go public at lower valuations, given their unrealistic valuations.

The Magic of the Unicorn