Thursday, 24 May 2012

Is the IPO Window Open... and Why Does it Matter?

I have spoken before about IPO windows; when they are open, an IPO is possible and when they are closed it is not.  We have seen a number of high-profile digital media IPOs over the last year including LinkedIn, Groupon, Zynga and Facebook.  While most of these issues “popped” on their opening day, Facebook notably did not.  LinkedIn was up 109% on its first day; Facebook closed pretty much even.

Of the seven well publicised IPOs listed above, only two were trading above their IPO price as of May 22, 2012.  It is interesting to note that the richest IPO (as measured by the highest multiple of LTM revenues), actually performed the best and more than 100% revenue growth has now pushed this multiple down from over 30 at the IPO to 17 as at May 22 (still very high).
An open IPO window is a symbol of general health in the financing markets.  IPO’s return cash to VCs who then continue to invest in private companies, and they provide the now public companies with cash and a currency for acquisitions.
It should be pointed out though that the window is not open for all companies.  There are many sectors that have a tough time raising capital right now including base metal companies, solar companies and smaller companies in general.  The IPO window often shuts quickly as a result of a disastrous event or as bubbles collapse (mortgage crisis in 2008, twin tower attacks and Greece leaving the EU may do it this time).
With Facebook not outperforming on its opening day, the S&P500 down over 8% since early April and the EU not taking any concrete action on its Greece and Spain challenges, is the IPO window still open?  I would have to yes, but not very far.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Thursday, 3 May 2012

Is Instagram Worth 1 Billion… only to Facebook

I ended my last post with the comment “at Facebook's estimated $100 billion valuation, there is a lot of room to pay a lot of money.”  What this speaks to is the notion of accretive acquisitions.   Companies want their acquisitions to be accretive because of a somewhat flawed notion that if you buy a company at a lower multiple of earnings than your own, then the valuation of the acquirer will get a lift as the combined earnings continue to benefit from the acquirer’s multiple (it is flawed because this ignores the impact of the target’s risk profile).
As a quick example: if the acquirer trades at 20 times net income of $10M (i.e. an enterprise value of $200M) and the target is purchased at 10 times net income of $1M (a price of $10M), then the combined enterprise generates $11 million (excluding possible cost savings from the combination) and, with the same multiple of 20, the enterprise value is now $220M. 
Most acquisitions are accretive, however in the case of Instagram, whether it was profitable or not probably wouldn’t have had much impact.  The metric that is driving Facebook’s valuation right now is not net income but user base and user growth, and on this front, Instagram generated over 30 million users in its first two years of operations.  Facebook has more than 800 million daily active users and it is worth approximately $100 billion, so approximately $125 per user. When you apply this metric to Instagram (30M times $125), then Instagram would be worth $3.75 billion.
I noted in my last post that reasons for Facebook wanting to acquire Instagram could include: to improve its mobile revenues (of which it had none), to eat Twitter’s lunch, to eliminate a potential future competitor, and basically to maintain its growth and market value momentum.  Now you can see the last point is well validated. This example illustrates the “value-to-the-buyer” which is not the amount buyers want to pay unless they are forced to in a competitive bidding environment.  In the end no other company had the room in the value-to-the-buyer to compete with Facebook.
To conclude, the typical valuation metric is a multiple of net income or free cashflow but in some cases it can be revenues or market penetration or subscriber growth.  In any case, most acquisitions are accretive with respect to the relevant valuation metric and in all cases the price is less than the value to the buyer.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.