Anomalies While Valuing Technology Firms Using Traditional Models

8/14/2019 Anomalies While Valuing Technology Firms Using Traditional Models

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About Sify

Established in 1998

First ISP in India with a subscriber base of 0.1mn in 30 cities.

Portals:

satyamonline.com

Walletwatch.com Carnaticmusic.com

Carstreet.com

Approx 13 mn page views per month


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About India World

Established in 1994 Provided web based solution Major portals:

Samachar.com

Khel.com Dhan.com Bawarchi.com Khoj.com

Approx 13 mn page views per month

Earning profits consistently for three years For FY 1998-99 :

Revenues:Rs.13 mn PAT: Rs.2.7 mn


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The Acquisition

In Nov 99 Sify announced acquisition of IndiaWorld

Per share value of Rs.24950 paid.

All cash two phase acquisition valuing Rs.4.99 bn 24.5% stake in IndiaWorld for Rs 1.22 billion during the

time of announcement of the deal an option of purchasing the remaining 75.5% stake at Rs.

3.25 billion in cash before September 30, 2000 by payinga premium of Rs 513 mn

Second phase later modified to cash + stock deal

with Rs.2.15bn in cash


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Acquisition Synergies

Large overseas Indian customer base of

IndiaWorld

Big Brand Name & Visibility Highly popular web sites

Providing total internet solutions


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Cont..

Lack of information regarding firm of

similar size for comparable valuation

technique to be utilised by analyst .


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Analysis of Price paid and synergies

The price paid was a P/E multiple of 8237 times

which was very high for a technology firm

The company had to grow at 11.97% till

perpetuity at 12.5 % WACC to justify the pricewhich is highly unrealistic .

The sensitivity analysis suggests that the

company needs to grow 31% annually to cover

the WACC of 31.5% to justify the amount paid .


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P/E Ratio Analysis

The price earnings ratio is not applicable forthe years 2000-01 and 2001-02 particularlyon account of the fact that Indiaworld has

had negative earnings during those twoyears.

The price to sales ratio of Sify has shown adramatic decline in the next two years

indicating that the firms price to sales ratiowas inadequate.


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Strategic fit

Sify had made forays into the domestic

market and was catering to Indian clients.

India world was on the other hand catering

to a variety of foreign clients .

However, its expectations have been

belied particularly on account of the fact

that India World has sustained hugelosses in 200-01 and 2001-02


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Cont..

The revenues of the firm has increases by 100%

in 2001 but has been accompanied by a 100%

rise in cost of service

The company has suffered huge increase in costof service, operating and general expenses and

marketing and promotion expenses

The revenues have risen due to marketing efforts

and not on account of expected synergies


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Dupont Analysis:

The Dupont analysis conducted shows that in

the year of acquisition the company had ROE

of 47% which may have caused the investment

bankers to value a high price of the company Sifys nearly threefold increase in operating,

Administrative , personnel and marketing

expense coupled with no synergies has resulted

in the company suffering huge losses


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Page view multiplier model:

At the acquisition price the market value per

page view is a 31.99 for India world much

higher than Sifys 14.23 .

Revenue per page view is pretty low at 0.15which indicates that there is a pretty low

conversion rate in terms of revenue

A high market value per page view with lowrevenue per page view creates anomalies in

the valuation process.


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Cont..

Valuation of the Price/ Revenue multiples hasbeen done considering three scenarios:

Scenario 1: This considers the market value ofSify as proxy for market value of Indiaworld.This is highly unrealistic on account of the factthey are not comparable companies in terms ofrevenue, asset base or otherwise.

Scenario 2: Using the preacquisition price asproxy price for India world.


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Cont..

Scenario 3: Using the book value of equity as proxy for

the market value.

The price revenue multiple varies from 3.3 to 202 to.25for scenario 1, 2 and 3 respectively. Moreover if Sify

price is used as a proxy for the price of India world, the

valuation of the company is at 83.03 million which is

much lower than the 4.99 billion paid


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Some points to note Uncertainty brings with it its own set of problems

Valuation of companies with volatile and negativeearning s need to be done cautiously

Too high a price should never be paid forcompanies not having a high asset base or a

proven track record Market might over hype value and sales but is

ultimately a great leveler as was witnessed in thedotcom crash that followed.

It is not prudent to acquire firms during bubble andmarket abnormal returns might not always be agood indicator of performance.


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Sify ADS Analysis

Revenue per share for Sify post merger showsthat it has increased at an average growth rateof 20% which is pretty low. The growth rate willhave to be much higher if the high price is to

justify itself.

price by revenue multiple has fallen downsubstantially from 2536.38 in March 2000 to23.11 in September 2002. The fall has been onaccount of decline in prices of the shares (ADS).

Prices of shares have dropped from 210.52 to4.28 in the same period.


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Cont Price paid prior to the dotcom burst was

unreasonable and irrationally higher for the two

companies

The earnings that were estimated post merger for

Sify and Indiaworld was too high. The price revenue ratio has come down from the

dizzying heights as the stocks of Sify post

acquisition of Indiaworld has failed to delver .

The average fall in price per quarter over the last 3years has been 7%.


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Valuing non-dotcom firms

Traditional methods:

DCF

EVA

Comparable Firms

Multiplier Method

Based on historical and current earnings

and other tangibles


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Limitations

Tangible physical assets include web

servers, some equipment and office space

Lack of sufficient historical data to project

future cash flows

Very few comparable firms

No well defined profitable revenue Negative earnings sometimes prevents

forecasting


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Valuation Factors for dotcoms

Internet traffic

Market size

Features of web site Competition

Replicability


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Valuation Models for Dotcoms

Valuation using page views as a multiplier

Valuation based on quantifying qualitative

factors

Modified DCF Model McKinsey & Co.

Damodarans Model

EVA Model Other Models

V l ti i i


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Valuation using page views as a

multiplier

Parameters needed to measure the price per page view of adotcom viewer- Market Capitalization Value

- Page Views

- Revenues Earned

- Calculate Market Cap- Determine avg daily page view

- Calculate Market value per daily page view

- Identify revenues per year

- Calculate revenues per page view

- Calculate price/revenue in terms of page view

Val ation based on q antif ing


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Valuation based on quantifying

qualitative factors

Three basic factors for valuation are

- Management

- Market Segment- Manner in which funds are invested


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Modified DCF Model McKinsey & Co.

Three changes made to traditional model:

Determine the state of the industry and company in future

when it had achieved a sustainable and moderate growth

rate

Work backward and estimate the current performance

Future financials predicted for a range of scenarios

D d M d l


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Damodarans Model

Based on cash flow generated by a firm

Two stage growth high growth period followedby stable growth

Parameter required

- Growth rate in revenues

- Length of high growth period- Capex, depreciation, and working capital during

high growth period

-Expected growth rate during stable period- Cost of capital

- Beta of comparable firms to be used


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EVA As A Valuation Tool

EVA Valuation is extension of the DCF valuationapproaches

The total value (debt + equity) of business could beexpressed in EVA terms :

V = (Total Invested Capital)t0 + ((EVAt) /(1+Kwacc)t)

Total Invested Capital = Current Cumulative Level ofInvested Capital

EVA = (Adjusted NOPAT) (Capital Charge)

Capital Charges = (Periodic Invested Capital) *Kwacc


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Other Valuation Models for Dotcom Cos

Value per Customer : The value of eachcustomer to the firm is:

VX = Summation (CFX/ (1+r) ^t)

where : CFX - cash flows generated per year

R - discount rate which can range from theriskless rate, if the customer has signed contracts

for n years to remain as subscriber or WACC.

T No.of years


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Cont..

Value of the firm = VX*NX

where : VX Value per customer

NX Number of Customers

If the firm decides to add the subscribers at a growth

rate, then there will be a cost of advertising and

promotion C for each period . Then the value of firm

will be =

(NX*VX) + Summation (NX (VX-C)/ (1+k))


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Cont.

Value per subscriber: For firms which rely onsubscribers for their revenue, the value of thefirm can be determined for comparable firms as

(Market value of Debt + Market value ofequity)/Number of subscriber.

This multiple of comparable firms could be usedto calculate the market value of the concerneddotcom.


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Cont

Value per customer: Firms which rely on retailcan determine value per customer ofcomparable firms as:

(Market value of Debt + Market value ofequity)/Number of customers

This multiple of comparable firms can be usedto determine the market value of theconcerned dotcom.


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Cont

Value per site visitor: Such can be calculated

as:

(Market value of Debt + Market value ofequity)/Number of visitors to the site

This ratio could be used to value the company


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Optimum Valuation Method

no single method is adequate to valuedotcom company particularly one which hasno proven track record and facing an

uncertain future

Each and every method has its own pitfallswhether DCF, comparable methodology or

specific sectoral multiples. The most idealmethod to value a dotcom is a combination ofeach of these methods


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Cont.

Assumption: the stock market is efficient ie. all

factors relevant to a stock are incorporated in the

stock price

The stock market valuation is used as Y for this

purpose: All other relevant methods including, the

DCF, EVA, comparative methodology and sector

specific multiples are considered to beindependent variables


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Cont.

Using these, for a set of similar companies in theindustry Discriminant analysis is run to obtainthe weights for each of the independentvariables

The weights obtained from analysis are thenused for the valuation done by different methods

for the concerned dotcom and the final value ofthe stock is determined.


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Thank You

Documents

Anomalies While Valuing Technology Firms Using Traditional Models