Pricing the IPO; Rosetta Stone

Basics

• Proprietary computer assisted language learning software whose name derives from stone inscribed with multiple languages and was the key to deciphering ancient Egyptian hieroglyphics

• Uses a combination of images, text, and sound to teach vocabulary terms and grammatical functions to users

• Currently offers 31 languages to customers in more than 150 countries

Brief History

• 1992- Harrisonburg Technologies is formed and Rosetta Stone product is released shortly after

• 2002- Tom Adams is hired as CEO• 2006- Harrisonburg Technologies is sold to ABS

Capital Partners and Norwest Equity Partners and renamed ‘Rosetta Stone’

• 2009- Rosetta Stone is the most recognized language learning software brand in the world

Going Public

• Why now?– Strong demand for shares

• Market Conditions?– 20% market rally in recent weeks

• Competitors going public?– Changyou.com– Bridgeport Education

Pricing Component

Competitors Beta MVE MVD weight d weight eK12 Inc $441.27 13.7 3.01% 96.99%New Oriental Ed &Tech Group 1.2 $7,508.73 0 0.00% 100.00%Other for profit education (median) 0.6 $71.64 1.7 2.32% 97.68%Activision Blizzard Inc. $13,630.77 0 0.00% 100.00%Electronic Arts Inc 0.9 $6,169.52 0 0.00% 100.00%Amazon 1.1 $32,050.59 74 0.23% 99.77%Google 0.9 $119,637.38 0 0.00% 100.00%Yahoo 1 $19,534.77 0 0.00% 100.00%Microsoft 0.8 $167,417.53 0 0.00% 100.00%

Discount Rate Factors

• Risk Free Rate – 3.15%– Simple average of recent 30 year US Treasuries– Less .5% for term premium on securities

• Market Risk Premium – 6.5%• Cost of debt – 7.5%

– Firm estimate

Valuation

• AssumptionsShares Offered: 6,250,000

Total Shares Post Offering: 20,314,500

Tax rate 38.00%Market Risk Premium 6.50%

Risk-Free Rate 3.1500%Inflation Rate 2.5000%

Unlevered Discount Rate 14.1981%Cost of Debt 7.5000%

Tax Shield Discount Rate 13.6981%Long-Term Growth Rate 0.4878%

COST OF CAPITAL

Valuation• Growth Rates

– Firm estimates were primarily used, though they were held at the lower bounds of the estimates due to market uncertainty

– Terminal value was calculated after from 2019 with long term growth held at .48% in real terms to prevent over-estimation

Comparable Firm Estimates for βua

• Comparison across firms– For-profit education firms– Internet firms– Various software industries

• Comparable firms were weighted based using– Similar growth estimates– Industry relevance– Relatable operating characteristics

Company Valuation

• Projections (in millions)

PV Tax Shield: $6.08

Total Enterprise Value: $510.65Value of Debt: $11.88

Value of Equity: $498.77Indicated PPS: $24.55

Total Money Raised: $153.45EPS $0.68

EV/EBITDA: 9.91Price/EPS: 36.15

Price/EBITDA: 0.48

PPS and Sensitivity Analysis

• PPS was estimated using unlevered value and the present value of debt tax shield

• Sensitivity analysis of this estimate focused primarily on the estimate for unlevered beta and long term growth rates

Sensitivity Graph

0.6 0.8 1 1.2 1.4 1.6 1.8 2 2.2 2.4 2.6$0.00

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0% Long Term Growth2.5% Long Term Growth5% Long Term Growth

Beta [ua]

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PPS Estimate

• Comparable firm ratios used to estimate firm value– Price/EPS– EV/EBITDA

• These ratios were averages and them multiplied by Rosetta Stone results