IPO & IPO range
Equity, b RUB
Share price, RUB
Key valuation assumption: Finam's revenue growth projections are correct.
Today (20.07.2011) Finam did an IPO of JCS Platforma Utinet.ru. This is a good event from several dimensions:
- Gives public investors more chances to invest in small cap Russian companies and in the growth of Russian internet
- Creates exit market which will stimulate VC and PE investments in small and medium Russian companies
- Brings more attention to Russian internet sector which is unfairly under covered
IPO was at 137x EV/EBITDA 2010 and 48x EV/EBITDA2011.
Investor Presentation, 2009&2010 IFRS reports and Finam research report are here:
This research report is awesome. Just take a look at the chart below.
- Finam's estimation of fair value: 8.57-9.19b RUR or 429-460 RUR/share
- IPO price range: 145-195 RUR/share
How did Finam come to so bullish views? Their report contains several big issues which explain it:
- Several unjustified assumptions (which is in many cases fine as soon as they are explicitly described)
- Violation or incompetent application of corporate finance rules (which is not professional)
If they are fixed, then:
- DCF would give fair value at $1.2b RUR or 62 RUR /share
- Comparables valuation would be hard to apply due to negative EBITDA in 2011 and 2012
1. EBITDA forecast
Revenue grows at 70% CAGR in 2011-2015. It's too questionable, but let's assumes that this is a good enough forecast. The company goes from -5% EBITDA margin in 2009 to 10% in 2015. Why?
General comment: the company cut many expenses in 2010 to get a high EBITDA in 2010 (pre-IPO year), so I almost don't take 2010 numbers into account as this level of costs is obviously pre-IPO manipulation and is not sustainable.1.1 Gross Margin
If we adjust for high Gross Margin for "Platforma" business (assuming 30% in 2010 and taking 57% in 2015 from Finam report), we will get that Gross margin for own trading business grows from 7%, 5% and 10% in 2008-2010 to 13% in 2015. The growth of discounts from laptop distributors should explain this growth. But there are three counter arguments:
- What defines discounts from distributors is market share and it will not grow that dramatically to justify additional 3-6%.
- Intensifying competition in retail will lead to drops in retail margins
- Between 2011 and 2015 there should be one-two "bad years" due to bad economy or other external conditions and margins should decrease in these years
- Gross Margin from trading business: 8.8% in 2011 (Finam), growing at 0.5% per year
- Which gives Gross Margin from total business: 10.8% in 2015
1.2 Marketing Expenses
Benchmarks: Marketing Expences as a % of revenue are declining from 6.0% in 2009 to 0.3% in 2015. This is unsustainable and in the long term will lead to market share loss. Below is the comparable data for all the companies WW in Internet Retail Industry with data for Advertising Expense available. Average: 9.8% of revenue. Amazon has 2.4%.
Source: Capital IQ
Company plans: "Согласно инвестиционной программе «Ютинета», до 70% привлеченного в результате IPO капитала пойдет на продвижение бренда «Ютинет»." (http://www.rbcdaily.ru/2011/07/13/media/562949980627656).
How is this ambitions brand promotion plan consistent with decrease in Marketing Expenses as a % of revenue?
My adjustment: keep Marketing Expense at 2009 level of 6%
These two adjustments lead to drastic decrease in EBITDA Forecast.
- If they cut them in 2011, the company may show positive EBITDA, but then
- Revenue growth for the coming years will be much slower than projected
- Market share will drop which will lead to loss of Utinet's market leadership in laptop online retail with long term consequences for margins and growth prospects
- If they don't cut them, then EBITDA will be negative in 2011 and 2012
2. Comparables Valuation
"Отметим, что аналоги из развивающихся стран обладают большим потенциалом роста продаж по сравнению с аналогами из развитых стран (ежегодные темпы роста продаж аналогов развивающихся стран в долларовом выражении в 2011-2015 гг. составляют 35-40%, в развитых странах – 24-28% по сравнению с 89%-м ростом продаж Ютинет.Ру), и оценки на основе их мультипликаторов не отражают перспектив роста, которые мы прогнозируем для Ютинет.Ру."
I assume these 24-28% growth forecasts for 2011-15 are average forecasts from many banks while 89% from Finam is an extremely optimistic forecast from one bullish bank motivated to sell shares on the IPO. For many on the discussed companies in emerging markets you can find local "Finam's" who can forecast 89% growth for them.
"Мы считаем, что данные Компании за 2011 г. не являются репрезентативными по сравнению с ожиданиями доходов на 2012 г. и далее с учетом экспансии в регионы, выхода в новые товарные категории, поэтому далее оцениваем стоимость Ютинет.Ру по средним прогнозным показателям 2011-2013 EV/EBITDA и P/E."
This phrase in bold can be applied to any of the comparables used as they are all fast growing companies.
My adjustment: If comparables' multiples are calculated based on 2011F numbers, then Utinet's equity should also be calculated based on 2011F EBITDA and Net Income.
New valuation range at Finam's EBITDA forecast: 1.3-2.3b RUR
At the same time, if EBITDA forecast from 1. is used, it will be almost impossible to use comparables as EBITDA<0 in 2011 and 2012.
There is one key principle of DCF method which is often misused by starting corporate finance professionals and which Finam clearly ignores in its report: DCF method requires use of market values for:
- cost of debt
- cost of equity
Finam assumed 13% for cost of debt. Can Utinet.ru borrow on the open market at 13%? Obviously not and we have facts supporting that. Based on 2010 report Utinet has two external loans from AlfaBank, each for 25% rate and each with a "Related-party collateral and guarantee" which for the question discussed is an external (to the company) guaranty. That means a loan taken on the open market would have even higher rate, if any bank agrees to give it to Utinet.ru.
With EBTIDA growth borrowing rate will drop, but I don't believe it will drop below 15-20% even in 2015.
My adjustments: cost of debt is 30% in 2011 and decreases to 15% in 2015
3.2 WACC – cost of equity
Investment in Utinet.ru is between investment in a venture (expected return on equity 50%) and a small cap public stock (15%).
My adjustment: cost of equity is 30%
CAPM could also be applied, though Finam's application of CAPM has two big mistakes:
- Small cap company requires 3- or 4- factor models (Fama and French and the Pastor-Stambaugh Model) that takes into account premiums for small cap, low liquidity and high book-to-market ratios.
- Beta as a very important parameter requires clear justification
This allowed then to increase share of debt capital which is cheaper in their model and significantly decrease WACC.
Real calculation of WACC is circular as E required for WACC and WACC required for E. That's why I would calculate here only approximate WACC, In the assumption that the company costs 1b RUR now, so share of Debt in 2011 is 0.25/1=25% and let's assume that the company will maintain this level of debt.
3.4 Working Capital
Positive change in WC is the biggest source of cash in 2011 and the second biggest in 2012. It mostly comes from growth in Accounts Payables as suppliers give 10 days credit to Utinet.
By looking at turnover, the first question is why it's jumping from 20 days in 2010 to 43 in 2011? The other question is how does this 10 days reconcile to 40 days? I don’t know well enough numbers for payment terms between electronic distributors and retailers, but would like to notice that this is very questionable and manipulative assumption to generate big positive cash flow in 2011 and 2012. One reason to explain that may be that to increase gross margin in 2010 the company agreed with suppliers to get bigger discounts and decrease financing from their terms. I would adjust this number close to 2010.
My adjustments: Accounts Payable turnover is 25 days in 2011-2015
3.5 Updated Utinet.ru DCF
Below is the model DCF built with all discussed adjustments.
Utinet.ru fair value is $1.2b RUR or 62 RUR /share.
Finam did so aggressive valuation for a purpose. Are real numbers so unattractive that it was the only way to attract investors for the IPO? It's hard to know the real story behind but my estimation of negative EBITDA in 2011 and 2012 tells me that Utinet.ru doesn't look attractive to most of public stocks investors.
5. Other facts
5.1 IPO Russian Sea Group (Русское Море)
In April 2010 Finam did IPO of Russian Sea Group (http://www.finam.ru/investments/ipo0000B00075/default.asp). The collapse of Russian Sea stock gives insight about potential behavior of Utinet.ru stock if IPO happens at the announced price range.
5.2 What it takes to achieve high growth
Finally here is a post from a blog showing how high growth is often achieved:
Исайкин Денис Сергеевич 13.10.2009 08:36
Серёга привет, меня зовут Ден, живу в Южно-Сахалинске, ты такой умный, может подскажешь что делать? Заказал в интернет магазине utinet.ru (ООО ГлавИнформСистема) ноутбук. Прислали модель ту которую заказывал, НО конфигурацию урезанную, которая стоит гораздо дешевле. Переговоры по телефону, а так же переписка по мылу ничего не дали. В ОЗПП сказали написать официальную претензию. Написал на директора Уколова. Вернулось письмо с пометкой, что такой организации по такому адресу не существует. Что делать? Вообще, существует ли справедливость?:( Редиски, обманывают народ и это постоянно сходит им с рук:(