ArchInvest: 2013

Sunday, September 15, 2013

Nokia decides to sell mobile business to Microsoft

Earlier at the begining of the month, Microsoft announced its decision to acquire Nokia's mobile phone business for almost $5B, as well as gain access to its patent portfolio for $2.2B. With this transition, Stephen Elop has earned himself a place in the contenders to replace Steve Ballmer as Microsoft's next CEO.

More importantly, Nokia is no longer a phone company but will be left with 3 lines of business. These are

1. Nokia Siemens Network: A telecommunications and network business provider
2. Nokia Here: A mapping and locations based services business acquired as part of Navteq acquisition
3. IP Group: Responsible for licensing and collecting royalties on Intellectual property portfolio built over the years.

Microsoft posted the strategic rationale for the acquisition on its website. This is embedded here.

1|30

September 03, 2013

Image: Web

The combined valuation as per preliminary analysis done by Trefis analysts in their Forbes article is $1.80 above the trading price before the announcement. Already, Nokia has added a little more price on the stock as can be seen from the graphic below.

Only time will tell whether there is more value unlocked here or not.

Tuesday, August 6, 2013

Relating P/E to Earnings Growth

Many years ago, Benjamin Graham suggested that the Price to Earnings Ratio (P/E) or "The Multiple" was related to the growth in earnings year over year forecast for a stock. Roughly, the formula translated to

Value = Current (Normal) Earnings X (8.5 plus twice the expected annual growth rate)

This was summarized in the following table

Expected Growth Rate	0.0%	2.5%	5.0%	7.2%	10.0%	14.3%	20.0%
Growth in 10 years	0.0	28.0%	63.0%	100.0%	159.0%	280.0%	319.0%
Multiplier of current earnings	8.5	13.5	18.5	22.9	28.5	37.1	48.5

This definitely allows us to understand the kind of growth anticipated just by looking at the P/E.

Saturday, July 27, 2013

By the numbers: Blackberry's updated valuation based on July 2013 numbers

A couple of weeks ago, Blackberry published their latest revenue numbers for the quarter. The market claimed disappointment, even disillusionment, and the stock price crashed.

I finally had the time to download the 10 K filings, and I decided to see what the real story was from my perspective. I might add that readers need to do their own analysis to make any real decisions around buying or selling the stock.

Reviewing my prediction

In my previous post in April on Blackberry valuation, I had looked at the revenue figures for each quarter. I had then come up with my own quarterly estimates. Now, we know what the real numbers were as well. I have included the actual numbers in an additional column on the right of my estimates. Here is the table.

In millions
	Jun 2, 2012	Sep 1, 2012	Dec 1, 2012	Mar 2, 2013	Jun 1, 2013 (E)	Jun 2, 2013 (A)
North America	$794	$868	$647	$587	$800	$761
Europe, Middle East & Africa	$1,028	$1,087	$1,160	$1,227	$1,100	$1,343
Latin America	$580	$520	$535	$479	$575	$449
Asia Pacific	$405	$386	$385	$385	$400	$518
Total Quarterly Revenue	$2,807.00	$2,861.00	$2,727.00	$2,678.00	$2,875.00	$3071

At this point, I am not sure what the fuss is about. With the exception of North America and Latin America, the phone fared quite well and even beat my personal expectations overall.

Looking Ahead

Now the task of looking ahead. To make projections, I had to make some assumptions. These assumptions are as follows:

Terminal Value of the stock is reached in Year 5
Revenue increases 10% Year over Year till Year 5 (This is the biggest assumption in the game. Others may be presuming a 2-3% growth or even a negative growth in their calculations.
Cost of Revenue is 62% of the Revenue
Operating expense reduces by 5% Year over Year till Year 3 when it becomes 20% more
Annual Depreciation is $1M except Year 3 when it is $2M
Tax rate is 25% each year
Most importantly, the annual revenue is 6 times the latest quarterly revenue. More about this later.
Beta is 1.59
Debt Financing Rate is 4.8%
Equity Financing Rate is 6.3%
Terminal Value estimates
1. Growth becomes 3% after Year 6
2. Alternatively, stock price stabilizes at 12 P/E based on Year 6 revenue.
3. Actual Terminal value was mid point between these 2 estimates
The value of the company is Present value of growth phase + Present value of the terminal value.
This gives us a per stock intrinsic value of $44 over the next 6 years.

		Year 1	Year 2	Year 3	Year 4	Year 5
	FY 2012-2013	FY 2013-2014	FY 2014-2015	FY 2015-2016	FY 2016-2017	FY 2017-2018
		4
Annual Revenue Factor	$11,073,000	$12,284,000.00	$13,512,400.00	$14,863,640.00	$16,350,004.00	$17,985,004.40
Cost of Revenue	$7,639,000	$7,600,947	$8,361,042	$9,197,146	$10,116,861	$11,128,547
Operating Expense	$4,669,000	$4,435,550.00	$4,213,772.50	$5,056,527.00	$4,803,700.65	$4,563,515.62
Total Other Income/ Expenses Net	$15,000	$20,000	$20,000	$20,000	$20,000	$20,000
Total costs	$12,308,000	$12,036,497	$12,574,814	$14,253,673	$14,920,561	$15,692,062
Net Income	-$646,000	$247,502.77	$937,585.55	$609,966.85	$1,429,442.59	$2,292,941.94
Depreciation	$1,918,000	$0	$250,000	$250,000	$250,000	$250,000
EBIT	-$1,220,000	$267,503	$957,586	$629,967	$1,449,443	$2,312,942
EBITDA	$698,000	$267,503	$1,207,586	$879,967	$1,699,443	$2,562,942
Tax rate	0.00%	25.00%	25.00%	25.00%	25.00%	25.00%
EBITDA X (1 – Tax rate)	$698,000	$200,627	$905,689	$659,975	$1,274,582	$1,922,206
Capital Expenditure	$413,000	$500,000	$500,000	$1,000,000	$500,000	$500,000
Delta Net Working Capital	$0	$100,000	$100,000	$100,000	$100,000	$100,000
Free Cash Flow	$2,203,000	-$399,373	$555,689	-$190,025	$924,582	$1,572,206
Beta	1.59
Debt Financing Rate	4.80%
Equity Financing Rate	6.30%
Discount Rate	14.82%
Assumed Discount Rate	15.00%
Number of outstanding shares	524,159,844
EPS	$4.20
NPV@15% of FCF's Year 1 to Year 5	3,009,785
Terminal Value Estimates
Perpetual Growth at 2%	$12,093,895.83

Shareprice at time of Analysis	8.88
Current P/E using GAAP Diluted EPS	-22.03
Assumed PE of 12	$27,755,303.32
Assumed Terminal Value	$19,924,600
PV of Terminal Value	$22,934,384.62
Current Intrinsic Value Per Share	43.75
Projected EPS Per Share	$5.74

This predicts that the current intrinsic value of the share is $43.75 and long term projected shareprice could be in the same ball park or higher. Ofcourse, the big assumption in this calculation is that the revenue grows 10% each year. If I assume a 2% growth instead of a 10% growth, the stock price works around $10.50.

The next quarter will reveal the actual trend.

By the numbers: Facebook Update

Facebook gets an uplift.

In my previous post on Facebook Valuation, I had looked at Facebook results for the last quarter. Accordingly, I had projected the Free Cash Flow for the firm in the years to come. I had come to the conclusion that the stock was slightly overpriced. However, Facebook released its June numbers and suprised everyone including themselves.

Based on the analysis, I have tweaked my model and I feel now that the stock is at its intrinsic value around $34. However, if the next quarter sustains this momentum, rest assured that the stock is going higher than its IPO price.

The basis of growth

As mentioned in my previous post, Facebook measures its business in terms of a few key metrics.

These are

Monthly Active Users (MAU): Users that access their account atleast once a month, on mobile or on a PC.
Daily Active Users (DAU): Users that access their account once a day, on mobile or on a PC.
Ratio of DAU/MAU: This provides a metric on engagement and ofcourse an opportunity for Facebook to earn revenue.
Advertising Revenue: Revenue earned by click or view only ads, similar to Google
Payment and Fee Revenue: Amount paid for by users for stuff like games, Facebook currency and so on.
Social Revenue: Money earned by Facebook through new social engagements like sending gifts and priority posts
Average Revenue Per User: Average money earned per user as a percentage of Monthly Active Users

Projecting the engagement

I had earlier conservatively projected the numbers for the next few quarters, and then using these quarterly projections, I had projected the revenue over the next few years. In my previous post, my June forecasts were predictions. In the latest post, these have been replaced with actual figures posted by Facebook.

		Jun 29, 2012	Sep 29, 2012	Dec 30, 2012	Mar 30, 2013	Jun 30, 2013	Sep 30, 2013	Dec 30, 2013
US and Canada
Internet Population (in millions)	MAU (in millions)	186	189	193	195	198	199	200
273	DAU (in millions)	130	132	135	139	142	144	146
Total Population (in millions)	DAU/MAU	69.89%	69.84%	69.95%	71.28%	71.72%	72%	73%
347	Adv. Revenue (in millions)	$479	$538	$631	$552	$721	$642	$665
	Payment+Fee (in millions)	$111	$99	$149	$127	$127	$132	$140
	Social Revenue (in millions)	$0	$0	$0	$0	$0	$1.00	$1.26
	Total Revenue (in millions)	$590	$637	$780	$679	$848	$774	$806
	ARPU	$3.20	$3.40	$4.08	$3.50	$4.28	$3.89	$4.03

Europe
Internet Population (in millions)	MAU (in millions)	246	253	261	269	272	278	284
518	DAU (in millions)	154	160	169	179	182	190	197
Total Population (in millions)	DAU/MAU	62.60%	63.24%	64.75%	67%	67%	68%	69%
739	Adv. Revenue (in millions)	$294	$295	$374	$367	$451	$409	$438
	Payment+Fee (in millions)	$52	$46	$66	$56	$54	$61	$65
	Social Revenue (in millions)	$0	$0	$0	$0	$0	$1.00	$1.27
	Total Revenue (in millions)	$346	$341	$440	$423	$505	$471	$504
	ARPU	$1.43	$1.37	$1.71	$1.57	$1.86	$1.69	$1.77

Asia
Internet Population (in millions)	MAU (in millions)	255	277	298	319	339	360	380
1034	DAU (in millions)	129	141	153	167	181	195	210
Total Population (in millions)	DAU/MAU	50.59%	50.90%	51.34%	52%	53%	54%	55%
3922	Adv. Revenue (in millions)	$115	$133	$168	$176	$225	$213	$236
	Payment+Fee (in millions)	$20	$21	$30	$21	$22	$29	$31
	Social Revenue (in millions)	$0	$0	$0	$0	$0	$1.00	$1.30
	Total Revenue (in millions)	$135	$154	$198	$197	$247	$243	$268
	ARPU	$0.55	$0.58	$0.69	$0.62	$0.73	$0.68	$0.70

Rest of the world
Internet Population (in millions)	MAU (in millions)	268	288	304	327	346	365	386
469	DAU (in millions)	139	152	161	180	195	210	228
Total Population (in millions)	DAU/MAU	51.87%	52.78%	52.96%	55%	56%	58%	59%
2009	Adv. Revenue (in millions)	$104	$120	$156	$150	$202	$192	$214
	Payment+Fee (in millions)	$9	$10	$11	$9	$11	$13	$13
	Social Revenue (in millions)	$0	$0	$0	$0	$0	$1.00	$1.31
	Total Revenue (in millions)	$113	$130	$167	$159	$213	$205	$228
	ARPU	$0.44	$0.47	$0.56	$0.49	$0.62	$0.56	$0.59

Worldwide
	MAU (in millions)	955	1007	1056	1100	1155	1,202	1,250
	DAU (in millions)	552	584	618	665	699	738	779
	DAU/MAU	57.80%	57.99%	58.52%	60.45%	60.52%	61%	62%
	Adv. Revenue (in millions)	$992	$1,086	$1,329	$1,245	$1,599	$1,512	$1,628
	Payment+Fee (in millions)	$192	$176	$256	$213	$214	$247	$266
	Social Revenue (in millions)	$0	$0	$0	$0	$0	$4	$5
	Total Revenue (in millions)	$1,184	$1,262	$1,585	$1,458	$1,813	$1,693	$1,806
	ARPU	$1.28	$1.29	$1.54	$1.33	$1.57	$0.71	$0.69

Total Quarterly Revenue		$1,184	$1,262	$1,585	$1,458	$1,813.00	$1,693.36	$1,805.86

Valuation

Based on the above projections, the fair value of the stock seems to be $22.

Here are some key assumptions

Terminal Value of the stock is reached in Year 6
Revenue increases Year over Year till Year 6 is based on individual growth rates in each geography. The MAU and DAU increase till they cap at 75% of the Total Internet users in each geography.
Cost of Revenue is a rolling percentage of the Revenue based on historic averages
Operating expense needs to cover the Tax burden from the $2.11 B tax liability that will be settled in the next 3 years. It matches historic averages after that.
Annual Depreciation is $500K except Year 3 when it is $1M
Tax rate is 30% each year except next 2 years when its 41 and 35% respectively.
Most importantly, the annual revenue is based on the growth in each market based on DAU, MAU and ARPU growth/ decline. .
Beta is 1.4
Debt Financing Rate is 1.46%
Equity Financing Rate is 6.3%
Terminal Value estimates
1. Growth becomes 2% after Year 5
2. Alternatively, stock price stabilizes at 9.5 P/E based on Year 5 revenue.
3. Actual Terminal value was mid point between these 2 estimates

	Year -1	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
	FY 2011-2012	FY 2012-2013	FY 2013-2014	FY 2014-2015	FY 2015-2016	FY 2016-2017	FY 2017-2018	FY 2018-2019	FY 2018-2018

Annual Revenue	$3,711,000	$5,089,000	$6,770,216.53	$7,887,689.98	$8,921,382.43	$9,908,894.32	$10,843,123.89	$11,518,883.49	$11,606,220.95
Cost of Revenue	$860,000	$1,364,000	$1,814,615	$2,114,130	$2,391,190	$2,655,872	$2,906,273	$3,087,396	$3,110,805
Operating Expense	$1,095,000	$3,187,000	$2,411,000.00	$2,290,450.00	$2,748,540.00	$1,946,113.00	$1,848,807.35	$1,756,366.98	$1,668,548.63
Total Other Income/ Expenses Net	-$19,000	$7,000	$510,000	$20,000	$20,000	$20,000	$20,000	$20,000	$20,000
Total costs	$1,955,000	$4,551,000	$4,225,615	$4,404,580	$5,139,730	$4,601,985	$4,755,080	$4,843,763	$4,779,353
Net Income	$1,737,000	$545,000	$3,054,602	$3,503,110	$3,801,652	$5,326,909	$6,108,044	$6,695,121	$6,846,868
Depreciation	$323,000	$649,000	$900,000	$1,000,000	$2,000,000.00	$1,000,000.00	$1,000,000.00	$1,000,000.00	$1,000,000.00
EBIT	$1,737,000	$545,000	$3,054,602	$3,503,110	$3,801,652	$5,326,909	$6,108,044	$6,695,121	$6,846,868
EBITDA	$2,060,000	$1,194,000	$3,954,602	$4,503,110	$5,801,652	$6,326,909	$7,108,044	$7,695,121	$7,846,868
Tax rate	41.00%	91.50%	41.00%	35.00%	30.00%	30.00%	30.00%	30.00%	30.00%
EBITDA X (1 – Tax rate)	$1,215,339	$101,514	$2,333,215	$2,927,021	$4,061,157	$4,428,837	$4,975,631	$5,386,585	$5,492,807
Capital Expenditure	$606,000	$1,235,000	$500,000	$500,000	$1,000,000	$1,000,000	$500,000	$500,000	$500,000
Delta Net Working Capital	$350,000	-$290,000	$100,000	$100,000	$100,000	$100,000	$100,000	$100,000	$100,000
Free Cash Flow	$582,339	-$194,486	$2,633,215	$3,327,021	$4,961,157	$4,328,837	$5,375,631	$5,786,585	$5,892,807
Beta		1.40	1.40
Debt Financing Rate		1.46%	1.46%
Equity Financing Rate		6.30%	6.30%
Discount Rate		10.28%	10.28%
Assumed Discount Rate		10.28%	10.28%
Number of outstanding shares		2,372,705,195	2,407,000,000
EPS		0.23	1.27
FCF per Share		-0.08	1.09
NPV@10.28% of FCF's Year 1 to Year 6		16,383,165	21,232,446
Terminal Value Estimates
Perpetual Growth at 3%		$79,486,051.03	$80,945,155.16
Shareprice at time of Analysis			34.01
Current P/E using GAAP Diluted EPS			147.87
Current P/E using Non-GAAP Diluted EPS			94.47
Assumed PE of 20	20	$133,902,414.72	$136,937,351.31
Assumed Terminal Value		$106,694,233	$108,941,253
PV of Terminal Value		$59,314,435	$60,563,620
Total Value		$75,697,601	$81,796,065
Current Intrinsic Value Per Share		$31.90	$33.98
Projected Earnings Per Share		$6.90	$8.82

One big change in my assessment was the Terminal Price to Earnings value that I have increased from 10 to 20. Although that is straight doubling, it is no where close to the impressive 148 P/E the market is giving based on its current earnings. I believe the value investors may be working with a P/E of 20, so I have simply adjusted my calculations to reflect reality.

Here is how the valuation would vary based on the long term P/E ratios the market wants to give

Assuming Terminal P/E for stock		10X	15X	20X	25X	30X	35X
Stock price		$26	$30	$34	$38	$42	$46

Conclusion

The stock has an intrinsic value of $34 which is quite sensitive to its P/E ratio. If the market continues to give a very high P/E ratio, we will likely see the stock jump to higher levels.

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