Allen Latta's Blog on Private Equity - Allen Latta's Thoughts on Private Equity, Etc.

Cons and Pros of the Lifetime Value (LTV) Formula

1/12/2013

Lifetime Value (LTV) is a tool used in marketing to estimate how much a customer is worth over the entire time the customer remains with the company. Bill Gurley, the author of the Above the Crowd blog, wrote an interesting post a while ago on the LTV formula and discussed several of its pitfalls. In "The Dangerous Seduction of the Lifetime Value (LTV) Formula" he lists 10 reasons to "avoid worshiping at the LTV altar":

LTV is a tool, not a strategy.
The LTV model is used to rationalize marketing spending.
The model is confused and misused.
The formula is not absolute. It's at best a good guess.
The LTV variables "tug" at one another. The variables in the LTV equation are interdependent, not independent.
Growing becomes a grind. Investing heavily in marketing doesn't necessarily lead to a commensurate drop in subscriber acquisition costs.
Purchased customers underperform organic on almost every metric.
The money could go to the customer to provide a better value proposition to the customer and to provide a better customer experience.
LTV obsession creates blinders. Companies that obsess over LTV can become overwhelmed by it, whereas scrappy companies can find more efficient forms of marketing. Bill uses a great example here.
Tomorrow never arrives. It's difficult to create permanent equity value with LTV.

Here's the link: http://abovethecrowd.com/2012/09/04/the-dangerous-seduction-of-the-lifetime-value-ltv-formula/
Also, some of the comments are very interesting.

J.J. Colao of Forbes, provided a defense of LTV in "In Defense Of The Lifetime Value (LTV) Formula." The article points out that with the proper oversight, LTV can be effective. It also provides a very interesting real-life example. The article offers five tips for effectively applying the LTV formula in a business:

Prize customer experience above all else.
Keep the variables clean.
Isolate customer segments, and then apply the formula.
Don't rely on conventional marketing. Use a variety of marketing approaches, such as viral, social and PR.
Maximize LTV to a point, then scale.

Here's the link:
http://www.forbes.com/sites/jjcolao/2012/09/13/a-dangerous-seduction-revisited-in-defense-of-the-lifetime-value-ltv-formula/

What Should Facebook's Stock Price Be? Analysts Say $49 to $9.50

5/25/2012

Facebook's stock is currently trading at roughly $31.50 per share. It priced its initial public offering a week ago at $38 per share, opened trading at $42.05 per share and traded as high as $45 per share. None of Facebook's underwriters have initiated equity research coverage on Facebook, but a number of analysts not involved in the offering have, with a range of target prices of $49 all the way down to $9.50 (see article here). In addition, Henry Blodget, former Internet equity research analyst, estimates that Facebook should trade between $16 and $24 per share.

Link to Henry Blodget article (which has a good analysis):
http://www.businessinsider.com/what-is-facebook-worth-2012-5

Link to CNBC article on analyst projections:
http://www.cnbc.com/id/47567766

Market Capitalization v. Fully-Diluted Equity Valuation - The Facebook Example

5/5/2012

There are conflicting reports of Facebook's valuation at its initial public offering. The Wall Street Journal reports an IPO valuation of $96 billion; Forbes indicates the IPO market cap is $86 billion; my prior post on the matter estimates an IPO market cap of $75 billion. What gives? Basically there are two reasons for the difference. First is the difference between "market capitalization" and "valuation." Second is how these terms are calculated, which in Facebook's case primarily relates to the issue of how to treat options and similar instruments.

"Market capitalization" or "market cap" is basically the stock price multiplied by the number of shares currently outstanding. In Facebook's case, the targeted IPO stock price is between $28 and $35 dollars (according to its registration statement - see prospectus cover page), and it will have 2,138,085,037 shares outstanding after the IPO. This gives an IPO market cap of $59.9 billion at the low end of the range ($28 per share), $67.3 billion at the mid-point of the range ($31.50 per share), and $74.8 billion at the top of the range ($35 per share). My post used the high end of the range to calculate Facebook's IPO market cap.

Market cap has a drawback in that it does not take into account the impact of stock options and the like, which when exercised adds to the number of shares outstanding. In Facebook's case, page 42 of the prospectus indicates there are potentially a total of nearly 681 million shares which could possibly be exercised at some point in the future and added to the 2.1 billion outstanding. This includes 378 million shares pursuant to restricted stock grants, 116 million shares through Class B stock options, 60 million from a stock option issued to Mark Zuckerberg, 25 million shares from recent option grants and stock issuances, 23 million shares to be issued to Instagram when the acquisition closes, and another 77 million shares that could be issued in the future under equity compensation plans. Backing out the 77 million reserved for future issuances (because this may or may not be issued), the total becomes 603 million shares that could be issued from exercises of stock options, etc. Assuming that all of these shares are issued (which is unrealistic, but provides an upper end to the range), total shares outstanding on a "fully-diluted" basis are 2,741,567,754, which multiplied by $35 per share (the top of the IPO price range) gives a "fully-diluted" valuation of nearly $96 billion. This is what The Wall Street Journal reports for the IPO valuation. At the mid-point of the range, the fully-diluted equity valuation is $86 billion, which is what Forbes is reporting. In my opinion, Forbes should not have used the term "market cap" in the title of the article as what it refers to in the article is fully-diluted equity value.

Now the corporate finance purists will say that the above analysis is incorrect, because it does not take into account the strike prices of the options. This is true - the above is a quick and dirty analysis. However, because the strike prices are very low (6 cents for the Zuckerberg option) and 95 cents for the Class B options, calculating the option shares using the Treasury method won't have a material effect on the above analysis. Also, some purists will say that the valuation should be "enterprise value" and they would be correct, but that's a topic for a future post.

Links:
Facebook S-1/A registration statement: http://www.sec.gov/Archives/edgar/data/1326801/000119312512208192/d287954ds1a.htm

The Wall Street Journal article:
http://online.wsj.com/article/SB10001424052702304746604577382210530114498.html

Forbes article:
http://www.forbes.com/sites/tomiogeron/2012/05/03/facebook-seeking-ipo-with-market-cap-of-86-billion/

My prior post:
http://www.allenlatta.com/1/post/2012/05/facebook-files-targeted-ipo-price-range.html

Zynga Files For Secondary Offering

3/14/2012

Zynga, the online social gaming company that went public on December 15, 2011, has filed a registration statement with the SEC to allow certain shareholders to sell up to $400 million of Class A common stock. According to press reports, the reason for this offering is to mitigate the impact of a large block of shares hitting the market when the IPO lock-up expires. Typically, underwriters of an IPO require company insiders to agree to not sell their shares for a period of 180 days after the IPO, which is known as the "lock-up" period. The purpose for this is to allow enough time for the newly public stock price to stabilize over time. At the time of the lock-up expiration, it is common to see the stock price dip in anticipation of a large block of shares hitting the market.

Interestingly, in Zynga's case, the lock-up period is 165 days rather than the typical 180 days.

My take on this is that the filing is to allow certain venture capital investors to sell their shares in a managed process. Zynga's venture capital investors include Kleiner Perkins Caufield & Byers, Institutional Venture Partners, Foundry Group, Avalon Ventures and Union Square Ventures.

Here's Zynga's SEC filing for the secondary offering: http://www.sec.gov/Archives/edgar/data/1439404/000119312512113668/d312579ds1.htm

Here's Zynga's prospectus for it's IPO in December (information on the 165 day lock-up is found in the underwriting section): http://www.sec.gov/Archives/edgar/data/1439404/000119312511343682/d198836d424b4.htm

Here's a link to the SEC's website discussing IPO lock-up agreements:
http://www.sec.gov/answers/lockup.htm

Here are some press reports discussing the offering:
Bloomberg:
http://www.bloomberg.com/news/2012-03-14/zynga-plans-400-million-share-sale-in-secondary-offering.html
CNET:
http://news.cnet.com/8301-13506_3-57397067-17/zynga-plans-secondary-offering-to-fend-off-stock-price-drop/

Here are links to my prior posts on Zynga:
http://www.allenlatta.com/1/post/2012/1/zynga-closes-above-ipo-price-finally.html

http://www.allenlatta.com/1/post/2011/12/zyngas-ipo-performance-an-analysis.html

http://www.allenlatta.com/1/post/2011/12/zyngas-ipo-on-track-for-next-week.html

http://www.allenlatta.com/1/post/2011/12/zynga-files-ipo-range.html

What's the Value of a Network? Facebook Valuation Article

2/23/2012

Robert Peck, the President and Partner of CoRise Co., LLC has an interesting article on Business Insider called "To Justify A $100 Billion Valuation, Facebook Has To Generate $400 Of Revenue Per Member." In this article, he discusses the value of Facebook from the perspective of the network. They derive a value per user implied by a $100 billion valuation, and then making assumptions regarding cost of capital, margins, growth rates, etc. determines the net present value of the revenues that the $100 billion valuation assumes for a Facebook user over its lifetime. It's a different take on valuation. Here's the link: http://www.businessinsider.com/to-justify-a-100-billion-valuation-facebook-has-to-generate-400-of-revenue-per-member-2012-2

Why Facebook Clearly Belongs in the 10X Revenue Club: Bill Gurley

2/2/2012

Bill Gurley is a General Partner at Benchmark Capital, and formerly was a Wall Street research analyst focusing on personal computer hardware and software. An earlier post on his abovethecrowd.com blog entitled "All Revenue Is Not Created Equal: The Keys To The 10X Revenue Club" provides an insightful look about using price/revenue multiples for valuation purposes. This article is very insightful and well worth a read. Here's the link: http://abovethecrowd.com/2011/05/24/all-revenue-is-not-created-equal-the-keys-to-the-10x-revenue-club/

Yesterday Bill posted his thoughts on why Facebook belongs in the 10X revenue club. It applies the factors from his prior post and in Bill's words "Facebook is a shoe-in fort he 10X+ revenue club." This is an insightful post and a good read. Here's the link: http://abovethecrowd.com/2012/02/01/why-facebook-clearly-belongs-in-the-10x-revenue-club/

SEC Adopts New Rules for "Reverse Merger" Listings

11/10/2011

The Wall Street Journal reports today that the SEC has approved new rules for "reverse merger" listings. Reverse merger listings are a way for foreign companies to obtain a listing on a US exchange without going through the registration process with the SEC. Foreign companies merge with publicly-traded shell companies to effect the reverse merger listing. The problem is that the merger process has allowed foreign companies without strong accounting controls to become publicly traded in the US. Here's the link to the WSJ story: http://professional.wsj.com/article/SB10001424052970204358004577028381460208046.html

The new rules make it tougher for foreign companies to list via reverse mergers. I applaud this move.

Groupon IPO Valuation Analysis: Business Insider

10/27/2011

Henry Blodget of Business Insider has a very interesting article analyzing the IPO valuation of Groupon. Here's the link: http://www.businessinsider.com/how-much-is-groupon-worth-2011-10?op=1. I think this is article serves as a very good basis for discussion of IPO valuation. I also agree with his statement:

"So don't believe anyone who tells you they know what Groupon's worth. They don't. All they know is what their estimate is of what Groupon is worth. And, unfortunately, the range of "reasonable" estimates of what Groupon (or any stock) is worth is wide enough to fly a 787 through."

Valuation is a very subjective analysis and is a little bit art and a little bit science. We won't know Groupon's IPO valuation until it actually prices.

Movie: Margin Call

10/22/2011

There is a review in the Atlantic of the movie Margin Call: http://www.theatlantic.com/entertainment/archive/2011/10/margin-call-a-financial-crisis-film-thats-on-the-money/247116/.

I saw this movie, and was a little disappointed. The movie focuses on the drama of a firm dealing with its exposure to Mortgage-Backed Securities, but only deals with MBS at a very high and vague level. Perhaps the subject matter is too complex to adequately explain in a movie, but without understanding more about the issue, the movie lacked substance to me. And maybe I went to the movie with expectations that were too high, given the positive reviews I read and the great cast.

So set your expectations lower and enjoy the film!

Valuation - Pitfalls of Using a Revenue Multiple

10/17/2011

Bill Gurley of Benchmark Capital posted an article on his website this past May discussing the limitations of using a price / revenue multiple as a basis for company valuation. Here's a link: abovethecrowd.com/2011/05/24/all-revenue-is-not-created-equal-the-keys-to-the-10x-revenue-club/. I agree with much of what Bill says in his article and think it is good read for anyone interested in valuation.