Valuation Final Project Fall 2015

Member
Amelia Tang
Chris Yue Wu
Francisco Mizgier
Jeffrey Hao Hu
Ji Ming Li
Nicholas M Reichard

Company
JC Penny
Activision Blizzard
AcuaChile
Cinda Asset Management
LinkedIn
GrubHub

[Amelias write-up to be inserted]

Activision Blizzard Inc.

1. Company Overview
1

Page Number
2

Activision Blizzard, Inc. is a worldwide developer and publisher of online, PC, video game console,
handheld, mobile and tablet games. The company offers games that operate on the Microsoft Xbox One
and Xbox 360, Nintendo Wii U and Wii, and Sony PlayStation 4 and PlayStation 3 console systems; the
PC; the Nintendo 3DS, Nintendo Dual Screen and Sony PlayStation Vita handheld game systems; and
mobile and tablet devices.
The company has three main divisions: Activision, Blizzard and distribution. Activision, Inc. develops,
markets and sells interactive software contents through retail sales and digital downloads. Games include
franchises Call of Duty, Skylanders and Destiny. Blizzard Entertainment, Inc. is the publisher of World of
Warcraft, Diablo, StarCraft, Heroes of the Storm and Hearthstone. The Activision Blizzard Distribution
business consists of operations in Europe that provide warehousing, logistical, and sales distribution
services to third-party publishers.
The most recent financial statements used in the analysis are from the third quarter of 2015. Below is the
LTM performance of the stock:

2. DCF Valuation
2.1 Cost of Equity
The companys Cost of Equity is calculated in US$, using the ten-year Treasury bond yield, currently
equal to 2.10%, as a proxy for the Risk Free Rate. The Unlevered Beta, equal to 1.58, represents the
average Levered Beta for multimedia and graphic software industry in the U.S., unlevered by their total
Debt-to-Equity ratio. This number, levered based on the companys current capital structure, represents
ATVUs Levered Beta, currently equal to 1.203. The Country Risk Premium takes into account the
companys revenue composition. Based on the latest financial statements, 52.3% of its revenues are
generated in North America, 38.29% come from Europe including Eastern Europe and Russia, while
9.41% come from Asia Pacific. As a result, the Weighted Country Risk Premium used in the valuation,
which represents a weighted average of these countries equity risk premiums, is equal to 0.732%.
Implied risk premium, currently 5.41%, is calculated from current S&P 500 index and earnings. Adding
weighted CRP to IRP, the total equity risk premium is 6.14%

As a result, Therefore, the companys Cost of Equity in US$ is equal to 9.49%.

2.2 Cost of Debt

The companys Cost of Debt is calculated in US$. Since ATVI does not have a bond rating available, the
analysis considers the firms credit rating as a proxy for default spread to be added to the risk free rate.
The companys current credit rating is BB+, which translates into a credit default spread of 2.75%. The
cost of debt, as a result, is 4.85%, as detailed below

2.3 Cost of Capital

The companys Cost of Capital, calculated in US$ based on the weighted average of the Cost of Equity
and Cost of Debt. Currently, ATVIs Cost of Capital is equal to 8.877%. The details are described below:

2.4 Model
Since the company has about 14% of debt to capital ratio, has a fairly stable capital structure, and shows
some potential to growth in revenues, a DCF model based in FCFF was chosen to value the firm.
One of the increasing trend in the gaming industry is that more and more companies chose to invest in
advertisements. There is no exception for ATVI. Their cost in advertisement far exceeds their R&D
expenses, which is reflected in their low reinvestment rate (11.65%) and hence low growth rate (1.97%).
In fact, taking a look at the financial statements from 2011 to 2014, despite a growth in earnings, ATVI
sees a gradual and steady decline in revenues, partly due to the substantial and inevitable loss of
subscribers from World of Warcraft and declining sales from Call of Duty franchise, but mostly because
of a low R&D investment.
Activision Blizzards strategy has been developing a few number of elite games and maintaining it for a
long time. Such strategy explains a low recurring R&D efforts. However, while Call of Duty, World of
Warcraft and Skylanders series have been a huge success and combined accounted for 67%, 80%, and
72% of the companys consolidated net revenues for the years ended December 31, 2014, 2013, and 2012,
3

respectively, Call of Duty and World of Warcraft have been around for more than 10 years and Skylanders
is entering its 6th year of history. The major problem of Activision Blizzard is lack of innovation.
Therefore, even with the new expansion of World of Warcraft series coming out next year and the
potential huge boost in temporary subscribers and revenue, I expected a moderate growth in revenue,
averaging 1.97% over the next five years. As the company returns to the industry average operating
margin of 25% (adjusted for R&D and lease commitments), we can see the estimated price per share is
$23.79, a 36% discount from the current share price.

3. Relative Valuation
3.1 Multiple
We opted to analyze Activision Blizzard based on an EV/Sales ratio. We believe that it is the most
appropriate multiple for the company because ATVI is operating in an industry with a reasonably stable
growth. Also, since the firm has a good debt structure, EV can reflect fairly about the firms performance.
As mentioned before, its important to look at the performance of ATVIs revenue instead of earnings. As
a result, EV/Sales ratio is a good indicator.
Nowadays, there are only a few public companies in the U.S. operating in the gaming sector. As a result,
we expand the list into multimedia and graphic software sector, even though it is still a small list with
very imbalanced information.
Therefore, we analyzed a sample of 16 public and operating companies. The result is as shown below:

3.2 Sector Regression

We also ran a regression to identify how the EV/Sales ratios in the sector have reflected the companies
fundamentals. As shown below, even though not all variables are statistically significant at a p-value of
0.05, many have demonstrated as a good indicator and the R-square is 77%. Also, their coefficients are in
the expected direction, with a higher expected revenue growth resulting in a higher EV/Sales and a high
R&D expense translating into higher multiples:

Subsequently, we can derive a formula: EV/Sales = 0.17 + 11.85*Adjusted Operating Income Margin +
5.93*net R&D/adjusted after-tax EBIT + 0.98*Beta 5.77*Debt Ratio + 23.27*Expected Revenue
Growth
Based on this regression, using the most recent information available, the company should trade at an
EV/Sales ratio of 3.68, with an enterprise value of 18,006 million and equity value of 19,038 million. A
per share price of $26.18 is then assigned to ATVI, which still indicates that the stock is currently
overpriced.

3.3Market-Wide Regression: U.S. Companies

For the market-wide regression, as indicated in the formula below, we chose the formula based on the
EV/Sales multiple for U.S. companies:
EV/Sales = 1.17 + 1.40 g+ 6.35Operating Margin + 5.26 DFR- 0.10 Tax rate
With g = 1.97%, Operating Margin = 31.22%, DFR = 13.69% and effective tax rate = 16.3%, the
company should trade at an EV/Sales multiple of 3.88, translated into an EV of $18,979 million and an
equity value of $20,056 million. The estimated price per share is $27.51.

4. Conclusion
The following are the overall results of our analysis of ATVI:

AquaChile S.A.

1. Company Overview
AquaChile S.A. is engaged in the farming, production, and sale of Atlantic and Coho salmon,
trout, and tilapia products. It has 163 aquaculture concessions that own a total area of 1648.68 hectares.
The company operates three stores in Southern Chile. It serves its customers in approximately 30
countries, including Costa Rica, Panama, and the United States. AquaChile S.A. is based in Puerto Montt,
Chile.
(Packaged Foods and Meats, Negative earnings)
2. DCF Valuation
We implemented a 2-stage FCFF discount model with normalized earnings because historically
the price of Salmon fish, Aquchiles main product, has been very volatile (see chart below). Currently,
high costs and low prices are creating a perfect storm for South American countrys farmers and
processors. Moreover, the industry suffered a major business loss and reputation blow when Costco
switched to Norwegian fish and ditched Chilean supplies because of the amount of antibiotics used in
Chilean farms.

However, there is a consensum amid anayst that growth will continue to accelerate. Much of that demand
for salmon will come from the worlds growing middle class. The Brookings Institution thinks the middle
class will grow by 50% to 3.8 billion people in just 10 years. We also expect that AquaChile will
experience a consolidation of the Chilean Salmon Industry as companies go out of business and that the
company will better control its cost and rebuild trust in the market. We expect that earnings will recover
quickly to normal levels from next year.

To value this company, we normalized not only its current revenues, but also the return on capital and
reinvestment rate. We estimated the normalized values by looking at average earnings over a period of 10
years and considered some analysts' expectations of company growth and salmon fish prices.
The inputs for the high growth and stable growth periods are listed below.
a. Inputs

Length of High Growth Period

Growth Rate
Debt Ratio used in Cost of
Capital Calculation
Beta used for stock
Riskfree rate
Risk Premium
Cost of Debt
Effective Tax rate (for cash
flow)
Marginal tax rate (for cost of
debt)
Return on Capital
Reinvestment Rate

High Growth
10
10.00%

Stable Growth
Forever
2.28%

48.44%

30.00%

1.67
2.28%
6.44%
7.78%

1.00
2.28%
6.44%
9.00%

20.00%

25.00%

20.00%

25.00%

13.00%
48.33%

7.00%
32.57%

b. Output
Firm Value
Value of operating assets of the firm
Value of Cash, Marketable Securities & Nonoperating assets
Current Market Price /share
Estimated Market Price /share
Price as % of Estimated Value

$ 182,164,776 million
$ 170,564,776 million
$ 11,600,000 million
$ 0.28
$ 0.21
133%

c. Commentary
Aquachile behaves like commodity companies. When Salmon fish prices are on the upswing, the
company and its peers have high earnings, whereas during a downturn, the industry experiences low
returns. So its value is highly linked to the price of Salmon fish and we see very volatile earnings and
cash flows. Given the low Salmon prices it is not a surprise that the company reported a net loss for Q3 of
2015 of $21.29 million, compared to a loss of $2.06m in the same quarter of the prior year.
With volatile earnings over time and current negative earnings, we tried to answer what would AquaChile
earn in a normal year. As mentioned before, we expect that earnings will recover quickly to normal levels
(2016).
c. Sensitivity Analysis

EBIT (normalized)

The key drivers for AquaChile are the normalized EBIT and stable growth rate.

15 million
17 million
20 million
3.
a.

Revenue Growth (year 1

10)10%

8%
$ 0.14
$ 0.16
$ 0.19

$ 0.15
$ 0.18
$ 0.21

12%
$ 0.17
$ 0.20
$ 0.24

(Current price
per share = $0.28
and EBIT = 2
million)

Relative Valuation
Summary

We ran regresions against a sample of 10 Packaged Fish companies in order to compare AquaChiles
market price to the sector generally. Enterprise Value to Sales (EV/Revenues) against just one variable,
EBITDA margin, produced the highest R-squared. The EV/Revenues is versatile enough because there are
significant differences in margins across companies.
The resulting equation and its application to AquaChile are reproduced below.

b. Regression Analysis
EV/Total Revenues = 0.39965 + 6.99368 * EBITDA Margin %

Constant
Revenue Growth

Coefficient
0.39965
6.99368

R
R-square

Standard Error
0.25925
1.92962

P-Level
0.16174
0.00674

0.78835
0.6215

Adjusted R-square

0.57419

0.52637

10

Actual EV/Sales
Predicted EV/Sales
Predicted Value /share

T Stat
1.54159
3.62438

0.90x
0.62x
$ 0.12

4. Market Valuation
We regressed AquaChile against the entire market. We used EV/EBITDA, using Damodaran
Onlines January 2015 full market regression equation.
EV/EBITDA= 19.12 + 6.35 g - 3.92 DFR - 18.04 Tax Rate
Actual EV/Sales
Predicted EV/Sales
Predicted Value /share

28x
14.1x
$0.23

5. Final Analysis
a. Summary of Data

Current Price
DCF Value
Sector Regression Value
Market Regression Value

Value
$ 0.28
$ 0.21
$ 0.12
$ 0.23

10

Market Price as % of Value

133%
233%
122%

b. Recommendation
The company is overvalued under all metrics and our recommendation is to SELL Aquachile.
Why it seems so overvalued? We have strong reasons to believe that AquaChile is being under the radar
of larger players. We mentioned before that the industry would likely enter into a consolidation process
and then larger and more consolidated companies can get a better hold of the market. If this is the real
reason, Aquachiles stock price might seem overvalued because of speculation that an acquisition deal is
imminent.

Cinda Asset Management Valuation

Cinda Asset Management was founded in 1999, initially created to help dispose of bad debts on
major Chinese Banks following the Asian Financial Crisis. It is largest of the four state-mandated baddebt banks and the only one to be listed aside from Huarong Asset Management.
Cindas core business is to buy loans from banks and financial institutions at a discount and then
either hold to maturity or renegotiate the terms with the issuing companies. Other than its core distressed
11

debt management business, Cinda has also expanded into brokerage, insurance, commercial banking, and
other asset management services.
Cinda is listed as 1359 HK on the Hong Kong stock exchange, but the majority of its business
(more than 99%) is from mainland China. Since its IPO in 2014, its stock price has fallen to HKD$2.71.

DCF Valuation
Risk Free Rate
GCNY10YR
Yield:
USGG10YR

China 10 Year Bond

3.06%
US 10 Year Bond

Yield:

2.21%

China CDS

1.54%

US CDS

0.34%

Adj. Default Spread

1.20%

CDS Based RMB Rf:

1.86%

1. Cost of Equity = Risk Free Rate +

Lambda * CRP + Beta * (Equity Risk
Premium)
Since the majority of Cindas business is in
mainland China, we will do the valuation in RMB
before converting the implied stock price to HKD.

12

In order to find the cost of equity, we will first find the RMB risk-free rate. Using CDS-implied
sovereign default spreads, we get a RMB risk-free rate of 1.86%.
We also want to find the country risk premium for China (CRP) and the Cindas exposure to that
risk (Lambda).

Country Risk Premium

China Default Spread

1.20%

Equity Market Volatility (360D)

HSCEI Index

25.73%

China Sovereign Bond Volatility

(360D)
10-year Government Bond

11.2%

CRP

2.76%

Equity Risk Premium:

Implied Mature Market ERP

China Export % GDP

6.07%

25.5%

Cinda Overseas Revenue

1.10%

Lambda

133%

Results from
Comparables:

Median
China Beta

We will use HSCEI Index as a measure of

equity market volatility. We chose HSCEI over the
generic HSI Index for all Hong Kong listed firms
because HSCEI exclusively tracks mainland Chinese
firms listed in Hong Kong, which is more appropriate
to our analysis.
Since the management recognizes that there
are effectively 3 separate divisions within the
company distressed asset management, asset
management, and other financial services. We will use
three sets of comparables to find Cindas levered beta.
And, because Cindas distressed asset management
division buys loans mostly from banks, we decided to
use banks as that divisions comparable set.

%Standar
d
Error

Emerging
Market
Beta

%Standar
d
Error

Median P/B
Ratio

Banks

0.93

4%

0.95

2%

1.33

Asset Management

1.56

30%

0.89

7%

2.10

Financial Services

1.21

2%

0.94

4%

1.02

While finding a bottoms-up levered beta for each division, we noticed that there was significant
difference between Chinese and Emerging Market betas, especially for Asset Management and Financial
Services. We speculate that beta for Chinese firms are high due to the equity bubble build-up and the
subsequent collapse this past year. However, we expect this to be an anomaly, so in the long term, levered
beta for Chinese firms will move to the emerging market average.

13

Book Value
Cost of Equity

(RMB 000) P/B

Estimate MV %Weights

Distressed Asset Management

339,425,300

1.3
3

Investment & Asset Management

165,322,100

2.1
0

347,586,201

36%

Financial Services

168,755,100

1.0
2

171,706,645

18%

452,505,860

47%

Total

Re
Year
1

Re
Year
10

11%

11%

15%

11%

13%

11%

13%

11%

Using median P/B values from the three comparable sets, we estimated the approximate market value
for each business division and used them as weights to find the combined cost of equity for Cinda in year
1 and year 10.

2. DCF Valuation FCFE Model

Cinda has grown at a break-neck speed for the past few years. Its total asset has grown by an
average of 45% and its net income has grown 53% yoy in the most recent reporting quarter. To
finance its growth, Cinda has issued new shares every year in addition to taking on more leverage.
The company has consistently re-invested more than its net-income and its capital adequacy ratio has
been falling every reporting cycle.

(Thousands RMB)
Net Income

Dec-312012

Dec-312013

Jun-302014

Dec-312014

Jun-302015

TTM

7,217,136

9,100,972

5,359,903

12,142,749

8,255,662

15,038,508

174,287

245,253

122,627

288,262

144,131

309,767

7,391,423

9,346,225

5,482,530

12,431,011

8,399,793

15,348,275

Adjustments
+ Operating Lease Expense * (1t)
Adjusted Net Income

14

% YoY Growth

26%

33%

1,806,410

2,815,863

3,571,284

-10,368,648

-14,624,823

-2,183,740

-8,562,238

-11,808,960

1,387,544

% Payout Ratio

-116%

-126%

11%

% Reinvestment Rate

216%

226%

89%

60,884,743

82,762,121

90,778,341

101,863,262

110,555,765

110,555,765

406,054

730,574

1,049,067

3,970,903

6,748,441

6,748,441

60,478,689

82,031,547

89,729,274

97,892,359 103,807,324

103,807,32
4

12%

11%

Dividends Paid
Shares Issued
Net Dividends Paid

Book Equity
- Investment Revaluation Reserve
Adjusted Book Equity
ROE:
Total Assets

254,614,358

Equity/Total Assets

13%

383,785,407 482,155,590

24%

22%

53%

19%

15%

544,427,417 657,957,433
19%

657,957,43
3

17%

We have made several adjustments to Cindas reported numbers. We have added back operating
lease less taxes to its net income and capitalized operating leases as additional debt liabilities. We have
also taken out Investment Revaluation Reserve from its book equity because that figure represents
unrealized gains on available-for-sale securities.
Cindas growth has coincided with the rapid ramp-up in debt in China since 2008, especially in
the private sector. Following the GFC, the Chinese government has turned to credit-fueled growth to
keep up economic activity. In turn, cheap credit has led to less scrupulous lending by the major banks.
However, as economic growth has slowed down nevertheless, many lenders faced trouble meeting its
obligations, leading to an explosion in the supply of bad-debt.
We reasoned that since the Ministry of Finance owns 75% of Cinda and the company has a statemandate to manage bad debt accrued by the major banks, Cinda will continue to soak up the growing
Non-Performing Loans. Using IMF projections and assuming that Cinda will maintain its current
market-share, we estimate the growth of Cindas assets in the following table:

Assumptions in Green
IMF Projections in Red
Calculations in Blue

China
GDP
Growth

RMB Trillion

China GDP

RMB Trillion

Total
Debt to
GDP

Total Debt
15

NPL
%

RMB Trillion

Market Share

RMB T

Total Market for

Bad-Loans

As %Cinda
Assets

Cinda
Assets

2012

8%

53.4

91.4

171%

0.95%

0.87

29%

2013

8%

58.8

107.5

183%

1.00%

1.07

36%

2014

7%

63.6

122.9

193%

1.25%

1.54

35%

2015

7%

67.9

138.0

203%

1.50%

2.07

35%

2016

6%

72.2

215%

1.75%

2.72

35%

2017

6%

76.6

225%

2.00%

3.44

35%

2018

6%

81.2

235%

2.25%

4.29

35%

2019

6%

86.3

245%

2.50%

5.29

35%

2020

6%

91.8

250%

2.75%

6.31

35%

2021

4%

95.4

250%

2.75%

6.56

35%

2022

4%

99.3

250%

2.75%

6.82

35%

2023

4%

103.2

250%

2.75%

7.10

35%

2024

4%

107.4

250%

2.75%

7.38

35%

Of course, this method requires

making various assumptions, but given the
lack of historical information and no
management guidance with regards to bad-loans acquisition growth, we believe this is the most
reasonable estimate of Cindas future decisions.
Before calculating for Free Cash-Flow-to-Equity, we need to account for two other variables
reinvestment rate and return on equity. Since we have already estimated for Cindas total assets, we can
use equity-to-total-assets ratio to back-track how much Cinda needs to reinvest in equity each year. As
mentioned previously, Cinda has been both issuing shares and levering up to support its asset growth.
However, Cindas leverage is limited by PRC regulation to maintain at least 12.5% equity for major
financial institutions. Thus, we assume that Cinda will continue to lever up to the regulatory minimum
before coming back to present levels.
Asset
Managemen
t

Financial
Services

Cindas overall ROE at 15% is significantly below

industry average, and even below its direct
competitor Huarong, the 2nd largest state-owned
Emerging Markets
15.29%
19.89%
17.98%
distressed asset management firm, whose ROE is
China
17.14%
20.02%
18.81% at 19%. However, when we separate Cindas
business divisions, we notice that it is its new
Cinda
21.74%
7.66%
10.38% entry into (non-distressed) asset management and
financial services that is dragging its overall ROE.
In the medium term, we assume that Cindas recent expansions into asset-management and financial
services will catch up to industry averages to achieve around 18% ROE before falling to equal cost of
capital in stable growth.
Return-on-Equity

Banks

16

DCF (Million
RMB)

Sum of PV:
Total Assets

Equity Value:

Equity/Total Assets

TTM

12/31
/15

12/31
/16

12/31/
17

12/31/
18

657,9
57

724,5
00

951,0
32

1,205,
693

1,503,
108

17%

16%

15%

14%

13%

110,5

115,9

142,6
55

181
%

Shares Outstanding (million):

Book
Equity Share
Implied

56 (RMB):
20
Price

116

RMB to HKD (Current): %

Reinvestment Rate

12/31/
20

12/31/
21

12/31/
22

12/31/
23

12/31/
24

883

2,208,
406

2,296,
742

2,388,
612

2,484,
156

2,583,
523

13%

13%

15%

17%

19%

19%

168,79
7

195,40 240,61
4
5
$2.67

287,09
3

344,51
1

406,06
4

471,99
0

490,86
9

131%

103%

$1.20141%

116%

125%

118%

113%

30%

30%

Implied Share Price (HKD):

12/31/
19

96,8981,850,
96,898
36,257

Stable

19%

$3.21

15,3 (HKD):
14,77 20,03
Current Stock Price
0

25,72
8

32,03
$2.80 40,16
1
9

45,83
9

52,32
9

58,29
2

63,63
5

61,54
4

63,55
3

FCFE:

1,38
8

2,328

16,22
7

7,847

1,094

16,52
8

7,199

13,21
9

10,27
4

8,334

43,28
5

44,69
8

%ROE

15%

15%

16%

17%

18%

18%

17%

16%

15%

14%

13%

11%

18.8
%

35.6
%

28.4
%

24.5
%

25.4
%

14.1
%

14.2
%

11.4
%

9.2%

-3.3%

3.3%

13%

13%

13%

12%

12%

12%

12%

12%

11%

11%

11%

2,190

12,73
1

5,468

-678

9,131

3,551

5,833

4,062

2,958

13,81
5

129,6
86

Net Income

Implied Upside:

48

%Net Income
Growth

Cost of Equity:

13%

Present Value:

15%

From our DCF valuation, Cinda should be trading at HKD$3.21, which implies a 15% upside on
the current stock price. However, because FCFE is negative for most of the growth stage, this model is
very sensitive to the stable-stage variables that determine the terminal value. So, we will run a sensitivity
table for stable stage growth and cost of equity. The sensitivity analysis shows that there is a large
variance to price as cost to equity changes.
Stable Stage Growth
Stable

$3.21

0%

2%

3%

5%

6%

8%

Stage

7%

6.62

6.73

6.85

6.97

7.08

7.20

Cost

9%

4.43

4.51

4.60

4.68

4.76

4.84

of

11%

3.07

3.13

3.20

3.26

3.32

3.38

Equity

13%

2.16

2.20

2.25

2.30

2.35

2.40

15%

1.51

1.54

1.58

1.62

1.66

1.70

In addition, we will also check the sensitivity of our valuation to the two assumptions made when
calculating Cindas total asset growth %NPL Growth in China and Cindas market-share in distresseddebt management. This analysis shows that Cindas price could plummet due to either increased
17

competition in the sector or a spiraling deterioration of debt quality that overwhelms the Cindas ability to
absorb them.
Cinda Bad Debt Market Share
$3.21

20%

23%

26%

29%

32%

35%

-0.05%

2.25

2.56

2.82

3.02

3.17

3.25

%Bad

0.10%

2.51

2.82

3.06

3.23

3.33

3.36

Loan

0.25%

2.64

2.92

3.12

3.23

3.26

3.21

Growth

0.40%

2.68

2.92

3.06

3.10

3.04

2.88

0.55%

2.67

2.84

2.91

2.85

2.68

2.40

0.70%

2.60

2.70

2.68

2.52

2.22

1.79

3. Sector Regression Price-to-Book Ratio

We will use price-to-book ratio to do relative valuation because more than other sectors, profitability
of financial services firms are driven by their financial assets, which are often marked-to-market on the
balance sheet. We ran regression against 275 global financial services firms including banks, asset
managers, brokerages, and other distressed-debt managers. Despite trying a variety of different variables,
from beta to payout ratio to different growth metrics, it was difficult to achieve a high R-squared. We
suspect this is because of the diverse range of financial services firms, but since Cinda was involved in so
many different aspects of finance, we had to use a broad definition.
After comparing different regressions, we found that Return-on-Equity, Reinvestment Rate, Cost of
Equity, 3Yr Asset Growth, and a dummy Emerging-Market variable gave the best P-value and highest Rsquared. The table below shows the regression results:

Sample Size:

275

Regression Stats:

R-squared
3.22

Term

Cinda

41%
Coefficient

Constant

R-sq(adj)
39%
Standard Error

R-sq(pred)
34%
P-Value

1.56

0.79

0.05

ROE

15%

0.17

0.02

0.00

RIR

89%

-0.05

0.02

0.00

Cost of Equity

13%

-0.11

0.05

0.04

3Yr Total Asset Growth

45%

0.08

0.01

0.00

EM (Dummy Variable)

-1.47

0.55

0.01

Expected P/B

0.05x

Actual P/B

0.77x
18

DCF Implied P/B

0.88x

Based on the regression, Cinda should have a Price-to-Book value of 0.05, but its actual Price-toBook ratio is currently at 0.77. The disparity is mostly due to Cindas extraordinarily high Reinvestment
Rate at 89%. According to the regression, the market is punishing firms in the financial services sector for
reinvesting too much and not giving back to equity investors. Even if the 0.05 regression result seems too
low, the data overwhelmingly suggests that Cinda should trade at a very low P/B multiple.

Price-to-Book Ratio Historgram

36 35 39

28
20

14

12 15

If we look at a histogram of all

P/B ratios in our sample, Cinda is already trading at left-end of the range (0.77x). Thus, the regression
result may not necessarily conflict with our DCF valuation, which implies a P/B of 0.88. Even at 0.88x
P/B, Cinda is still trading at the left-tail of the P/B range where only 5% of the companies in our sample
are trading at that level or below.

4. Market-Wide Regressions
Here, we will use Damodaran January 2015 Online Librarys market-wide price-to-book
regression equation: PBV= 0.61 + 10.24 gEPS - 1.31 Beta + 1.33 Payout + 12.92 ROE

Coefficien
t

Cinda
Constant
g(EPS) Expected

0.61
16.6%

10.24

1.2

1.31

Payout

11%

1.33

ROE

15%

12.92

Beta

Expected P/B

We find that the expected P/B ratio using the

market-wide regression should be 5.97x, much higher
than the other valuation methods.

5.97x

19

5. Conclusion Buy
Methodology

HKD$ per Share

Implied Upside (Downside)

DCF

$3.21

15%

Sector Regression

$0.18

-94%

$21.83

680%

Market-wide Regression
Current Market Price

$2.80

Though the three methodologies give a wide range of value/per share that seemingly do not agree
with each other, we can gain useful insights from each of the three exercises. The sector regression
suggests that Cinda should be trading at significantly lower P/B ratio than the industry average, which is
happening already. Cindas P/B ratio at 0.77x is at the bottom 5% of our sample of 275 financial services
companies. On the other hand, the market-wide regression suggests that, given Cindas high growth and
relatively high ROE, its share price should be trading much higher than its current level. Our DCF
valuation confirms this view: though Cinda should trade at a low P/B multiple, the market has overpunished the company.
Indeed, Cindas credit position has deteriorated and its FCFE has been negative for consecutive
years. However, the reason for levering-up and issuing more equity is not because the company is in
trouble but because there has been a rapid expansion of distressed-debt in China. The explosion in the
supply of NPL from major Chinese banks, according to the IMF, should continue at least until 2020. As
the current market-leader, Cinda is well-positioned to take advantage of the booming market size and
come out of the Chinese debt-crisis with handsome profits. We recommend to buy Cinda Asset
Management.

20

LinkedIn Corporation
1. Company Overview
LinkedIn operates an online professional network through which the Companys members are
able to share their professional identities online, engage with their professional networks, access shared
knowledge and insights, and find business opportunities. The Company is the worlds largest professional
network on the Internet, with approximately 400 million members in over 200 countries and territories.
Competition
LinkedIn holds a dominant position in the professional social network market. However, entry to
barrier is low, as any network with existing user base could develop directly competitive products.
Existing competitors include Viadeao from France and XING from Germany.
Viadeao was founded in 2004 in Paris. It had grown its presence through acquisition into China
(Tianji.com), South America (ICTnet), India (ApnaCircle), and Canada (unyk.com). Based on the latest
available figures from December 2014, Viadeo has 65 million members worldwide. (25 million in China).
XING, a publicly traded competitor based in Germany, has an estimated 35 million users as of
Mid-2014. The company has sizable presence in and only in Germany, Austria, and Switzerland. XING
had exited closed offices in China, Spain, and Turkey back in 2011.
These two products are very similar to LinkedIn but have only regional dominance in certain
markets - Viadeao in francophone countries and select emerging markets. LinkedIn also competes with
online recruiting companies including Indeed and Monster.
Given LinkedIns established and growing user base, and its exhibition of network effect, which
makes its services more valuable as more people use it, I foresee LinkedIn becoming the juggernaut in the
professional social network industry. Achieving global dominance is extremely challenging, but I believe
LinkedIn will guard its position in existing markets, and that it can effectively enter newer markets.
Furthermore, I see LinkedIn displacing traditional online recruiting tools like Indeed and Monster.
Business model
Key value proposition: connection to opportunity
Sources of revenue: Talent Solutions, Marketing Solutions, and Premium Subscriptions
21

Talent Solutions: driven by subscription model

o Hiring solutions for recruiters to access professional databases, post jobs, create
career pages, or to place personalized ads
o Learning & Development individual and enterprise subscription to recently
acquired Lynda.com platform
Marketing Solutions: cost per click or cost per advertisement model; mix shifting to cost per
click; typical duration of advertising contract is approximately two months
o Advertisements (content-based, graphic display, or text link) shown on website and
on mobile platforms
Premium subscriptions: driven by length of contract period (monthly or annual subscriptions)
o Grants users premium features including InMain and visibility to a wider network

2. DCF Valuation
Guided by the professors model-selection template, I elected to use an n-stage FCFF model for a
growth period of 10 years. LinkedIn is a negative-earning, high growth company.
Narrative: LinkedIn will maintain its dominant position in the professional social network space in
countries in which it already operate, and will effectively enter new markets. It will moderately expand
the marketing solutions and sales solutions industry, substantially expand the talent solutions industry, and
have little effect on the online learning & development industry. It will take advantage of network effect
to get a dominant market share, and effectively monetize on its user base through a combination of
freemium + talent solution + marketing solution business model.
Addressable market: 115 billion (Marketing solutions: 45 billion; learning & development: 30
billion; talent solutions: 27 billion; sales solutions: 15 billion; of these markets, Sales solutions and talent
solutions are Sales-as-a-service based, and marketing solutions and learning & development are consumer
web based) [Source: LinkedIn April 2015 presentation]
Given LinkedIns user base of 400 million users across 200 countries and territories, the regional
reach of its existing competitors, and the network-effect nature of the professional social network
business, I foresee LinkedIn capturing the majority of the talent solutions (targeting recruiters and HR
professionals) market. Furthermore, I do not believe there are social network platforms that have the
option of expanding into the professional social network space, since it is unprofessional to combine
personal and professional web-identities. Thus, the threat of, say, Facebook entering the market is limited.
(2/3 of market = 18 billion) In 2014, talent solutions generated 1.3 billion in revenue.
Sales solutions is based on social selling: the process of using professional brand to fill your
pipeline with the right people, insights, and relationships. This solution would target premium-subscribers
and enterprise users. I see LinkedIn capturing half of the addressable market. (1/2 of market = 7.5 billion)
In 2014, sales solutions generated 114m in revenue.
Marketing solutions: marketing to professionals for B2B or B2C considerations. I have trouble
seeing LinkedIn balancing the amount and/or efficacy of advertisements with its clean, professional
platform. I see LinkedIn capturing only a fifth of the addressable market. (1/5 of market = 9 billion) In
2014, marketing solutions generated 455m in revenue.
Learning & development: advancing professional development & e-learning. Currently, this
segment constitutes only Lynda.com. I see an opportunity for LinkedIn to provide an authoritative,
22

standardized e-learning model, allowing professionals to learn through online platforms and be
recognized for their work. However, I think this space is very competitive. (Think of online university,
courser etc.) I will assume LinkedIn can triple its existing revenue of 149m over the next 10 years to
450m.
Target market share: (18+7.5+9+0.45)/115=30.4%
Revenue target by year 10 = 35 billion

a. Inputs

Length of period
Revenue
Rev Growth Rate (CAGR)
Operating Margin
Return on Capital
Reinvestment Rate
Cost of Capital

Growth Period
(10 years of high growth)
10
2,772 million (Base Year)
28.5%
7.0% (Base Year)
20.4% (Year 10)
2.4% (Base Year)
18.2% (Year 10)
188% (Year 1)
19% (Year 10)
10.47%

Terminal year
(Stable Growth)
Forever
34,719 million
2.1%
20.4%
13.13%
16.2%
8.13%

b. Output

Enterprise Value
Equity Value
Estimated Value /share
Current Market Price /share
Price as % of Estimated Value

$ 22,785 million
$ 23,245 million
$ 166.9
$ 230.6
138.2%
c. Commentary

Cost of Capital
For cost of equity, I used the global average unlevered beta for Software (Internet) companies,
with a value of 1.35. Equity Risk Premium was calculated as a weighted ERP based on source of revenue,
arriving at 6.30%. The Company has no straight debt, but does have convertible debt. Its convertible debt
is broken down into straight debt and equity portions, with the former added to debt value of operating
leases to arrive at amount of debt in the capital structure. An actual rating of BB+ was used to compute
cost of debt, giving a pre-tax cost of debt of 4.88%.

23

Riskfree Rate
Equity Risk Premium
Levered Beta
Cost of Equity
Debt/Capital
Tax Rate
Credit Rating
Pre-Tax Cost of Debt
After-Tax Cost of Debt
Cost of Capital

2.13%
6.30%
1.41
11.03%
6.9%
40%
BB+
4.9%
2.9%
10.5%

Key assumptions
Growth rate was backtracked from target market share by year 10; revenue grows at 40% CAGR
in the next 5 years. Used Industry average of 20.41% for target EBIT margin. For sales to capital,
assumed that the company can achieve a ratio of 3.0x in the first year, which is an average for last 3
years sales/capital ratio. Going forward, stepped down to 0.91x, which is the industry average, by year
10.
Other information

Cost of capital after year 10 calculated as risk free rate + 6% considering the company is in a
risky, cyclical business
Return on capital after year 10 at 13%, a premium to terminal cost of capital as I believe LinkedIn
will have long-lasting competitive advantages
Number of shares outstanding incorporates Class A, B, and RSU
Calculated market value of Non-controlling interest based on global industry-average P/BV ratio
of 4.55x
Capitalized R&D; 3 year amortization
Capitalized operating leases

3. Relative Valuation
a. Summary
For relative valuation, I selected a sample of 21 companies. The commonality among these companies is
network effect the more users, the higher the value proposition.
List of companies:
58.com, Angie's List, Care.com, Facebook, Groupon, GrubHub, HomeAway, LinkedIn, Match Group,
MeetMe, Momo, Renren, RetailMeNot, Shutterstock, SINA Corporation,
Spark Networks,
TripAdvisor, Twitter, Yelp, YY, and Zillow Group
To decide on what multiple to employ, I examined regression results for various multiples using different
methods. Given the small sample size, I chose to have only one dependent variable. Multiples being
evaluated were 1-year forward multiples, and NOPAT margin and growth rates were 1-year forward24

looking as well. Certain samples were eliminated in the process of running the regression due to either
missing data point or outlier data point. Note: All regressions were run using 0-intercept.
Independent
Variable
EV/Revenue
EV/Revenue
PEG
EV/EBITDA

Dependent
Eliminated
Sample Size
R^2
Variable
samples
NOPAT Margin
1
20
0.11
NOPAT Margin
8
13
0.75
2-year Beta
7
14
0.48
Revenue
5
16
0.73
Growth
EV/EBITDA
EBITDA Growth
5
16
0.35
Given the tradeoff between sample size and significance, I elected to use EV/EBITDA with Revenue
growth.
b. Regression Analysis
LinkedIns EV/NTM EBITDA

31.5x

High
75% Percentile
Median
25% Percentile
Low
Mean

35.0x
22.1x
19.5x
13.6x
1.5x
18.0x
EV/NTM EBITDA = 0.7023*(Expected revenue growth, NTM)

Note: 10% growth entered as 10

Revenue Growth
S = 10.72

Coefficient
0.7023

R-Squared = 0.73

Actual EV/NTM EBITDA

Predicted EV/NTM EBITDA
NTM EBITDA
Predicted EV
Predicted Value/Share

Standard Error
0.1097

T Stat
6.40

P-Level
1.19E-5

Adjusted R-Squared = 0.67

31.5x
22.5x
$943 million
$21,218 million
$155.4
c. Value/user study

I sought to replicate the Professors study on how social media companies are valued. User data
are most recent data extracted from 10Q or 10Ks. I attempted to standard measure of number of users by
identifying which, among the many metrics that a company provides, is fundamental to the companys
revenue generation. For most companies, Monthly Active User was used. All figures are in millions
Company
Name

Market
Capitalization

Enterprise
Value

LTM Total
Revenue
25

LTM EBITDA

Number of Users
(millions)

TripAdvisor
LinkedIn
Zillow Group
Facebook
HomeAway
Yelp
Groupon
Match Group

11,987.7
31,387.3
4,590.2
295,186.0
3,382.7
2,305.2
1,867.4
500.2

Correlation
Matrix
Market Cap
Enterprise
Value
LTM Revenue
LTM EBITDA
Number of
Users

Market Cap

11,589.7
29,439.7
4,283.5
279,478.0
2,802.0
1,936.2
1,160.3
410.0

1471.00
2772.40
567.60
15938.00
485.30
505.90
3235.10
991.90

Enterprise
Value

1
0.9999

0.9844
0.9958
0.9804

0.9842
0.9958
0.9808

LTM
Revenue

366.0
229.5
(15.7)
6,655.0
61.4
16.2
85.8
260.5

350.00
100.09
142.12
1550.00
90.67
168.14
48.64
59.00

LTM EBITDA

Number of Users

1
0.9815
0.9538

1
0.9853
1

Running a simple regression, putting y-intercept as 0, gives the result

Enterprise Value = 169.95*Number of users (in millions)
Predicted enterprise value = $17,011 million
Predicted Value/Share = $124.50
4. Market Valuation
I elected to use the US company, EV/Sales multiple. I would have preferred to use the multiple with
highest R^2 data, but LinkedIns lack of certain data points (e.g. Payout ratio, negative Net Margin)
prevents the usage of more predictive multiples. I chose not to use EV/EBITDA due to its 3.8 R^2.
EV/Sales = 1.17 + 1.40 g+ 6.35Operating Margin + 5.26 DFR- 0.10 Tax rate
Actual EV/LTM Sales
Predicted EV/Sales
Predicted Value /share

10.2x
2.37x
$47.91

5. Final Analysis
5.1 Summary of Data
Current Price
DCF Value
Sector Regression Value
Value Based on Number of
Users
Market Regression Value

Value
$ 230.6
$ 166.9
$155.4
$124.50

Market Price as % of Value

$47.91

481%

Recommendation

138%
148%
185%

Hold

26

LinkedIn appears over-valued under all metrics. I would not read too much into the market regression
value since given LinkedIns money-losing, high growth nature. However, given the pricing game played
in the social network space, I would not be comfortable shorting the stock unless I am sure of an
upcoming catalyst. (E.g. Lower-than-expected user or topline growth) My final recommendation is hold.

27

GrubHub Inc.
1. Company Overview
GrubHub Inc. provides an online and mobile platform for restaurant pick-up and delivery orders
in the United States. The company connects approximately 35,000 local restaurants with diners in
approximately 900 cities. It operates GrubHub and Seamless Websites through grubhub.com and
seamless.com. The company also offers GrubHub and Seamless mobile applications and mobile Websites
for iPhone, iPad, and Android devices; and Seamless Corporate program that helps businesses address
inefficiencies in food ordering and associated billing.
(Services, High Growth)

2. DCF Valuation
2.1 Cost of Capital
Because GrubHub is only in one line of business, and derives all of its revenues in the United
States, it was relatively easy to calculate the Cost of Capital. We used a composite unlevered beta of
internet software and restaurant industries, in order to reflect GrubHubs exposure to the risk of each
industry. We approximated the stable growth cost of capital based upon the average cost of capital for
mature companies. GrubHub has no conventional debt and only minimal lease commitments. We used a
synthetic rating based upon interest coverage ratio to estimate its cost of debt. We used the implied equity
risk premium from Damodaran Online.
Riskfree Rate
Equity Risk Premium
Tax Rate
Beta
Equity Risk Premium
Debt/Capital
Interest Coverage Ratio
Synthetic Credit Rating
Pre-Tax Cost of Debt
Cost of Equity
Cost of Capital

2.13%
6.11%
40%
1.12
6.11%
0.79%
161x
AAA
2.4%
9.00%
8.94%

2.2 DCF Model

28

We implemented a 3-stage FCFF discount model because the firm is still in high growth. The
inputs for the high growth and stable growth periods are listed below. The interim 5-year period sees a
gradual transition down to stable growth levels in terms of growth, cost of capital and return on capital.
Length of period
Growth Rate
Revenue
EBIT (1 t)
Operating Margin
Tax Rate
Return on Capital
Reinvestment Rate
Cost of Capital

High Growth
5
26.15%
$ 422,831.07 million (Year 1)
$ 63,804.03 million (Year 1)
18.63%
40%
17.81%
109.38%
8.94%

Stable Growth
Forever
2.13%
$ 1,878,216.45 million (Year 11)
$ 281,743.47 million (Year 11)
15.00%
40%
6.5%
30.77%
6.50%

2.3 Output
Terminal Value (Year 10)
Enterprise Value
Equity Value
Estimated Value /share
Current Market Price /share
Price as % of Estimated Value

$ 2,600,607.29
$ 1,295,607.45 million
$ 1,592,231.63 million
$ 17.88
$ 24.43
136.62%

2.4 Commentary
Revenue growth and terminal year after-tax margin (ATM) are important drivers of value, but
difficult to predict. GrubHub describes their market as the $70 billion per year restaurant take-out market.
We revised this figure down to $35 billion to reflect our belief that GrubHubs current business model
only works in dense urban areas. Although GrubHub is the clear leader in its space, it only earns a small
percentage of each sale for its service and therefore will not be able to achieve a huge market share. We
assumed that they would get to 2% of domestic urban take-out by year 5 and 3% by year 10. We also
believe that the operating margin will erode due to increased competition. As the number of comparable
firms increases, restaurants will have to ability to shop for the take-out platform that charges them the
lowest fees. Still, GrubHub has a substantial competitive advantage at the moment because it has the
biggest base of restaurants and users, which should allow it to keep relatively high margins for the
foreseeable future.

2.4 Sensitivity Analysis

Because are difficult to predict, we looked at sensitivity of our valuation to changes in each.
Ultimately we are comfortable with the inputs we selected, for the reasons discussed above.

10%
15%
20%

Terminal ATM

Revenue Growth (year 15)

21%
$ 10.01
$ 14.53
$ 19.06

26%
$ 11.56
$ 17.88
$ 23.64
29

31%
$ 13.41
$ 21.26
$ 29.11

* Current: Terminal ATM = 15%, Revenue Growth = 26%

3. Relative Valuation
3.1 Summary
We ran regresions against a sample of 77 Internet service companies in order to compare
GrubHubs market price to the sector generally. It was difficult to find a regression with a materially high
R-squared, because many of the companies in the sample are money losing companies. After regressing
Enterprise Value to Sales (EV/Sales) and Price to Book Value against a number of different variable
combinations, ultimately a regression of EV/Sales against just one variable, Expected Revenue Growth,
produced the highest R-squared. The resulting equation and its application to GrubHub are reproduced
below.

3.2 Regression Analysis

EV /Sales=2.1561+ 0.0978( Expected Revenue Growth)

Constant
Revenue Growth
S = 2.42943

Coefficient
2.1561
0.0978

R-Squared = 0.39265

Actual EV/Sales
Predicted EV/Sales
Predicted Value /share

Standard Error
0.34476
0.01404

T Stat
6.25385
6.96331

P-Level
2.24038E-8
1.08776E-9

Adjusted R-Squared = 0.38455

5.21x
4.71x
$ 22.31

4. Market Valuation
We regressed GrubHub against the entire market. For consistency, we again used EV/Sales, using
Damodaran Onlines January 2015 full market regression equation.

EV /Sales=1.17 +1.40 g+ 6.35(Operating Margin )+5.26 DFR0.10 Tax rate

Actual EV/Sales
Predicted EV/Sales
Predicted Value /share

5.21x
5.70x
$ 26.23
30

5. Final Analysis
5.1 Summary of Data

Current Price
DCF Value
Sector Regression Value
Market Regression Value

Value
$ 24.43
$ 17.88
$ 22.31
$ 26.23

Market Price as % of Value

136.62%
109.50%
93.14%

5.2 Recommendation

GrubHub seems overvalued under all metrics except the full market regression. This full market
regression seems probably the least important; especially given that GrubHub is overvalued compared to
its sector. The DCF value is likely the most accurate: Even if the driving estimates prove to be
pessimistic, GrubHub still may not be a good value at the current price because its value only exceeds the
current price in one of the nine scenarios considered.

For these reasons, our recommendation is to SELL GrubHub.

31