Rosetta Stone - Pricing The 2009 IPO

Rosetta Stone: Pricing the 2009 IPO
Advantages of Going Public

The financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to
fund research and development, fund capital expenditure, or even used to pay off existing debt.
Another advantage is an increased public awareness of the company because IPOs often generate publicity
by making their products known to a new group of potential customers. Subsequently, this may lead to an
increase in market share for the company.
The increasing liquidity also allows the shareholders, for example, private equity investors and executive
officers to diversify.
Disadvantages of Going Public
One of the most important changes is the need for added disclosure for investors. In addition, public
companies are regulated by the Securities Exchange Act of 1934 in regard to periodic financial reporting,
which may be difficult for newer public companies. They must also meet other rules and regulations that are
monitored by the Securities and Exchange Commission (SEC).
More importantly, especially for smaller companies, is that the cost of complying with regulatory
requirements can be very high. Some of the additional costs include the generation of financial reporting
documents, audit fees, investor relation departments, and accounting oversight committees.
The equity holders become more widely dispersed. This makes it difficult to monitor management.
Fund Raising
Rosetta Stone sells 6.25 million shares in the price range of $15 to $17 per share, which means it raises
$93.75 million to $106.25 million.
There are several alternative approaches for Rosetta Stone to raise capital from the market. Generally, two
methods can be applied: equity financing and debt financing.
Speaking of equity financing, Rosetta Stone can turn to private equity investors for a later round of fund, or
it also can search for a strategic investor who would like to acquire a portion of equity.
On the other hand, Rosetta Stone also have the option of debt financing, including issuing bonds and
applying for loans from banks.
Use of Proceeds
Repay the outstanding balance under the credit facility (Approximately $9,9 Million)
Make stock grants to 10 of key employees including executive officers
Fulfill the tax obligations
Use for working capital and other general corporate purposes, which may include the acquisition of
other businesses, products or technologies
Amount of shares sold
Primary shares: Rosetta sells 3.125 million newly issued shares
Secondary shares: 3.125 million shares owned prior to offering (major stakes offered by entities affiliated
with ABS Capital Partners (1,89 Million) and Norwest Equity Partners VIII (1,24 Million), see Exhibit 9).
The underwriters severally agreed to purchase (Rosetta Stone and Selling Stockholders agreed to sell) ≅
4.09 Million shares
Selling Stockholders granted to underwriters an option (Greenshoe Option) to purchase a maximum of
612,750 additional (secondary) shares of common stock at the IPO price, exercisable for 30 days after the
IPO, less underwriting discounts and commissions (underwriters are not obliged to take or pay for over-
allotment option’s shares)
The case suggests that the number of shares offered by Rosetta is low when compared to the demand of
the market, emphasising that Morgan Stanley reported “that the book was more than 25 times
oversubscribed” (p7) implying that for every share offered by Rosetta, 25 shares were being ordered.
Is the moment of introduction chosen wisely?
Rosetta’s IPO is planned for 2009, only one year after 2008 which was a period of deep economic turmoil
(collapse of financial markets, significant deterioration of global economic activity).
Valuation of worldwide language learning industry exceeded $83 billion (self-study learning being
responsible for more than $32 billion). The US market (where Rosetta made 95% of its revenue) was $5
billion for total language learning and $2 billion for self-study learning. Language learning market was
expected to grow in the future.
Impressive financial performance by the company (52% revenue growth in 2008 despite the economic
contraction, see Exhibit 7).
In early 2009, Rosetta was considered one of the most recognized language learning software brand
globally.
Company’s structure and organization prepared for years for public introduction by senior management.
Current Investors and Their Motivation
The IPO of Rosetta Stone creates value to its current investors, ABS Capital Partners and Norwest Equity
Partners VIII, both of which co-led major private equity investments in Fairfield Language Technologies,
the predecessor of Rosetta Stone in January 2006.
ABS general partner Laura Witt has served as chairman of Rosetta’s board of directors, while ABS
managing general partner Phillip Clough and Norwest managing partner John Lindahl also gain board seats
as director.
In its S-1 filing on September 23rd 2008, Rosetta Stone points out that ABS Capital owned around 44% of
the company, while Norwest Equity accounted for 28.7% prior to IPO. Following the IPO, those stake will
fall to 28% and 18%, respectively. Half of the shares (3,215 million out of 6,25 million, see Exhibit 9)
offered in IPO are being sold by selling stockholders, i.e. ABS Capital Partners and Norwest Equity Partners
VIII.
The Bookrunner and Its Incentives
S-1: “Under the terms and subject to the conditions in an underwriting agreement, the underwriters named below, for whom Morgan
Stanley & Co. Incorporated is acting as representative(bookrunner), have severally agreed to purchase, and we and the selling
stockholders have agreed to sell to them, severally, the number of shares indicated below:”
The bookrunner gains a significant proportion of profits for taking charge of the underwriting process. During this period, the lead
underwriter bagan to form the underwriting syndicate.
The selling agreement grants the power of attorney to the lead underwriter, and stipulates (a) the management fee that each syndicate
member are required to pay the bookrunner, (b) the share allocation, (c) the fixed reallowance, or concession, for each share sold.
The primary responsibility of the lead underwriter is to head the negotiation of final offering price, which will also determine the
compensation level syndicate members obtain from the issue.
DCF Analysis
To carry on the DCF Analysis we took into consideration the projections in Exhibit 8, covering a 10-years-
period (2009-2018)
DCF Analysis
To integrate and complete the DCF Analysis we computed a WACC to discount the Free Cash Flows to the
Firm.
We took into consideration the Capital Structure of Rosetta Stone Inc. as in 2008 (E/EV equal to 88,86%
and D/EV equal to 11,14%).
Since we decided to use as a Risk Free Rate the 30y Government Bond Yield (of 30/01/2009) equal to
3,58%, we had to use a Risk Premium of 6,5% (as stated in the first paragraph of Page 2 of the the case).
For the 𝛃 of Equity, we analyzed comparable firms, computed their unlevered betas, and took the median
value (0,59), and relevered it accordingly to the capital structure of Rosetta, obtaining 0,66.
For the Cost of Debt we decided to use the prevailing borrowing rated faced by Rosetta Stone Inc. in the
debt market, equal to 7,5%.
We obtained a WACC of 7,53%
DCF Analysis
Further assumptions have been made regarding the Terminal Growth Rate. We chose a value of 3% because
we believe the potential of the company doesn’t justify an higher growth rate.
With all the assumptions previously mentioned, we obtained a Share Price of $47,08 (with 17,19 Million
shares outstanding), and hypothetical Discounted Share Price at issuance of $40,02. We decided to compute
this value too because we know that at IPO companies are used to underprice their own shares (typical
discount of 15%) in order to be able to choose their own investors → this is clear from the fact that the
underwriters maintained orders for 25 shares for every Rosetta Stone share being offered in the deal.
The price we obtained with the DCF method, much higher than the proposed price range of $15-$17, is
probably a consequence of the fact that the projections on which the analysis is based are particularly
optimistic about the future of the company.
Multiples Approach
In the Multiples Valuation we decided to analyze the comparable companies operating in the same industry
of Rosetta Stone Inc., with particular attention to K12. This company is probably the closest comparable in
terms of growth, debt outstanding and industry. Furthermore, the K12 EV/EBITDA multiple result to be the
median value of the sample.
Multiples Approach
Given the EBITDA of Rosetta Stone Inc. equal to $34,63 Million in 2008, using the 13,4x multiple we
obtained an Enterprise Value of approx. $464 Million. With a $9,91 Million of Debt, the Equity Value is
equal to $454 Million.
The Equity per Share is equal to $26,42-per-share. The Discounted Share Price (15% discount) is equal to
$22,45.
The value we obtained with the Multiples approach is much closer to the suggested share price range $15-
$17. It means that estimating the share price through the actual data of the company (2008 EBITDA) and
the data of comparable companies in the same industry seems to be more reliable than the DCF method,
given the high number of assumption that method requires.
Suggested Stock Price
We think the price range chosen is fair, given the fact that the Multiples Approach provided a valuation quite
close to that price. Therefore, the money left on the table seems to be a reasonable amount, also because of
the particularly negative condition of the IPO market (underpricing increase with uncertainty).
Investment Suggestions
POSITIVE SIGNS RED FLAGS
● The company is going public in an extremely ● The IPO market is at an historic low level
negative period for IPOs, this means that there’s
strong confidence on the financial solidity of
Rosetta Stone ● Newly issued shares (usually) underperform the
market over long-term horizon (29%
underperformance over 3 years)
● The “roadshow” created significant excitement
around Rosetta’s IPO
● The advent of new technologies and smarter ways
to interact (iPhone launched in 2007) could
● From our analysis, the IPO price is going to undermine the success of Rosetta’s product
embed a consistent underpricing, therefore with a
strong possibility of an initial price increase
Would we invest in the IPO?

YES
BUT mainly as a short-term investment

Rosetta Stone - Pricing The 2009 IPO

Uploaded by

Copyright:

Available Formats

Rosetta Stone - Pricing The 2009 IPO

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Rosetta Stone - Pricing The 2009 IPO

Uploaded by

Copyright:

Available Formats

Rosetta Stone: Pricing the 2009 IPO

Advantages of Going Public

Would we invest in the IPO?

You might also like