The article I'd like to discuss, entitled, "Snapchat's Revenue Gap is an Opportunity"1, was a very interesting read, and was full of concerns as to the validity of the arguments made.
Back to the article, the author argues that the relative ARPU (average revenue per user) to total stock valuation of Snapchat ratio makes Snapchat look like a more attractive buy than Facebook. There are several troubling aspects to this claim. First, let’s discuss ARPU. This is a typical metric in SaaS, social media and other internet driven businesses. It is calculated as follows:
ARPU = Monthly Recurring Revenue / Total Number of Users4
Total revenue is straightforward—however, how is an Average User (or Unit in some cases), defined? For example, does this number consider a rolling average during the period that revenue is determined, or is it perhaps a snapshot in time? What about users with multiple accounts, that represent just one user? Or, consider the fact that “total number of customers” is a very macro metric and may not represent outliers, exclusions or other factors.
Secondly, the article leads one to believe that the ratio of ARPU to stock market value is referring to market capitalization, but it does leave room for assumption.
Thirdly, why is the ratio of ARPU to Market Cap relevant? Let’s look at the figures. Snapchat is said to have an ARPU of $2.17, whereas Facebook has an ARPU of $27.35. Snapchat’s market capitalization is $15.59B3 as of today, and Facebook sits at $554.65. Therefore, we’re comparing a ratio of 7.9% for SnapChat vs. 4.9%. The article presupposes that a higher ratio indicates better performance—but what is this anchored in? It leaves much to the imagination. The article does not give any real insight into a wider swath of these ratios outside of Snapchat and Facebook, leaving one to wonder how relevant the comparison is.
Lastly, the article really doesn't delve into any of the standard metrics such as RoE, EPS, etc. to determine true valuation comparables.
To the writer’s credit, they do determine at the end of the article that SnapChat has a few issues that may discredit the core idea of the article, and that as usual, it’s about execution of business that will really win the day.
1https://www.bloomberg.com/news/articles/2017-12-04/snapchat-doesn-t-look-insanely-valued-relative-to-facebook
2https://www.investopedia.com/articles/investing/061915/how-snapchat-makes-money.asp
3https://www.marketwatch.com/investing/stock/snap
4https://www.chargebee.com/resources/glossaries/saas-metrics/arpu/
Big Tobacco Valuation - Big Missing Piece
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The report/analysis I read was on Altria Group, the largest domestic tobacco manufacturer. I'm a shareholder in the company, so I'm always curious about the news surrounding it's value and the pulse on the future of the company. The report was titled "Altria - A $62 Discount Cash Flow Valuation" - the writer worked up his own DCF valuation for the company.
Starting with a positive, he mentioned the huge tax benefits the company received from the president's Tax Reform bill passing in early 2018. The company was previously one of the highest corporate tax payers at ~33% before, and now has an estimated effective tax rate of ~23%. Getting this number correct significantly increased the free cash flows from FY 2017 to FY 2018.
Performing a DCF valuation vs. a different type is, in my opinion, the error the writer made here. By performing this type of valuation, he did not include the company's 10.2% ownership stake in AB InBev that drives big income year after year. As we've learned so far in the course, a DCF valuation isn't the right choice for companies with high cash investments. Cash investments are treated as a bad thing in DCF, as it reduces free cash flow every time an investment is made. This cash investment into AB InBev by Altria is significant, and would certainly increase the 'estimated value' put forth in this report.
An additional error is his assumption of 2% net working capital. Correct valuations can never be based off of what we assume will happen in the future. His reasoning for it seems off as well, saying that because Altria has had "excessively negative net working capital in 2017... the company has to make working capital investments in the coming years." While he does state in the report that it's difficult to forecast, I didn't see any research presented on how he arrived at the figure for his valuation, or why he believes they "have" to make capital investments soon. It's possible the company can go several more years without needing to invest in new manufacturing equipment or facilities and survive.
Article Link: https://seekingalpha.com/article/4178405-altria-62-discount-cash-flow-valuation
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