Assuming that you have access to no financial products such as FactSet, Bloomberg, CapitalIQ, Thomson or otherwise, we thought it would be helpful to give a step by step guide on how to ramp up on a new company from your home computer. Using FaceBook as an example, lets go ahead and start with the website you will visit the most when you start your job on Wall Street (be it investment banking, research or otherwise).
1) SEC Filings and Understanding the Story
The 424B: This is the best spot to start if you’re looking for a long history on the company, grab the first equity raise (IPO) by simply going to this link:
http://www.sec.gov/edgar/searchedgar/companysearch.html
Type in FB for the ticker then enter 424 as your filing. Note, you can search for S-1 documents as well to get a longer history, however IPO price, total raise etc. will not be shown on the cover (page 1 where the banks are shown as well). The good news is you can likely get a few more quarters of back dated information by looking at older S-1’s.
Prospectus Summary & The Offering: Here you will get a “snapshot” or quick view of the Company. Read the entire section. You should write down the key metrics they use to measure success (monthly users, daily users, reach, likes, comments, mobile vs. desktop views etc.). You’ll get a good backdrop here and you can boil down some of the key high level themes. To save you some time the basics are: 1) User Growth, 2) Activity of Users, 3) Monetization of Users. You can take a deeper dive into any company and of course there is more to the story than the three simple points, but now you have a concise understanding of the main tenants of the story.
Once the story is laid out continue reading and you’ll get an idea for how the company delivers value to its advertisers (reach, relevance, social context and engagement). More importantly as you read on you’ll come across a section that summarizes the market opportunity “According to an IDC report dated August 2011, total worldwide advertising spending in 2010 was $588 billion”. (Note: This is not the same for every single sector, take a look at Pfizer and you’ll see the focus is quite different)
Next as you move to the tail-end of the section you get an idea for “risks to the story”, in simple terms, things that could go wrong. Essentially the negatives would be 1) unable to monetize for advertisers, 2) stagnation in user engagement or user growth 3) privacy concerns and the usual speech on issues with being a public company. The section ends with a decent explanation of Zuck’s controlling interest as well.
In summary when you are done with this section you should know 1) the key drivers for the Company, 2) the addressable market or opportunity for the Company, 3) the risks of owning the stock and 4) an idea of the ownership structure
Look Into Revenue Drivers: Now that you understand the basic story. You should search for measurements of these key themes within the filing. Simply put, you are looking for user activity and user growth numbers which should be provided in the filing. Go to the management’s discussion and analysis (page 48 is where it really begins) and you see they take a deeper dive into these metrics. Now you can get all of this information into excel and begin tracking monthly average users (MAUs), daily average users (DAUs), mobile MAUs and engagement levels. (Note: Again this is not the same for all companies, for example if you were ramping up on Apple you would be breaking out line items (iPad, iPhone etc.) by revenue)
Once you have the metrics down, you can start tracking the performance by geography as well. Knowing that the USA is a much more saturated market it would be smart to track growth by geographies, see page 51 and begin tracking this on a go forward basis as well. You now have Average Revenue Per User or ARPU according to the document by region.
Look for Profits: Now that you have an idea of the Company’s business model, top-line growth and revenue generation, it’s time to see how you’re making real cash from the security. Internet companies are generally valued off of EBITDA numbers, again this is different for each sector, some are simply valued off of sales numbers/revenue growth if they are profitless.
Jump to page 64 (quarterly breakouts) and you can now get an idea for the income statement results. Look for seasonality and profit margins (EBIT or operating income). Now that you’ve got an idea for the EBIT number on an annual basis, check the cash flow statement (page 66) and you’ve now got an idea for the EBITDA for the firm, $2B+ for 2011. Before you move on do a quick check on yahoo finance for next year estimates: Facebook Estimates
This also gives you a free glance at consensus estimates for Sales and EPS, so you can quickly calculate the sales and P/E multiples on both an LTM and Next Fiscal Year basis. (Note: It should be stressed that companies are valued differently, be sure to check if your industry is valued on alternative metrics such as P/BV, Free Cash Flow etc.)
Stop and Formulate the Elevator Pitch: At this point you should have decent working knowledge of the Company and likely have some good ideas on comparable companies as well (Linked-in and Google for example) and you can now come up with rough metrics for the firm and pitch the stock.
“Facebook is a ~$65B company that is looking to grow its revenue through increased advertising fees by driving both user growth and user engagement. If the company is unable to grow its user base or is unable to continue monetizing ad space the stock will likely suffer”
2) Build Out Your Model
Now that we know the story well, lets go ahead and build the financial model. To do this lets review the latest earnings print (8-K) to see what information we are working with on a quarterly basis. Before we begin, this is a technology stock so you see they give both GAAP and Non-GAAP numbers, generally speaking for technology you use Non-GAAP numbers because tech stocks have quite a bit of stock based compensation (SBC) expense. The 8-K currently does not breakdown revenue by segment within the IS but does give a slight breakout in the comments.
Q1 2013 Highlights: With the basics out of the way, notice how the items we want to track are also disclosed on the 8-K. Daily active users (DAUs) were 665 million, Monthly Active Users (MAUs) were 1.11 billion; Mobile MAUs were 751 million. In addition the Company does give some breakout of revenue in the Q1 highlights (although exact numbers are not disclosed to the decimal point on the IS. Revenue from advertising was $1.25 billion, representing 85% of total revenue; Mobile advertising revenue represented approximately 30% of advertising revenue; Payments and other fees revenue was $213 million for the first quarter of 2013
In addition, note the other highlights in the most recent quarter: 1) Launched Facebook Home; 2) Instagram reached 100 million 3) Launched new advertising products such as Lookalike Audiences, Managed Custom Audiences, and Partner Categories 4) Partnered with Datalogix, Epsilon, Acxiom, and BlueKai 5) Enhanced ability to measure advertiser ROI through acquisition of Atlas Advertising Suite; 6) Appointed Susan D. Desmond-Hellmann, M.D., M.P.H., (UCSF), to the company’s board of directors.
Revenue: With the basic first quarter out of the way go ahead and build out your three statement model (yes this will take some time), generally at least 5 years of data should be a good starting point. Now you can break out the revenue line item.
1) Notice Q4 has higher revenue followed by a dip in Q1 (seasonality, IE: Q4 generally has a higher net contribution to annual revenue than Q1, Q2 or Q3)
2) Continue to build out the geographic break out (not from the 8-K however disclosed in 10-Q filings so you can track regional ARPU numbers and other metrics, page 19 and 24).
3) While your financial model will simply have a revenue line, continue to track the 10-Q and 10-K filings and you will see that they disclose advertising and payment revenue (page 27).
4) Now break out the numbers we were told Mobile advertising was 30% of advertising revenue, we now know that Advertising revenue was $1.245 billion from the 10-Q so you can break out mobile versus desktop/notebook revenue by applying 30%*1.245B = $0.3735 billion in mobile advertising revenue $0.8715 billion in desktop/notebook
At this point, you have a general break out of revenue and have a top-line number to build out your financial model.
Expense: Read through the expense lines to understand how the items are being broken out starting with COGS which represents the operation of data centers, facility and server equipment, energy and bandwidth costs, support and maintenance costs, salaries, benefits, and SBC associated with such activities. This is followed by 1) R&D which is primarily salaries, benefits and SBC for employees in engineering; 2) Marketing and sales, sales support, marketing, business development, and customer service functions; 3) General and administrative salaries, benefits and SBC for executives as well as legal, finance, human resources, corporate communications and others. Run the numbers as a percentage of sales for now and go through the 8-K to find guidance and long-term plans.
To wrap things up and make sure you have tied all the loose ends on the financial statements, go through the quarterly company slide deck (some companies do not have any) and build out the additional numbers as you see fit. Here’s the link to the deck.
Facebook Deck
You now have an idea for the expense structure on a historical basis and it is now time to turn to building out the future quarterly earnings
Build Out The Model: Finally, now that you have a large set of historical numbers to review and also have information broken out by segment you can start to build out a forward model. The easiest way to get a proxy for forward estimates would be to review the analyst consensus numbers as of now. You can simply check yahoo finance for that as mentioned from part of Step 1.
To keep things simple set up a model that is in-line with consensus, then we can move on to part three where you come up with a differentiated approach. Attached is a more complicated financial model for Apple so you understand how to build a bottoms up model with a detailed breakout by revenue and even gross margins.
3) Coming up with a Differentiated Opinion
The final step is explaining how to come up with a differentiated opinion on the security, again this will vary by company and you’ll have to adjust your process appropriately as no person or firm will view a single security in the exact same fashion. With your financial model in front of you it is time to start digging into management, valuation and sustainable long-term growth.
Management: A significant piece of valuation for securities is within the intangibles. One main intangible is the consistent execution and delivery of a strong management team. The main negotiators and sirens for the firm should deliver a clear message, set expectations appropriately and slightly exceed said expectations. For example if your company has the best operating margins and free cash flow for your industry, you will become an attractive security due to performance alone, however you must set the expectations appropriately. As an example, if you are promising 10% revenue growth in a space where 5% growth is average, you will not be given much credit for delivering 6% revenue growth as you are setting the bar much higher than your results. Even though 6% growth would see investor interest, it would be wise to set the bar at the average (5%) and execute slightly above (6%). This gives the company more credibility and investors will take note.
A good way to gauge the Company’s ability to beat and raise, is to simply review guidance on historical conference calls which can be found in the investor relations section of most company websites
Going with the Facebook example, the management team is still relatively new so you can peg this as neutral to negative unless you have a differentiated opinion of Zuck & Co.
Clean Numbers: As many of you know the income statement can be manipulated quite easily so it is important to look for any accounting discrepancies that could explain a valuation divergence. An obvious but simple one would be comparing Non-GAAP numbers to GAAP numbers, a company that reports solely on a GAAP basis with no history of restructuring charges or other one time events will likely deserve a higher multiple (earnings basis).
Notably, Facebook is a standard Internet tech stock from a financials perspective, so it reports both GAAP/Non-GAAP numbers, most models you find will run with it on a Non-GAAP basis. With this in mind the multiples should be in-line with the peer group.
Glancing quickly through the filings there are no positive or negative moves from a financial statement perspective.
Differentiated Financial Model: Generally speaking, if the company reports guidance that is roughly in-line with actual results on a quarterly basis, consensus numbers will center around the mid-point and your estimates will reflect normal seasonality. Based on your new knowledge and opinion of the space (growth rates of users, demographic shifts, expected products and use cases for the firm etc.) you should have a differentiated financial model. This means your “real” expectations are likely above or below consensus numbers in a meaningful way. This differentiation in revenue growth and earnings power should drive some extra upside/downside to the current stock price.
Peer Group: Here is where many debates arise, by now you know if you approve of the management team and you have dialed in your expectations for the future financial performance so now it is time to decide what multiple the company (Facebook) deserves. You’ll need to look at the comparables (LNKD, GOOG, BIDU etc.). Cutting to the chase in simple terms since this is a basic guide, the best bet is to look at your numbers and decide on the long-term revenue and EPS growth rates. This should then be compared to the peer group where a higher or lower multiple is warranted.
The Final Lap: At this point you’re wrapping up and its time to take a stand on the stock, you have 1) an understanding for management, 2) a strong and differentiated financial model, 3) worked out possible valuation disconnects due to accounting changes, restructuring charges, charge offs or other wise and 4) understand where the Company should trade in your view..
With the grunt work out of the way the final step is coming up with a differentiated metric/opinion/view that the Street may not understand. This is general for a reason, because the final step is always the most difficult. Ask yourself the following questions now that the numbers and management team are out of the way, again focusing on Facebook as the example:
1) Will new products and services for Facebook be more margin accretive?
2) Is the total addressable market under/over estimated, why?
3) Is there a competitive monopolistic/duopolistic environment?
4) How could your current thesis be entirely wrong (write down all reasons)?
Notice the final step is open ended, given that this is a basic guide if you are able to go all the way up to the final step you will be in great shape for interviews and understanding the basics of finance when you hit the ground running. If you’re able to impress with a non-consensus view then you’ll be more than prepared for the future.
With all of that said if you have questions feel free to leave a comment.
