DocuSign (DOCU)- An LBO Analysis

(Disclaimer: Excel file attached below the post) 

DocuSign has been making strides in the financial world because of Bain and Hellman & Friedman's attempt to take the company private. The deal is still in its introductory stages, and so I was not able to ascertain the offering price, value or even the offered EBITDA multiple given my limited resources. I did, however, come across an article discussing $8B in funding that the investors are seeking, and so I am basing my analysis on that one number alone. This is an educational and hypothetical experiment to solely satisfy my personal curiosity. As is the norm with my posts, I'd like to start off with the company's historic performance, both on a standalone basis and compared to its close competitors as well as some of the most followed indices; I'd like to then move on to the company's business model and its operations, and finally end it with the LBO analysis and what the returns might look like five years down the road. 

DocuSign- Past Performance

DocuSign- Historic Share Price and Volume

DOCU had its IPO in April 2018 at an offering price of $29/ share; stock debuted at $38/ share and held its ground throughout the day. The company sold 21.7 million shares at its public offering and raised $629.3M, bringing its total shares outstanding to 152.1 million at that time. The chart above is pretty self-explanatory in that the stock is relatively stable with the exception of the period encompassing the breakdown. The share at one point during the pandemic was trading around $300/ share, the monumental jump is not surprising when you ponder on the company's business model and its directly proportional relation with the consequences of worldwide lockdowns. DOCU, as I am pretty sure you know, offers applications and software for e-signing contracts and making the process as frictionless as possible; during the lockdowns, when consumers and businesses were unable to conduct their operations in person, everyone relied on companies such as DOCU and Adobe to offer alternative avenues for the entire journey of the contracts: from drawing up papers to tracking various stages of the process and finally signing the papers in the luxury of their own homes. DOCU, along with myriad of other equities and sectors, saw this exponential boost that everyone thought would remain; alas, that was not the case. The stock plummeted soon after things started to get back to normal; personally, I think it is back in the price range where it belongs because without even conducting a valuation, I can say with a fair amount of certainty that the stock is not worth the price tag that it traded at for those couple of years. Lets now move on to how it has faired against some of it competitors.

DocuSign Vs. Comps

DOCU, for the most part of its existence in the public sphere, has been trading on par with its compatriots; the company, along with its competitors, saw the Corona boost we talked about earlier, but unlike most of its close comps, it has not been able to maintain or even attempt to claw back up to its glory days. One of the reasons could be that the company has not been able to maintain its expected growth or even consumers and number of contracts it attained during the pandemic, or that it lost its competitive advantage, or it could also be that other companies such as Adobe and Dropbox have chewed away some of its potential. Lets now compare the company to three of the highly followed indices: S&P 500, Russell 3000, and the Nasdaq.

DocuSign Vs. Indices

I believe, even without being an expert on the company or its sector and sub-category, one could clearly see the implausible growth and attraction attached to the company; I am not dumbfounded, even in the least, at the stock's downfall. I believe that on one hand, pandemic reeled in the lofty, unsustainable, and unjustifiable valuations to reality, but on the other hand, it pumped adrenaline into other undeserving equities, but I guess such are the tantrums of the market. Having gone through DOCU's past performance, the next likely stage to delve a little deeper into is its business model and operations; because I believe it is paramount that we understand the business before we can move onto the LBO analysis.

DocuSign- Business Model and Operations

DOCU is one of the leaders in the e-Signature category. The company offers products and services to not only smoothen the signing stage of the process but also to make other steps along the way as convenient as possible. Its offerings, along with its e-signature product, enable agreements and contracts to be signed electronically on a wide variety of devices, rendering it virtually accessible in 180 countries. Its applications help with the automation, auto-generation, and tracking of agreements and contracts for individuals, small businesses, and major corporations and enterprises. Its value proposition, as its 10K states, is simple, "...eliminate the paper, automate processes, and connect to the applications and systems where work gets done. This allows organizations to reduce turnaround times and costs, largely eliminate errors, and deliver a streamlined customer experience." As of Jan 23, company's services were being used by 1.3 million users across 180 countries around the globe. 

DOCU prides itself in the benefits that its platform and services offer. The company believes that its differentiation is driven by its stringent security standards, high availability, simplicity in its usage, the fact that it is developer friendly, high auditability, and its global presence. The company's offerings allow its customers to conduct their respective businesses faster by replacing manual paper driven processes with automated digital workflows. The company offers following key products:

• DocuSign eSignature
• Main product, enables sending and signing of agreements and contracts on a wide variety of devices
• CLM (Contract Lifecycle Management)
• Allows workflows across the entire agreement process. It provides organizations the flexibility to automate complex processes for generating, negotiating, and storing agreements
• Gen for Salesforce
• Allows sales representatives to automatically generate polished, customizable agreements using Salesforce 
• Identify
• A group of applications that are used for enhanced signer-identification options
• Standards- Based Signatures
• Supports electronic signatures that utilize digital certificates, including those specified in the EU's eIDAS regulations for electronic signatures
• Monitor
• Uses advances analytics to track DocuSign eSignature web, mobile, API account activity across the customer's organization

With a somewhat solid understanding of the company's operations and its business model, lets move on to the LBO analysis. 

LBO

If you are reading this post, I am assuming that you are somewhat familiar with the PE industry and how LBOs typically work along with the related financial jargon. Nevertheless, I would like to take a few minutes and discuss the usual drivers for an LBO. The first one is the insane amount of debt that is levied on the portfolio company, and so investors typically look for companies with stable cash flows; please, don't confuse negative EBIT or NI with cash flows. Additionally, debt is a cheaper form of credit because unlike equity owners, companies only have to pay interest and balloon payments whereas equity holders get a piece of the pie. So one of the main goals is to use the company's excess cash flows to deleverage as quickly as possible throughout the holding period. Second driver would be top line growth and expansion. The expectation is that the company will be able to either maintain its current growth trajectory or expand its market share. The third drive is the reduction of costs, both COGS and other operating expenses such as R&D and SG&A. The reduction in costs will translate into higher gross profit and margins and, consequently, higher cash flows. The fourth driver is the expansion of EBITDA. LBO transactions are typically made in one of two ways: one is when a company is publicly traded and investors offer a price per share, and the other is when the company is privately held and so the transaction takes place as a multiple of EBITDA, our case would be the offering price per share. Lastly, better asset utilization, which means that the new owners will manage to find a way to better control working capital and the deployment of fixed assets. With the understanding of the typical drivers of an LBO, lets move onto our analysis. Below is a snapshot of my assumptions.

As stated earlier in the post, the deal is still in its infancy at best, and so I went ahead and assumed that Bain and Hellman & Friedman will offer a premium of 21% or $75/ share over the stock's price of $62.21 as of this analysis. The offer price gives us an offer value of roughly $17B, which given DOCU's net debt of -$810M, yields an enterprise value of $16B, giving us an EBITDA multiple of 29.3X. DocuSign also has cash and cash equivalents of $1.6B and I expect the investors will use a huge chunk of that cash balance- $1.3B to be exact- to partially offset the debt they'll have to take on. I have additionally assumed the investors will take on term loans A , B, and Senior note of 6X EBITDA, along with Subordinated note of 5X. Lastly, I have assumed transaction fees to be 2% of the offer value and financing fees of $842M for the transaction. Lets move onto the forward looking income statement.  

Starting off with revenues, DOCU reported revenues of $1.4B, $2.1B, and $2.5B for the FYs '21, '22, and '23, respectively; with growth of 45% from FY '21 to FY '22, and 19% from FY '22 to FY '23. In my base case, I expect the new owners and investors to maintain a steady growth rate throughout the next 5 years; from 21% in FY '24 to 25% by the end of FY '28. I believe the growth in revenues will be driven off of several factors: the company's brand, its existing customer base, ability to acquire new customers, expand to other locales and geographies, and finally investing enough to not only enhance its existing products and services but also invent new ways of penetration into other parts of the industry. The company also reported costs of revenue margins of 25% (FY '21), 22% (FY '22), and 21% (FY '23). Costs of revenue consist of  costs for subscription and costs for professional services and other; as a result, I expect the costs to settle somewhat around the same level, 22% of the total revenues in FY '28. I am not expecting a huge reduction in these costs because of their nature, and as the business grows, I expect these costs will grow in line with revenues. The next line items are the operating expenses: R&D, SG&A, and Restructuring and other. Upon inspection of its income statement, it is abundantly clear where most of its revenues dissipate to. Company reported operating expenses of $1.2B, $1.7B, and $2.1B for FYs '21, '22', and '23, respectively, with margins of 86.9% (FY '21), 80.8% (FY '22), and 82.2% (FY '23). Given the nature of the transaction, I expect the new owners to be able to gradually bring down the operating expenses over the next two years where they are only 58% of the total revenues; this might be harder said than done, but it could be achieved with the advent of new technologies such as AI, and reduced headcount. Additionally, I got an adjusted EBITDA of $565M for FY '23- I am slightly off from what the company reported because it is hard to nail down exactly what is recurring and what is the normal course of business. With all of my assumptions in line, here is what the going forward cash flow statement looks like:

Going Forward Cash Flow Statement

The company clearly generates healthy amount of cash flows; my projections show $158M in FY '24 to $1.9B in FY '28. Free cash flows easily allow for mandatory debt amortization, with the exception of first year where I project the company might need to draw on its revolver, but then is able to completely pay off the revolver by the third year, and start to make additional discretionary payments for proposed term loans A and B. Delving deeper into debt service, my model shows me that with the company's operations and free cash flows, new owners, along with making mandatory debt payments for different tranches of debt, will be able to make discretionary payments starting from year 3 and bring down the term loan balances to $1.17B by year 5. Here is what the exit might look like given my transaction and operational assumptions:

Exit Analysis

Assuming the same entry EBITDA multiple at exit, I get an equity value of $57B, a monumental increase from the initial offer value of $17B. If for some reason the owners aren't able to get the same EBITDA multiple at exit, the equity value is still pretty significant even for 26X or 28X EBITDA. On the upside, an exit multiple of 34X gives us an offer value of $66B. Lets look at IRR and MOIC for the assumed lenders and equity sponsors:

IRR and MOIC

 

As is clear from the analysis, all of the lenders and equity sponsors are projected to get healthy amounts of returns. What stands out is the equity owners' IRR at various EBITDA multiples. If we take our conservative assumption and assume that the owners will be able to exit at 30X, that translates into an IRR of 63%, way above, I believe, any PE firm's hurdle rate. The IRR is 57% even if the investors exit at 26X; I could clearly see the attraction to take DOCU private. One more analysis that is typically done in LBO analyses is to look at the range of offer values given investors' different rate of returns. 

If we assume a 30% rate of return, which is typically the norm in PE industry, the investors can manage to offer $27.8B in equity value, yielding an offer price per share of $120, a premium of 93% over $62.2/ share1. You can look at other numbers and just marvel at how lucrative and beneficial this deal could be for the lenders, equity sponsors, and DOCU's shareholders. 

Forest For the Trees

As is the case with valuations and analyses of these kinds, it is easy to loose sight of what truly matters. For all intents and purposes, the transaction looks like a solid deal, but what could it mean for DocuSign's existing shareholders? The stock's offering price at the time of its IPO was $29/ share, it is now trading at around $62/ share, I think the deal with a premium of around 25%-30% could prove to be very profitable for its existing shareholders. Shareholders that are hoping against hope and waiting for the stock to reach its pandemic driven high of around $300/ share (or even to cross $100/ share) or anywhere near that vicinity, might be in for a rude awakening.  

Note: All numbers in this post are based on my base case. 

Links:

DocuSign LBO

DocuSign 2023 10K

DocuSign 2023 3rdQ 10Q

Snowflake (SNOW)- A Company Valuation

  (Disclaimer: Excel file attached below the post) 

Snowflake (SNOW) had its stupendous IPO on Sep 16, 2020, and by the end of its debut trading day, the price was 112% more than its expected offering range of $100-$110/ share. The company sold nearly 28 million of its shares and raked in $3.4B, the largest software IPO ever. Company has some of the largest asset managers as investors, i.e., Salesforce, Altimeter, Sequoia, and Berkshire Hathaway. What is it about the company and its operations and future prospects that attracted and adorned it with the attention it got? This deep dive is meant to trace the company's history, its operations, the broader cloud market, and what the future might hold for the company. 

A Brief History of SNOW

Snowflake was founded in 2012 by three ex-Oracle data warehouse experts, Beniot Dageville, Thierry Cruanes, and Marcin Zukowski. The company anointed Bob Muglia- a Microsoft executive- as its CEO, and successfully raised $26M in 2014 and came out of stealth mode. Snowflake managed to raise another $45M in 2015 and launched its first Cloud Data product. The company's future prospects and enticing story garnered multiple capital raises over the next few years, I think it reached series G; which probably means that plenty of VCs were able to attain its shares early on. Company juggled its C-suite and brought in Frank Slootman, ex-CEO of ServiceNow, as its CEO in 2019; Frank brought in Michael Scarpelli, his colleague from his days at ServiceNow, as the CFO. At the time of its IPO, it was considered one of the best unicorns within the software space, and had all its growth ahead of it. To better present the mania around the company at the time of its public offering, lets look at its share price change along with its trading volume since its inception into the public space. 

SNOW- Historic Share Price and Volume

As mentioned before, the stock's offering range for its IPO was $100-$110/ share, but you can clearly see that it debuted well above its offering price, and that was mainly driven off of the demand for the stock and also the high profile investors as well as the outlook for the cloud data warehouse industry and the need for big data in big and small businesses simultaneously. The market saw the company as a possible competition to Oracle, Amazon, Microsoft and Google's regime. Snowflake's model- that partially gave the company its edge- was to essentially let its users pay for only the services that they utilize, unlike some of its contemporaries that require a premium irrespective of the services used. The company also managed to tie the knot with some of the major corporations in corporate America, and its value proposition to its customers had assisted the company in putting double and triple digits growth at the time of its IPO. We will delve deeper into its operations and the reasons that make it unique, for now, lets compare SNOW to some of its competitors and see how it has performed, comparatively speaking. 

SNOW Vs. Competitors

Snowflake had an oneiric start to say the least; the stock closed more than 100% higher than its offering range on day 1.It came down to below $100/ share and then- with the rest of its peers- skyrocketed again in 2021to above $150/ share. I think that start itself was pretty much the sole unique thing in its history,  because as is evident, SNOW has been motioning the same trajectory as its peers. The more I look at the above image, the more I am compelled to question its initial rise, was it because it truly had something unique? Was it because of the Warren Buffet and the Salesforce effect? Or was it something else? To further compound our understanding of the company, lets take a quick break and do a comparison with some of the vastly tracked indices. 

SNOW Vs. Indices

The start is pretty self-explanatory, but the story a few months into its public journey is, at best, common. Why has the company failed to hold on to its early momentum? One answer could be that the initial boost was in part due to the usual craze hovering an initial offering, everyone thought that it was one of the next best things, and they all wanted a piece, not to mention the company's partnerships with Salesforce and Berkshire Hathaway also might have injected some fuel into the initial craze; but everything thus far tells me nothing unique about the company. I think we should next move on to its core operations and history and try to dissect its early boost, the subsequent fall, and then with everything under our belt, move on to its future and assess whether it is trading at a premium, and if so why? 

The Business

Snowflake is in the business of cloud data warehouse services, which- in layman terms- means that the company helps its customers in collecting, compiling, and analyzing data along with using its immersive platform to provide insights and intelligence that then the companies can use to improve their own businesses and attract and retain customers. As per the company's own filings, "The platform supports a wide range of workloads that enable [their] customers' most important business objectives, including data warehousing, data lakes, and Unistore, as well as collaboration, data engineering, cybersecurity, data science and machine learning, and application development." The company processed on average 2.6 billion daily queries across all of its customers; which essentially means that the platform is being heavily used and utilized to drive data driven insightful business decisions.  

Snowflake's platform, and the bundle of various facilities along with it, offer companies the chance to deal with big data in a way that they couldn't before, as well as offering solutions for siloed data and information. The company is hoping and counting on the wide spread acceptance of data cloud by corporations across the globe; the more data the companies store on its platform, the more information the company will have to exchange with other customers, data providers and consumers. The platform, as of this post, is being used globally by organizations of all sizes across myriad of industries and countries. As of Jan 31, 2023, SNOW had a total of 7,828 customers, an increase from 5,967 customers as of Jan 31, 2022. The company also boasts as having 573 customers that were on the Forbes Global 2000 list, and those high tier customers contributed 41% of the revenues in FYE '23. 

The Numbers

The company reported revenues of $2.06B in FYE '23, a 70% increase over FYE '22's revenues of $1.22B. The company also reported cost of revenues of $717M and other operating expenses of $2.19B, yielding an operating loss of -$842M; other operating expenses included sales and marketing, research and development, and general and administrative, all of which have risen from prior years, a delightful thing for a company that is growing; It shows me that the company is expanding, both in terms of its revenues and expenses, and that the numbers tell the stereotypical story of any start up: compounding revenues associated with inflated losses. 

For the past five years that I observed for this case study, SNOW's revenues have grown at a triple digit growth rate, except for FYE '23, which, as stated before, was 70%, not triple digit, but also not bad. Company grew its revenues from $96M in FYE '19, a 173% YOY growth, to $2.06B in FYE '23, the numbers tell me that they seem to have figured out an unmet demand in the industry. As is typical for any start-up and so called "unicorns", the company has been operating in losses for its entire operational history. Operational losses for start ups are expected, as in their early years, they endeavor to settle in, and invest heavily in their operations, and are concerned very little with profits as all of their profits are in the future along with their growth. It isn't all bad though, as companies often tend to increase their DTA, or NOLs, in case they incur losses, and SNOW, as of the writing of this post, disclosed NOLs of $1.57B on its FYE '23 10K. 

The company has also been investing heavily in its operations as is evident from its capex spending, which was $25M for FYE '23, with D&A of $63M. I know, the D&A is more than capex and how is that possible for a start up? Well, it isn't; if one were to look at its historical numbers over the last few years, one would realize that D&A is ahead of its capex precisely because the company invested heavily in the preceding years, resulting in higher D&A compared to its capex. Additionally, the company's NWC has been increasing steadily over the last few years; NWC (difference between its operating current assets and current liabilities) was -$167M in FYE '20 (63% of revenues), fast forward to FYE '23, NWC was -$989M or 48% of its total revenues; which means that nearly for all of its operational history, the company has had more current liabilities than its operating current assets. 

Moving on to its latest quarterly report, The company had a cash and cash equivalents (which included short and long term investments) balance of nearly $4.5B, and no debt at all, current or long portion, except for operating leases. The company also reported revenues of $2.03B for nine month ended Oct 31, 2023, a vivid increase over $1.48B revenues for the nine months that ended on Oct 31, 2022. Furthermore, SNOW reported cost of revenue of $656M, and other operating expenses of $2.2B for the nine months ended on Oct 31, 2023, yielding an operating loss of -$819M, a bigger loss than -$602M the company incurred for the same time period of the prior year. 

I think the numbers give us a clear picture of the kind of company we are dealing with, a company that is still in its infancy, and is investing as much as it can back into the business for its much needed growth. The compounding losses do not necessarily mean that there is something fundamentally wrong with the company or its business model, in this case, it simply means that the company has its growth and profits somewhere in the future. To understand the company's future, lets next look at the cloud data industry as a whole, and what its prospects look like. 

Cloud Data Warehouse Industry

In order to better understand what the future holds for this industry, I think it would be prudent for us to step back a little and assess and analyze the world we currently reside in. We live in a world where all of our data is stored on one cloud or another, in one shape or another form. We all utilize our cell phones and the accompanying applications for our daily needs, we gladly accept help from all sorts of apps for the most mundane of tasks to operations that require thinking and analyzing; lets now expand our discussion to include companies, organizations, and enterprises. Companies have access to their own data, of course, but they are more than willing to pay for data and relevant consumer information from other companies and enterprises because everyone has come to realize the sheer importance of data in business decision making and other facets of our lives. Cloud technology, over the course of last few years, has emerged as sort of a phoenix rising from the ashes of physical data storage warehouses and facilities. Cloud technology is much easier for companies to deal with, and it entails less capex and maintenance on the companies' part. Enterprises and organizations are more than willing to pay for cloud services, and have not only access to their own data, but also a variety of other products and services that help them enhance their customers' experiences, better equip them with the tools needed for their respective industries, and give them invaluable insights into growing their customer base as well as retaining their existing consumers. 

The global cloud data warehouse market size is expected to grow at a CAGR of 23.5% from 2023-2030. This growth is driven by multiple factors including the growth of data, access to data, cost effectiveness of cloud storage, various products and services that can deliver incalculable insights to businesses as well as new technologies such as 5G and generative AI that will boost internet usage in the years to come. I, personally, believe that the cloud storage data industry is barely out of its infancy, and given its promises and the endless possibilities that it provides corporations and organizations with will only fuel its growth further. The industry is also smeared with other enterprises that provide somewhat similar services to SNOW; these other companies include but are not limited to Amazon, Microsoft, Apple, Adobe, Oracle, and DocuSign. In order to stand out, SNOW will have to invest heavily in its operations and be willing to incur losses for the foreseeable future if it desires to hold on to its existing customers as well as expanding to other territories and industries. 

The immense need for cloud storage also presents SNOW with another possibility within the industry: companies' willingness to utilize multiple cloud storage platforms instead of exclusively being on one. This gives companies, such as SNOW that are smaller in size in comparison with Amazon and Microsoft, a fair and equitable chance to compete for market share. I think that with enough invested in capital, SNOW might just be able to keep growing at a double digit growth rate. One last thing that I will mention for the future would be the hype around generative AI. I can not say that I agree with people that say, "AI is the single best technology in the history of mankind," but I also can't deny its significance and the innumerable benefits that it will bring to the world of business, but I have to say that I fail to see AI inducing any growth for our company, SNOW. I think that AI's impact- given SNOW's business model and the fundamental operations- will be incremental at best. As a matter of fact, I think that they might even be adversely impacted by it. Why do I say that? Well, lets think about the mania around generative AI, among other things, it is expected to provide better insights and analysis for companies to review, and if companies can manage to develop an in-house architecture of generative AI, then their need for a cloud storage platform that provides AI driven insights will dissipate. Anyways, we could talk on length about this and still not agree on most of the things, so lets move on to the crux of this post, the valuation. 

Corporate Cycle

Before moving on to valuation and the numbers, I think that it is always a good practice to look at company's history, and try to locate where it is on the cycle because, I believe, valuation becomes easy once you know what stage of the cycle the company is in. 

Corporate lifecycle

Having the benefit of studying the company, its financial statements, and the fact that it went public in 2020, I'd say that SNOW is in the childhood stage of the cycle. I do not see the company turning any profits for the next few years. I expect the company to put up double digit revenue growth along with higher costs and operating expenses. As it moves up the cycle, I suspect its margins will improve as management will get a better grasp of the costs along with consistent increase in revenues. I also expect the company to invest as much as it can for the foreseeable future for two reasons; first, I expect the company's current market share will come under threat as its grows for the next few years, and secondly, as it grows, it will need more and more facilities and other tools to provide products and services to its consumers and organizations world-wide.

Valuation

When valuing a company through DCF, there are a few items that one has to not only track but also have somewhat of a theory as to their predictions. One of the said items is revenue and revenue growth. In my base case, I expect company to grow at a CAGR of 28.4% over the next ten years; I expect revenues to grow from $2.06B in FYE '23 to $25.1B in FYE '33. I expect this growth to be driven by multiple factors; the first of which is the growth of the cloud data warehouse industry, second is the fact that companies are increasingly leveraging more than one platform for insights which provides SNOW with an avenue of growth, thirdly, I believe that as the company grows, it will innovate more and spend more on R&D and not only increase the number of its services, but also improve its offerings in terms of efficiency and compatibility, and lastly, I believe AI, no matter how much I dislike how openly it is being exploited, will play somewhat of a role in the company's growth, implicitly or explicitly. 

The second of the aforementioned items is the reinvestment. I expect the company to invest more and more as it progresses towards maturity. I expect the company's capex to be 2.4% of revenues in FYE '24 to 7% by FYE '28; I also suspect that after FYE '28, the company's capex would start to taper off at which point its D&A will overtake its capex. Additionally, I expect the company's NWC to decrease as it moves up the cycle, which means that as it grows, it will see more and more cash inflows. Knowing what I know about the company and its future, as well as keeping macro economic factors in mind, I expect the company will grow at 3% into perpetuity. As mentioned before in the post, the company does not carry any debt, short term or long term, on its balance sheet and so its WACC is essentially its cost of equity, which I calculated to be 8.98%, I will further carry this cost of capital into the future and not get into the complications of changing WACC throughout the projected years or even for the terminal year, although I suspect it would be different as I expect the company to take on debt as it moves up the cycle. Converting all of my assumptions into numbers, I get the following price per share.

DCF

The price per share that I got for SNOW is $163.56/ share, the stock was trading at $197.85 at the time of the post. In my base case, based on my assumptions, I believe the company is trading at a premium of 17% and if I had to assign this premium to a couple of factors, they would be the generative AI hype and having Warren Buffet's Berkshire Hathaway as an investor. Lets analyze the stock price more through sensitivity and statistical analysis and assess what the possible values could be given changes in some of the factors. 

Sensitivity

Sensitivity, I believe, is one the paramount activities when valuing a company because it allows the inquisitor to not just look at the value based on his/her assumptions, but also how changes to various factors might affect the derived value; so, as such, I decided to look at what the share price might be given changes in WACC, perpetuity growth rate, revenue growth rate and operating margins. Below are the data tables with assumed changes in different variables. 

Image 1

Image 2

As you can see, a slight change in one or more variables gives us vastly different values. The idea of these sorts of tables is to look at your assumptions and assess whether the changes are the ones you can comprehend and, if need be, defend. I for one, think that the long term growth rate of 3% is well within SNOW's grasp, and it is a matter of efficiency and a little bit of luck that they get to grow at 3% in perpetuity. Changes in WACC are very likely down the lane, because I suspect, as the company grows and matures, it will take on more debt, thereby changing its cost of capital. Image 1 give us a range of $118-$292 depending on what one thinks about the long term growth rate and the company's WACC.

Image 2 shows a range of $108-$454/ share, again, depending on what you think the company's revenues and margins will be in the final year. I think that my assumptions are not only intelligible but also reasonable because, in my base case, I am assigning the company a growth rate that I think the management will be able to manage and sustain; additionally, I believe margins of about 20% are also within the company's range given its business model, and the outlook for the industry as a whole. 

As with all of my prior work, I conducted a statistical analysis of the company's share price given changes in its final year revenue growth rate, margins, and WACC. I ran a Monte Carlo simulation and decided to graph the distributions on not only histogram, but also the box and whisker chart. The results of the simulations are presented below. 

Statistical Analysis

I ran 10K simulations assuming a 2% standard deviation in my final year revenue growth rate and the operating margins, as well as assigning a 1% standard deviation to the company's calculated WACC. The mean value across the 10K simulations was $169.86/ share, with a minimum of $85.06 and a maximum of $613.49. Some of you might be thinking why 2% and 1% in standard deviation, in the spirit of complete transparency, those numbers are completely arbitrary. I just know that there is no world in which the probability of me being correct is 100%, and so I have accepted my fallacies and assigned margins of error to see what the distributions might look like if I had selected different factors in my valuation. As you can see, most of the values lie between $137-$170/ share. The box and whisker plot on the right presents somewhat of similar results. Given my assumptions, the data tables, and the statistical analysis, I think that I am pretty content with my DCF derived share price of $163.60/ share.

Conclusion

As with any valuation, it is a case of not only numbers but narratives along with understanding of other factors. Valuations differ immensely depending on what one thinks about the company, its prospects, and the future of the industry. Based on my comprehension of Snowflake's business, its operating model, and the future of the cloud data warehousing industry, I believe that the company is trading at a premium. My recommendation would be to sell/hold if you own it, and maybe to put in a buy-limit order if you don't. But, don't take my word for it, download the excel file attached below and feel free to make it your own and incorporate your own narratives and assumptions, and see what share price you get. 

Links:

2023 10K

3rd Q 10Q

Snowflake Valuation

Adobe (ADBE): A Company Valuation

 (Disclaimer: Excel file attached below the post) 

Adobe (ADBE) recently reported its FY '23 results, and being that I am an avid user of Adobe products, I wanted to look at its operations, history, and the future. This valuation will be slightly different than my prior works because instead of valuing the company simply through DCF, I decided to analyze and predict its financial statements and let them drive my valuation. I will stick to my tradition of first reviewing the stock performance, then going over the company's segments and mulling over its operational history and performance, and finally moving on to valuation coupled with sensitivity and statistical analysis of my findings. 

Adobe- Overview

My typical approach to any valuation- for a publicly traded company- is to look at the stock performance over the past decade, and judge how prone the equity is to the broader market and the macro fluctuations, and as such, here is Adobe's stock performance for the past decade along with its trading volume.

As is observable from its performance over the past decade, Adobe has seen steady and predictable growth from FY '13 to FY '20, but since the breakout of the pandemic, the story has been anything but predictable. The stock went through its ups and downs during the last three years, but these ups and downs have mainly been in line with the broader market. One more thing that stands out is its exponential growth over the last one year alone; it went from around $300/ share at the end of '22 and the beginning of '23 to almost $580/ share at the time of this post. Why the drastic growth? Well, that can be majorly attributed to the generative AI mania among other factors. In order to further understand Adobe's performance and past operational history, I think we should move on to its history and look at all of its products, offerings, and services. 

Offerings

Adobe was founded in '82, and incorporated in California in '83; it was later reincorporated in Delaware in '97. Adobe is one of the largest and most diversified software companies in the world. It offers products and services that are vastly used by creative professionals, including photographers, game developers and designers, and content creators to name a few. The company reports subscription revenue in three segments: Digital Media, Digital Experience, and Publishing and Advertising. 

The Digital Media segment offers products, services, and solutions that enable individuals, teams, and organizations to create, publish, and promote their content. The segment is centered around Adobe Creative Cloud and Adobe Document Cloud. Adobe Creative Cloud is a subscription based service that allows its users to utilize Adobe's Cloud services along with its other creative products. Adobe Document Cloud is a cloud based document services platform that integrates Adobe's PDF technology with its Acrobat and Acrobat Sign applications to integrate and deliver a smooth flow of documents. 

Digital Experience side of the business provides an integrated platform that enables brands and organizations to not only create, but also manage, monetize, and optimize customer experiences. The company provides data insights, analytics, and various other tools that help businesses and organizations attain and retain consumers through superior and frictionless experience. Lastly, Publishing and Advertising segment contains legacy products and services that are majorly used in the publishing and advertising market space. The company generates revenue in Publishing part of this segment by licensing its technology to OEMs; and through usage-based offerings for its Advertising part of the segment. Enough with words, following is a snapshot of Adobe's past decade.

Adobe's Historical Financials

Adobe's revenues have grown from $2.9B in FY '09 to $19.4B in FY '23, at a CAGR of 14.42%. As is evident from the image above, revenue growth has not been steady. There have been years when Adobe put up double digit growth, but then there have also been instances when its revenues shrank, e.g., -7.9% in FY '13. Moving on to its operating income and margins, despite its unpredictable growth in revenues, its operating margins have surprisingly been steady and in double digits. Upon further scrutiny, its margins are vividly beyond standard for its industry; this could be because of its competitive advantage, its elongated operational history, competent management, brand, and due to its first mover advantage in most its products and services. Furthermore, Adobe had Net Income of $386M and net margins of 13% in FY '09; the company has managed to increase its Net Income at a CAGR of 21% to $5.4B in FY '23, yielding a net margin of 28%. For the kindred spirits that enjoy graphs and charts, below is a graphical representation of its revenues, operating income, and margins. 

Let us delve a little deeper into other metrics. Adobe has been investing a significant amount of capital back into the business- explaining its growth and margins. The company invested $3.9B in FY '09 with a ROIC of 21.7%, well above its cost of capital; fast forward to FY '23, Adobe invested $12.7B with a ROIC of 41.6%. Additionally, the company's ROE has inflated from 15.4% in FY '09 to a whopping 35.5% in FY '23. Another line item worth mentioning here is its debt over the years, the company has been remarkably comfortable with raising debt every year; company's debt has grown from $1B in FY '09 to $4B in FY '23. This could be driven due to growth in its top line as well as its healthy cash balance and relative cheapness of its debt. 

With this plethora of information under our belt, let us now move on to valuation. 

Valuation

Income Statement

The first logical step in my valuation was assessing Adobe's Income statement. I do not have access to paid data platforms and so I will only look at the last four years of historical data and, with the understanding of the company's business and operations, try to project out the next five years. Historically, Adobe's revenues have grown from $12.8B in FY '20 to $19.4B in FY '23. Adobe reports subscription (comprised of Digital Media, Digital Experience and Publishing and Advertising), products, and services revenues on its income statement, with subscription revenue accounting for the bulk of the revenues; $11.6B (90.4% of TR), $14.5B (92.3% of TR), $16.3B (93.1% of TR), and $18.2B (94.2% of TR) in FYs '20, '21, '22, and '23, respectively.  

Adobe divides its cost of revenues in line with its revenue segments; cost of revenues consist of costs for subscription, product, and services and other revenues. Cost of subscription, for obvious reasons, is the bulk of its total cost of revenues; subscription costs have been around 10% of subscription revenue for the observed period. Costs of product were 7.1% of the product revenue in FY '20, and 6.3% in FY '23. Lastly, cost of services and other was 78.6% (FY '20) and 75.6% (FY '23) of the services and other revenue. Adobe has additionally put up gross margins around 85% for the last four years. The company also has other operating expenses such as research and development, sales and marketing, and general and administrative; all of which have been hovering around 53% of TR for the last four years. Another notable thing here might be the cheapness of Adobe's debt as its interest expense was $116M (FY '20) and $113M (FY '23), cheap if you compare the interest expense paid to the total amount of debt which in FY '23 was $3.6B. Moving on to shareholder's equity, big items that stand out have been Adobe's retained earnings and its share repurchases; the company has clearly been returning cash back to its shareholders through its share repurchase program (which in FY '22 was $6.5B, 120% of its NI). 

Adobe's Income Statement

For the future, in my base case, I expect Adobe's subscription revenues (consist of Digital Media, Digital Experience, and Publishing and Advertising) to grow from $18.3B in FY '23 to $34.8B in FY '28, driven mainly by the fact that we live in a world where content creation, promotion, and designing is rapidly increasing by the day, and also the fact that Adobe's Creative Cloud coupled with its Document Cloud- along with a variety of other products and services- provides individuals, teams, and organizations with a synchronous and frictionless experience, an experience that is truly one of a kind. I also expect its subscription revenues to increase due to its dominance within the customer experience and retention space; the company offers myriad of products and services to companies and organizations that allow them to improve and enhance their customer experience, retain consumers, and also to expand their customer base; with consumers being the end goal of every company in existence, I expect Adobe will not only manage to maintain its current customer base within this space, but also find new avenues of growth through either acquisitions, or inflation of its customer base through its pioneering technology, brand name, and its place in the industry. I also expect Publishing and Advertising to contribute a 2% growth by the end FY '28, moderately increasing from $123M in FY '23 to $131M in FY '28. Furthermore, I expect its Product revenues to be a slightly lower part of its overall revenues, decreasing from being 2.4% of TR in FY '23 to 1% of TR by the end of FY '28. Product revenue is comprised primarily of fees related to licensing of its software to OEMs and other partners on a perpetual or fixed basis; as a result, I expect the company to maintain its current operations within this segment, but I do not see a significant growth in this part of the business. Last leg of the revenues, I expect its Services and Other revenue to increase from $665M in FY '23 to $725M in FY '28. Services and Other revenue is primarily made up of fees related to consulting, training, maintenance, and support for its licenses as well as its advertising offerings. To bundle it all together, in my base case, I expect Adobe's revenues to grow from $19.4B in FY '23 to $35.9B by the end of FY '28. Finally, given the growth that I am expecting in its business and operations, I expect its costs of revenue (cost of subscription, product, and services and other) to increase from $2.4B in FY '23 to $4.05B in FY '28.

Balance Sheet

Adobe's Balance Sheet

The company is known for having a significant amount of cash and cash equivalents on hand. Adobe's cash and cash equivalents have increased from $5.8B in FY '21 to $7.8B in FY '23; one thing to note here is the fact that the cash balance has not increased in line with the cash the company generates from its various activities and that is because the company uses a significant chunk of its cash balance to buyback its shares. Its total assets have also increased from $27B in FY '21 to $30B in FY '23. Its liabilities, including both current and non-current, have also increased from $12.4B in FY '21 to $13.2B in FY '23. One last thing to highlight here would be the fact that its treasury stock has been significantly increasing over the last three years; it went up from being $17.3B in FY '21 to $28.1B in FY '23- again, underlining its rampant pace of buying back its shares. 

Adobe's Cash Flow Statement

I am not privy to the management's plans for the future and so I project out some significant line items on the balance sheet, but most of them have been straight-lined. I do not know if the company is planning on raising more debt down the road, perhaps to roll over some existing debt or maybe even to raise more for other purposes, and so I have carried its existing debt of $3.6B in to the projected years. I expect its retain earnings to increase from being $33.3B in FY '23 to $75B in FY  '28, driven by growth in its operations and the consequent increase in its NI for the projected years. As is evident from its cash flow, the company generates a healthy amount of cash flows and so I expect the company to continue to buy back its shares; I have gradually decreased the share repurchases as a percentage of NI from 120.7% in FY '23 to 100% in FY '28, essentially what I am trying to say here is that the company will be using 100% of its NI to buyback its float, thus increasing its share price and EPS. Adobe does not pay dividends.

Corporate Life Cycle

One last pit stop before the valuation town is to look at the corporate life cycle and where the company is in the cycle.

Having gone through its SEC filings, rummaging through its history, and analyzing its financial statements, I sternly believe that Adobe is in its adulthood, slowly approaching maturation. I believe that Adobe's years of explosive growth are behind it. I expect the company to grow organically at a modest pace, and of course other avenues of growth such acquisitions and modern technological innovations (e.g., AI) could contribute towards its future growth and existence, but I don't see it being anything too drastic. Moreover, I expect the company to be more concerned with returning cash to shareholders through dividends and buybacks rather than focusing on growth. 

DCF Valuation

With a deep understanding of its operations, products, offerings, and services, and a well thought-out projection period, let us now move to the Discounted Cash Flow analysis. 

DCF Analysis

As stated at the beginning of the post, I have extracted the required information for the DCF analysis from our prior work on the Income Statement and Balance Sheet. Line items such as revenues, operating income, capital expenditures, depreciation and amortization, and changes in NWC have been brought in from other sheets in the workbook. Additionally, I calculated its WACC to be 10.98%, its net debt to be $-3.7B, and expect its growth rate to be 3% in perpetuity. Given my projections and assumptions, I get an enterprise value of $131.7B, which given its diluted shares outstanding of 465.60M, yields a price per share of $290.90; the stock was trading at $573.15 a share at the time of the post. 

Sensitivity

I think the next step- in order to further justify my valuation and to better understand why its trading at almost double the price per share- is to do some sensitivity tests and also look at other statistical analysis. 

Image 1

Image 2

Image 3

Image 1 shows the price per share at various long term growth rates and WACC. Image 2 shows implied equity value given differing WACC and long term growth rates. Image 3 is the one that I'd like to spend a few seconds on. Image 3 shows the price per share if we sensitize revenues and the operating margins in the final year. As I mentioned before, the stock at the time of this post was trading at $573.15, and in order to justify that price, Adobe needs to generate $62.7B in revenues and attain margins of 54.4% by FY '28; I simply do not see the company achieving that. I understand that the recent rise in price per share is because of the entire mania surrounding generative AI, but I do not think that AI will help the company increase its revenues from $19.4B in FY '23 to $62.7B in FY '28. Furthermore, I believe that given the stage of the corporate cycle that the company is in, AI will only go as far as to help the company manage and maintain low to mid double digit growth. To further solidify my thesis, I also ran a Monte Carlo simulation, and the image below highlights the distribution of values around the mean, which in this case would be my implied share price.  

I ran 10K simulations, with the help of my dear friend Excel, with standard deviations of 3% and 2% for revenue growth rate and operating margins, respectively, as well as 1% standard deviation for WACC. As you can see, majority of the values reside between $268 and $296 a share. To further test my assumptions, if I were to assume that the 10K simulations that I ran represent the population of Adobe's share price (I know it is a relaxed assumption, but only for the sake of our discussion here), and I draw a random sample of 30 from the 10K possible outcomes, I can say with 95% confidence that the true mean of the population presides between the interval of ($280.58, $310.80).  

Conclusion

As with any valuation, this is all based on my assumptions and hypothesis. Some might agree, others might vehemently disagree, and I am content with that, and if you believe AI will contribute enough where Adobe will generate $62.7B in revenues yielding margins 54.4%- therefore justifying its current trading price- kudos to you; I for one, do not see that being a possible outcome. As always, I have attached the excel file below, feel free to plug and chug your assumptions. Until next time!

Links:

Adobe Valuation

Adobe 2022 10K

Adobe 4Q/2023 10Q/10K