Reddit (RDDT): Savior of IPOs?

  (Disclaimer: Excel file attached below the post) 

Reddit recently filed for its IPO, and given the raucous that it has caused in the capital markets, in particular the hedge funds, in recent years, I decided to value the company and assess whether or not the offering price of $31-$34 per share and an equity value of $6B-$6.5B is a fair value and worthy of investors' interest and greenbacks. At this point, everyone is pretty much acquainted with what Reddit is, what it does, and how its communities and users interact with each other and the rest of the world, and so I will not go into the history of it, and instead will delve right into its past and potential future with a minor detour. 

Long and Arduous Journey

This is not the first and only time when the company has filed for its IPO; Reddit pursued the public and capital markets back in 2021 when IPOs were all the hype- total value of $339B according to Bloomberg. Back in Aug '21, the company raised $410M from Fidelity Investments, one of its major shareholders, at a valuation of around $10B. Just a few months prior to that in Feb, Reddit raised approximately $500M in late stage funding at a valuation of around $6.5B. The monumental increase of around $4B in equity value from Feb '21 to Aug '21 can easily be attributed to investors' appetite for higher returns in a low interest environment. Compare that to the current macro environment, we have rates hovering around 5.25%-5.50% territory, with many projecting a 0.75% decrease in the rates over the course of the remainder of the year, and investors are less inclined towards growth stocks given higher returns in other financial products; additionally, profitability has never been a bigger concern for the masses as it now. Reddit, I believe, might have been better off going public in '21 as compared to now because I do not see this environment being friendly to growth stocks, at least for as long as rates remain sky high. 

As for the IPO,  the social media platform, along with its management and executive team, are offering 22M shares in its IPO in the $31- $34 per share range. At the top end of the range, the company is looking to raise around $748M (net proceeds of $450.9M or $552.7M if the underwriters exercise their over-allotment option in full) according to a new version of its prospectus filed on 03/19/2024. As of the filing of its S-1, the company has no debt and so intends to use the proceeds for, "general corporate purposes, including working capital, operating expenses, and capital expenditures. The company may also use the proceeds to in-license, acquire, or invest in complementary technologies, assets, or intellectual property" as well as settling some tax related issues. With this minor detour lets now move onto Reddit's financial performance over the last two years.

Ghost of Reddit's Christmas Past

In order to better understand a company, knowing its business model or reputation isn't enough, we also need to look at its numbers and see how in line they are with the general sentiment around the company. And so to better understand the company's past as well as prognosticating about its future, we need to look at the numbers and analyze its past financial history. Here is a look at Reddit's income statement as disclosed in its prospectus.

Looking at the statement, I don't think I see anything extraordinary in terms of the company's performance, margins or its costs; what I see is the stereotypical income statement of a "growth" company. The company reported $804M in revenues for FY '23, a 20.6% YOY growth; the company also reported costs of revenue  of $104M (15.7% margins) and $111M (13.8% margins) for FY '22, and '23, respectively, giving the company gross profit of $562M (84% margins) and $693M (86% margins) for FY '22 and '23, respectively. Another notable observation is the skyrocketing degree of associated operating expenses; as you can see, Reddit reported $438M (54.5% margins) for research and development, $230M (28.6% margins) for sales and marketing, and 165M (20% margins) for general and administrative, giving the company an operating loss of 140M and margins of -17% for FY '23. With all said and done, the company reported a NI of $-91M (net margins of -11.3%) on revenues of $804M. Aside from spectacular gross margins, I fail to see the attraction in Reddit as a company. It has been operating for nearly 20 years now, and still has not found the path to profitability, whose to say that the future might be different? To further elucidate its financial position, here is a snapshot of its historic balance sheet and the numbers speak for themselves.  

Despite the company's mounting losses over pretty much the entirety of its existence, it has managed to maintain a significantly healthy cash balance; the company reported cash and cash equivalents (including marketable securities) of $1.26B and $1.23B for FY '22 and '23, respectively. Additionally, company reported total assets of $1.59B and $1.59B for FY' 22 and '23, respectively. Aside from current and long-term liabilities, the company also reported a shareholders' equity (deficit) of $-413M for FY '23 due to losses over its operational history. 

What I Wish the Future Holds

I believe that by now we have a better understanding of Reddit's past and all of its financial ghosts, and so I think we should now look towards the future and see if there are ways of exorcising Reddit of its past and setting it ablaze on a path towards redemption. 

Reddit is very much a social media platform that derives a bulk of its revenue from advertising. Reddit, given how the platform works, is in a unique position and there are multitude of avenues the management can take in the future to further drive its ad revenue upwards. Continuous expansion of its current platform and capabilities, coupled with constant innovation and advancement of products, should allow the company to compete with behemoths such as Meta, Google, Pinterest, and Amazon. The company could improve its ad revenue in the following ways (not an exhaustive list):

• Marketplace optimization
• The company is still in early stages of using machine learning and prediction models to better match supply and demand and deliver ROI for its advertisers. An improvement of such models and technologies will allow the company to attract more advertisers through higher efficiency and an even better ROI. 
• Demonstrate ROI
• Another measure of improving ROI for its advertisers is by improving ad measurement and providing better data to show advertisers their ROI based on their usage of the platform.
• AI Powered audience reach
• I am not a huge fan of companies nowadays using buzzwords like AI and machine learning to attract capital, but I believe that Reddit is in a unique position to leverage its data for AI and machine learning. 
• Expanded formats and offerings
• Continual development of new products and constant enhancement of its current offerings could prove existential for Reddit as far as its ad revenue is concerned. 
• Acquire more advertisers
• This goes without saying that in order for Reddit to grow, it needs to be able to expand its current relations as well as develop and attract new advertisers through a seamless and higher ROI experience. 

In addition to ad revenue and its growth strategies, there are other avenues that the management can take in order to improve its profitability and margins. Given the vast amount of data available to Reddit, another path of growth and profitability could come in the shape of data licensing. Reddit is one of the largest depositories of public information that is not only authentic but is also constantly updated. We live in an increasingly data driven world and there should be no bounds on Reddit's imagination as far as using its data for higher profits is concerned. The company, as of this post, is in early stages of allowing third parties to license access to search, analyze, and display historical and real time data from its platform. Customers and companies can pay to access real time data streams of public discussion via data APIs. These APIs are able to provide access to evolving and dynamic topics such as sports, news, fashion, and the latest trends. Moreover, Reddit's data could prove to be an essential piece in the construction and development of large language models (LLM). Another path to profitability could come in the shape of user economy; users utilize Reddit's platform to sell everything from daily items to developed video games and so Reddit is in a place to provide these developers and sellers with additional tools and increased monetization opportunities; this will further improve user experience which will morph into additional users, and consequently, more authentic and conversational data for Reddit to leverage. 

Corporate Life Cycle

Before we move onto the valuation, I believe that it is paramount for us to understand the corporate life cycle and how a company's behavior changes, or rather should change, according to what stage of the cycle they are in; It is ever more important when valuing growth stocks such as companies on the verge of going public. 

I think that it goes without saying that Reddit is very clearly in its infancy (at least in terms of being public) and I would categorize it as being in the "Childhood" stage of the cycle. The company has been reporting growth in its revenue for the past number of years, but it has not been able to rail in its direct and indirect costs of revenue; therefore, reporting mounting losses over the years. Reddit has without a doubt been reinvesting heavily in its business, albeit majorly on generating ad revenue, but as far as the numbers are concerned, I fail to see a decent return on its invested capital. Additionally, given the industry and the players, I believe, Reddit's future will very much mirror its past and path to profitability will be constantly hindered by its costs, other major players in the industry that are well established, and waning investor sentiment- at least for the next few years. It isn't all gloom and doom, though, as I do see the company turning the table somewhere in the next ten years as demonstrated by my model down below in the valuation section. I believe as the company grows and improves its operations and asset utilization as well as innovation and better relations with suppliers, users, and the markets, it should start to see lower costs, higher growth in revenues, higher margins (both operating and net), and it should start to return capital to its investors in the form of dividends or buybacks.  

Valuation

Valuing companies is very much a subjective issue where no two valuations are the same, and it becomes even more daunting when valuing a company that is on the verge of going public. Lack of public information and financials make an already fretful task even more threatening. Additionally, IPO prices and valuations are based on pricing and relative methodologies where bankers and underwriters look at other companies in the space and apply the same multiple to the subject company to arrive at a price per share or an equity value, as such, I wouldn't be at all surprised if my DCF derived value ends up being different from the offered range. Furthermore, given that I am dealing with a company that is about to go public, I have decided to divide my DCF into two three stages: stage 1 will be a high growth and high cost stage, stage 2 will be driven by mild growth in revenues as well as lower associated costs, and finally, stage 3, the terminal stage. Before sharing my intrinsic value of Reddit, I believe that it is pivotal for me to share my assumptions so that you can hopefully better understand why and how I arrived at my price per share. 

Assumptions 

• Revenue growth
• Given the company's position in the ad industry, and the eventual possibility of using its data for good as well as fully embracing user economy, I expect Reddit's revenues to grow at a CAGR of 24.39% over the next two stages, or the next 10 years. I expect revenues to increase rapidly over the course of the first stage from $804M in FY '23 to $3B by the end of FY '28. After the high growth stage, I expect the company to be in somewhat of a better position, and its revenues should continue to increase, although, not at the pace of the first stage. In the second stage, I expect revenue growth to taper off from 35% in FY '28 to about 10% by the end of FY '33. 
• Costs (both direct and operating) and gross margins
• Given the growth that I am assuming for Reddit's revenues, I believe the costs (both direct and operating) should inflate to sustain the top line growth in the first stage; in the second stage, as the growth in revenue slows down, I expect the costs would reduce as well. Additionally, company reported gross margins of 86% for FY '23, I expect its margins to decrease over the course of the first stage due to higher costs for higher revenue growth. As the company enters the second stage, I believe its gross margins would start to improve and be in line with the historical figures by the end of the projected period. 
• Operating income and margins
• Sadly, I do not see a way for the company to turn profitable anytime in the near future. As a matter of fact, my model shows that the company will report a positive operating income and margins sometime in the late second stage, somewhere between years 7 and 8. 
• WACC
• Since I do not have access to data bases such as FactSet or CapIQ, I did not even attempt to calculate a WACC using comps for Reddit, but I am assuming a 9% WACC (very close to the industry average) initially, and as the company grows, I believe their capital structure will change and with it their WACC. I believe its WACC would increase over the high growth stage where it will be ~11% by the end of stage 1. As the company gets a better hold of its operations and capital structure, its WACC should start to revert back to around 9%. I have accounted for this anomaly in my sensitivity analysis.
• Relations
• Another factor that I believe will play an important role in Reddit's foray into the public markets is its relations with its users and moderators. As of the writing of this post, Reddit itself is marred with posts about shorting the stock as soon as it starts trading due to its users' bearish point of view about its future. Additionally, I believe that in the near future, for the next 2-3 years, management needs to cater to its advertisers as well as trying their utmost best to attract new companies and organizations. 
• Reinvestment
• It is nearly impossible to project out reinvestment for a company that is about to go public as individual line items such as depreciation and amortization, capex and working capital could prove to be very volatile; and so to account for this uncertainty, I have calculated reinvestment in two different ways. In the first path, I try to project out company's capex, D&A, and changes in working capital, and for the second part, I look at the company's relationship between reinvestment and revenue and use that to project out reinvestment for the projected years. For the first route, I am assuming that Reddit will continue to invest in its capex in order to support its revenue growth and that D&A will be about 90% of capex by the end of the projected period in order to sustain the 3% growth in perpetuity. I am also assuming that working capital will be about 25% of revenues both by the end of stage 1 and 2. As for the second way of calculating reinvestment, I looked at Reddit's reinvestment for FY '23 which was -1.7% of revenues; I am assuming that as the company grows rapidly in the first stage, its reinvestment as a percentage of its revenues should increase to about 5%, and then start to slow down as the company grows and gains a foothold. I have added the functionality in the model that allows you to change the type of reinvestment you'd like to use.

With all of this information and assumptions, here is my valuation for Reddit. 

Based on all of my assumptions about the company, for my second approach, I get an equity value of $5.04B and a price per share of $28.08, and for reminder, the offered range was $31-$34 per share. And if I were to use the first approach where I project out individual line items for reinvestment, I get a slightly higher equity value of $5.65B and a price per share of $31.50. I understand that there are a lot of uncertainties and assumptions in my model, and to account for some of them, I also looked at the DCF derived price per share given changes in certain variables. 

Sensitivity

Image 1

Image 2

Given that WACC is pretty much the only variable that I slacked off on, I wanted to see what impact a higher or lower WACC will have on the company's valuation given different perpetuity growth rate and revenues in FY '33. Image 1 shows the impact of different WACC and perpetuity growth rate, and as you can se, If I assume the same perpetuity growth rate but a lower WACC of 8%, I get a price per share of $40.01, and if the WACC changes to 11%, the price per share goes down to $13.92. Similarly, if we assume higher revenues in FY '33 but the same WACC, we get an equity value of $9.53B, significantly higher than the proposed value of $6B-$6.5B. Sensitivity analysis for approach one (with projections for individual line items for reinvestment) can be seen below:

Image 3

Image 4

Conclusion

Based on my analysis, I believe the stock is being offered at a range that is higher than its true intrinsic value. Personally, I'd wait for at least 10 days until all the hype has dissipated and the markets correct bankers' aspirations and ambitions. Again, as I state in all of my valuations and posts, this is very much a subjective game, and so I have linked the excel file below for you to dissect and make it your own. 

Links

Reddit IPO Prospectus

Reddit Valuation- 03/20/2024

New York Community Bancorp (NYCB): The Next Domino or a Stalwart?

   (Disclaimer: Excel file attached below the post) 

I have for the most part, steered clear of the macro environment and the general sentiment and prognostication around interest rates, what might or might not the FED do, the fiscal and monetary policies as well as the bank failures, and the reason is two fold; firstly, I am not an economist or a fixed income expert and so my two cents might not prove accretive to the whole conversation, and secondly, there are tons of proclaimed oracles and analysts that have put out a deluge of articles on these subjects and some have proven their credentials while others were not so accurate. But, I am fascinated by the nuances and intricacies of monetary policy and its vast impacts on all facets of life, and so I have tried my utmost best to stay up to date on the developments in the banking system, i.e., the failure of SVB, Signature, and Credit Suisse banks. I have also, for the better half of the last year, kept tabs on the regional banking system and how the current environment, macro and micro, has compelled managements and organizations to reassess their priorities, their risks and their relationships with investors and customers. As such, I have been seeing NYCB circulating financial news- with new $1.05B of equity raised among other reasons- lately and I wanted to put my interests to test and assess whether NYCB will be the next domino to fall in the banking system or if it could prove to be the stalwart that keeps vultures at bay. Here is my analysis of the bank's past performance, its income statement, balance sheet, and also valuation driven by a Dividends Discount Model.   

NYCB

Past Performance

There are multitude of metrics that one can use when assessing the past performance of a company; its share price, ROIC, P/E, EPS growth, P/BV and dividends payout ratio, but I, personally, like to look at a company's share price and how it has weathered its trials and tribulations. The reason I look at the share price is because, I believe, that all other metrics, implicitly or explicitly, show up in the share price, and most important of all, share price signifies investor expectations not only about the company but also the general state of economy and its impacts on the company's future. And so, I will initiate this analysis by looking at NYCB's share price and the difference between the returns of NYCB, its competitors, and S&P. 

Reginal banks have historically been below par when compared to the broader market, as evident from the image above. We can see the volatile nature of the business by the abrupt fluctuations in the share prices of the various regional banks and their subservient performance when compared with S&P. Due to the nature of the business, banks are inherently more prone and easily affected by investor sentiments and the overall performance of the economy. We can see that NYCB, over the course of the last 5 years, has put up significantly lower returns compared to the S&P, and pinpointing the reason(s) for its poor performance are harder said then done, but I can think of some transparent reasons why NYCB, or the regional banks in general, have yielded lower returns. 

One of the obvious reasons is the current interest rate environment and its impacts on the banks and their balance sheets. Without going into too much granularity as to how banks operate, they have assets (cash, loans, interest bearing deposits and other investment securities) and liabilities (deposits, borrowing and other subordinated debentures and notes) and it is almost existential that they are able to match customer demands, in this case their liabilities, with adequate amount of capital. In an environment of low interest rates (prior to COVID), banks have excess capital that they then deploy in forms of loans and securities (typically long-term) and earn interest on their investments, since the interest they earn is low, they endeavor to underwrite as many loans as possible in order to drive their net interest income and margins upwards. From the consumers and customers stand point, individuals and corporations alike, are more inclined and motivated to take out loans due to the low interest rates and the resulting lower cost of capital.

On the other hand, in an era of high interest rates (today and the past year and a half) banks have to compete for deposits not only with other banks but also with other high yielding investments and securities such as the governmental or various municipal offerings. During times of elevated interest rates, customers are inherently attracted towards investments that yield higher returns compared to parking their cash at the bank, and so consequently, they [banks] have lower amounts of deposits to loan out and that goes against the very nature of the banking world. A corollary to this problem is the fact that banks almost always make out loans that are long-term (student loans, mortgages, and various other consumer loans) and their liabilities are almost always short-term; it essentially means that banks, at any given moment, are at risk of not being able to match their liabilities in case of bank runs or other distressed situations. This is an oversimplification of the way banks work and how predisposed they are to the macro environment, but I think that this brief elucidation should suffice as far as our conversation here is concerned.  

Second reason for why regional banks have been sub-par at best is the fact that they are regional and small (with only $100B-$300B in assets in most cases), which means that they are not protected by the motto, "Too big too fail." As a result, investors ask for a premium, and as stated above, it shows up in their stock prices. Third reason that I can think of is the regional banks' portfolio; regional banks are heavily invested in start-ups, real estate, development and construction loans and so they are exposed to more risks compared to the "Too big to fail" banks. With an understanding of NYCB's past performance and a primer  on the banking operations, lets now move onto NYCB's operations and historical numbers. 

Overview

New York Community Bancorp is the parent organization of Flagstar Bank. The company went public way back in 1993 and has been growing through organic and inorganic avenues for the past few decades. As of the end of FY '22, the company had $90B of assets, $69B of loans, deposits of $58.7B, and total stockholders' equity of $8.8B. NYCB has leading positions in several national businesses, including multi-family lending, mortgage originations and servicing, and warehouse lending. The company is the second largest multi-national portfolio lender in the country and leading multi-family portfolio lender in New York City market area, where it operates and specializes in rent regulated, non-luxury apartment buildings. NYCB services its consumers through 395 branches across nine states as well as 24-hour online access to their accounts. Moreover, there are three overarching facets of the markets and the macro environment that NYCB has to cope with and plan for- just like any other bank regardless of their size- and they are the following:

• Competition for deposits
• One of the pillars of the banking industry is the everlasting battle for deposits, and NYCB is no exception to that rule. The company competes, nationally and regionally, with other banks for customer deposits through competitive rates and varying products and services to meet its customers' ever-changing needs and wants. Its ability to attract deposits, as stated above, is a function of short-term interest rates and the rates offered by other players in the market. In addition to offering checking and savings account, retirement accounts, and CDs, the company offers a suite of cash management products for small to mid-size businesses and organizations. Additionally, the market has become increasingly saturated with non-traditional financial technology, FinTech, companies breaking into the industry and gradually snatching market share from traditional regional banks such as NYCB. 
• Competition for commercial and consumer loan servicing
• Along with competing for deposits, the bank has to face stiff competition from institutions such as commercial banks, national mortgage lenders, local savings banks, FinTech companies and credit unions for its commercial and consumer loans and servicing. The competition the bank faces varies depending on the types of loans and geographies; in New York City, where majority of the building collateralizing multi-family loans are located, the bank competes for such loans on the basis of timely service and operations. NYCB's ability to compete for its CRE loans depends on its own offerings as well as what other lenders and competitors are offering. 
• Monetary Policies
• There are entire books and college major and specialties are dedicated to the topics of monetary and fiscal policies, but I will succinctly define the impact of monetary and fiscal policies on banks and lending institutions to better explain my hypothesis and rationale regarding my valuation. Fiscal policy is when the government steps in and initiates programs, such as lowering taxes or increasing other benefits, to fuel growth or the inverse in recessionary and inflationary times; such programs and initiatives can substantially impact a bank's operations. Monetary policy on the other hand, defined at the start of the post, is when the FED pumps cash in or out of the economy through market operations, reserve requirements, federal funds rate, the discount window, and margin requirements. FED's actions, as one can imagine, can severely impact a bank's operations, and going forward, NYCB's growth, just as currently, will be heavily impacted by FED's policies. 

Numbers

Over the course of the last few years, NYCB has fared exceptionally well due to the company's diverse business model and by focusing on its core competencies; multi-family/commercial real estate lending, retail banking, commercial lending, and residential mortgage origination and servicing. In addition to keeping its head over the water, the company in March '23, through its bank subsidiary, Flagstar Bank, N.A., announced that it would be acquiring certain assets and assuming certain liabilities of Signature Bank from FDIC. The purchase included approximately $38B of assets, including $25B in cash and $13B in mostly commercial loans. Additionally, the company assumed $34B of deposits, its wealth management and broker-dealer business as well as all of Signature's 40 locations. Additional assets and liabilities from the transaction further solidify NYCB's market position within the regional banking industry, and it posits to show the confidence the management has in its balance sheet and the company's future ability to generate healthy profits. I have used the FY '22 10K (the company filed an extension for its FY '23 10K and will be publishing it in the near future) for this analysis and, therefore, does not include this particular transaction which I think is serendipitous in some sense because I would like to know the financial condition of the company based on its own merits and not artificial flavors generated from inorganic activities; speaking of financial condition, below is a snapshot of the company's historical income statement.

The company reported NII of $1.1B, $1.3B, and $1.4B for fiscal years '20, '21, and '23 respectively. Company reported a lower NII growth of 8% YOY compared to a 17% for FY '21, and that I believe is primarily due to higher costs of liabilities and lower generation of assets and as a result lower interest income. In line with the general sentiment revolving the macro economy, the company put aside a significantly higher amount for its provisions for credit losses; $133M in FY '22 compared to only $3M for FY '21. Another observation here would be that the company's operating expenses (compensation and benefits, occupancy and equipment, and general and administrative) have stayed decently flat for the past three years with fluctuating non-interest expenses for the three observed years. NYCB reported a NI of $617M (a 9% growth YOY) in FY '22 compared to the $563M NI reported for FY '21. Below is a snapshot of company's EPS and dividends policy over the course of the past three years. 

With an understanding of the company's income statement and its EPS and dividends policy, I think the next intelligible step would be to look at its balance sheet and various assets and liabilities the company holds. 

The company reported total loans and leases of $68.6 (including the deduction for allowances for credit losses) for FY '22, an increase from the reported amount of $45.5B for FY '21. Including all of the other assets, the company reported total assets of $90B for FY '22. Additionally, the company reported total deposits of $58B in FY '22 compared to $35B in FY '21, a growth of 68% YOY. As you can see, NYCB also has wholesale borrowings and other subordinated debentures and notes, giving the company total liabilities of $81B for FY '22. On the equity side, the company reported shareholders' equity of $9.8B for FY '22; one thing to note here is that the reported cash and equity balance are higher in my screenshots than the latest FY '22 10k, and that is because I have reflected the latest equity raise of $1.05B. In addition to the typical income statement and the balance sheet, there is another equivalently important factor to analyze and that is the bank's ability to meet its capital requirements mandated by federal law. Here is NYCB's capital position over the last few years. 

As you can see, NYCB has consistently been above its federally regulated and mandated requirements with reporting higher Tier 1, Total, and Leverage Capital ratios for the past four years. I have not included CET1 ratio in this analysis, only because I didn't see the addition being accretive to the whole point which is that NYCB has had no issues in the past maintaining an adequate amount of capital based on its liabilities and the requirements set by the government.

Valuation 

When dealing with companies that distribute much of the value to shareholders in the form of dividends, it is almost fretful and futile to try and value them using DCF or other valuation methods. The age old Dividends Discount Model (hence referred to as DDM) is the ideal avenue to take, and so I have tried to put my understanding and valuation of NYCB in the form of a DDM; I could have also used the Residual Income Model as well but I doubt the results would be any different. Before we move onto my valuation of the company, I think it is prudent to briefly discuss some of the drivers and factors that affect a bank's valuation. 

Assumptions

• Monetary Policy
• Monetary policy, as discussed above, is one of the major factors to consider when trying to assess a bank's operations and possible future. I am not a macro strategist or an economist and so my understanding is limited in terms of understanding the nuances of interest rates and the general state of the economy, but I believe that I possess enough mental wherewithal to predict as to what I think might happen to interest rates and how it will impact NYCB's operations. Going forward for the next five years, I believe FED will be able to combat inflation in the fashion that they desire and that should kick start the economy again. I believe that rates will gradually start to decrease by the end of this year simultaneously because of FED's policies as well as consumer expectations; this gradual reduction in interest rates, I expect, will be accompanied by equivalent increase in deposits and, consequently, the loans.  
• Net Interest Income and NI Growth
• The Company reported, for FY '22, interest earning asset yield, interest bearing liability cost, and spread of 3.53%, 1.35%, and 2.18%, respectively. Going forward, I believe as the rates begin to reduce, company's interest earning asset yield should begin to decrease over the next five years; also, I believe, company's reported interest bearing liabilities cost should also decrease over the course of the projected years driven by the general reduction in interest rates and better and positive economic outlook. I am maintaining company's spread flat at 2.18% for the next 5 years because the spread is very much driven by what the management desires to achieve and as you can expect, I do not have access to the management or their future expectations, that right, unfortunately, is reserved for the analysts that cover the company. Given my assumptions about the asset yield, the cost, and the spread, here is what I think the NII and margins might look like in the future. 

• Given my assumptions about the interest income, interest expense, and other non-interest income and expenses, as well as the adequate reflection of the latest equity raise, following is what I expect should happen to NYCB's NI to common stockholders and EPS.

• We can clearly see the impact of the latest equity raise in the going forward basic and diluted earnings per share. I expect, based on the issuance of new dilutive securities, the diluted EPS to be lower for much of the projection period, and as the company grows its operations and its NI, both basic and diluted EPS should start to go uphill again. 

• Dividends Growth and Payout Ratio
• As the company grows and efficiently navigates the macro environment, I believe it will have more than enough excess capital to continue paying dividends for the next five years. I expect the company's payout ratio to decrease from 51% in FY '23 to 30% in FY '27, and as the company's NI, equity, and risk weighted assets grow in the years after FY '27, the payout ratio should reflect the returns in the form of dividends.
• Deposits
• The company has historically reported loans at around 130% of total deposits, and I believe that overtime this relationship should be one for one by the end of FY '27. Using the historical relationship between loans and deposits, here is what I think loans and deposits could look like in the future. 

• Allowances for Credit Losses
• The company reported allowances for credit losses of $393M for FY '22, an increase of 97.5% YOY, and I believe that was due to the turmoil in the banking industry as well as the general state of economy, and going forward, as the FED begins to lower interest rates and as the general position of the economy gets better, the balance for the company's allowances for credit losses should gradually increase over the following five years in line with the company's loans' growth. Here is what that might look like:

• Capital Requirements
• As mentioned before, NYCB has a splendid track record when it comes to meeting the minimum capital requirements set by the government, and in the future, I expect that trend to hold. I expect a mild growth in risk weighted assets as well as Tier 1 and Total capital ratios. I believe the bank will be well capitalized for the projected period as displayed by my model:

• Latest Equity Raise
• As of the timing of this post, NYCB's announced that it completed a previously announced transaction resulting in individual investments aggregating to approximately $1.05B. As a result of this transaction, the company will issue roughly 525M new shares if all of the options and warrants are exercised. I have accounted for this transaction in my valuation as well where I have added the total dilutive impact of 525M shares in the share count as well as adding $1.05B to the company's equity and cash account on its balance sheet. 
• Cost of Equity
• As of the writing of this post, risk free rate per WSJ is 4.10%, NYCB's beta is 0.95, and equity risk premium is 4.18%, giving us a cost of equity of 5%. Additionally, given the bank's portfolio of loans and its exposure to the whims of the real estate industry as well as the general consumer and market sentiment and operations of banks, I have added a 5% premium to the cost of equity to reflect all of the additional risks for investing in banks these days. 
• Risks and future
• The possibility is not loss on me that you are here wondering if I believe NYCB could default similar to SVB, Signature and Credit Suisse, and the short answer is that I don't think it will fail. For starters, I don't believe that there will be bank runs in the future due to the emotional stage of consumers when it comes to the banking industry. Other banks failed because consumers, at the time, were worried about multiple issues such as the inflation, recession, and unemployment and so they rushed to retrieve their funds for safekeeping or kosher investments, and I simply don't think that that is the case now. I believe that NYCB does have duration mismatch in the sense that most of their loans are long-term and deposits are often short-term so that risk is inherent and comes with the territory; what matters is how the management handles the peaks and troughs and I believe NYCB's management has more than delivered. Moreover, the latest transaction of equity will most certainly go a long way in assuaging bank's consumers' and stakeholders' concerns about the safety of their money as well as future profitability.  

With all of my above mentioned assumptions and thoughts, here is my valuation of NYCB.

In case the image above is not legible, I get a share price of $6.37, the stock at the time of this analysis, was trading at $3.25. I believe that given my projections about all of the variables, NYCB is trading at a discount. Of course, one can never be entirely certain when analyzing and valuing companies and so down below I look at the range of share prices given changes in certain drivers. 

Sensitivity and Statistical Analysis

The image above shows the range of NYCB's price per share given changes in the long-term growth rate and the cost of equity. I specifically wanted to see the impact of cost of equity because as mentioned in my assumptions, I added a premium of 5%, and I wanted to see what the price might be without the premium. As you can see, if I don't attach a 5% premium, I get a share price of $16.76 as opposed to $6.37 generated by my model. Given the vast range of share prices and where they lie on the spectrum, I believe that I am content with $6.37 per share. Below is a look at the relationship between cost of equity and final year dividends and its impact on the share price. 

As is clearly evident from the image, the amount of dividends the company pays and the its cost of equity have a significant impact on its valuation. For instance, if I keep the dividends paid in the final year the same, and reduce my cost of equity to 9.07%, I get a valuation of $12.99 per share, almost 4x its current trading price. As a result, I believe that the model generated price of $6.37 is well within reason and truly reflects NYCB's intrinsic value. 

Conclusion

As I mention in all of my valuation posts, valuation is very much a singular view, and no two valuations will ever be the same, unless done by the same individual. Based on my assumptions, I believe that the stock is undervalued, and if you were to jump in, you might not agree with my numbers and come up with an entirely different share price. As always, I have attached the excel file and the 10K for your review and dissection. 

Links

NYCB Valuation- 03/14/2024

2022 10K

Everbridge (EVBG): LBO Analysis

   (Disclaimer: Excel file attached below the post) 

As I mentioned before in one of my other posts, I am subscribed to almost all of the fathomable applications and websites; and I am bombarded every morning with multitude of notifications and newsletters keeping me abreast of everything happening in the financial and economic stratosphere. One such newsletter is from an organization called Private Equity International (PEI), and I came across Thoma Bravo's bid to take Everbridge private on one its correspondences. Here is a snapshot of the press release:

Being that I am fascinated by IB and PE transactions, I jumped at the opportunity to analyze the deal and see if this could prove to be a lucrative transaction for the sponsors as well as lenders and Everbridge. I started rummaging the company's financials and was fortunate enough to find the latest- released on 02/26- 10K and 8K on the company's investor relations page. I will begin the analysis with an overview of the company's operational history- because I believe it is paramount to understand how the company has faired in the past in order to understand what the future holds- and then move onto the exercise. 

Past Performance

Before we go any further, I believe we should look at the company's operational performance in the public eye and inquire how it circumnavigated the trials and tribulations of the markets. Here is a snapshot of the company's performance over the past five years, which coincidentally is its entire length of trading, and how it weighs when compared to certain indices. 

There are a couple of big notions that instantly stand out when we look at the map. To begin, we can all see the explosive growth in the share price before the pandemic and especially leading to it and during it, which if you understand what the company does, is not at all surprising or riveting. Secondly, we can also take notice of the stock's almost instantaneous tumble, and the fact that it has not been able to recover, which again, you'll understand once we go over the company's business and its model. Looking at simple charts might seem futile if you don't understand the company or its operations and industry, and so to put the above posted chart in more perspective, I think we should try and understand the story behind the company's inception, its customers, and business model as well as its offerings and products. 

Overview

Everbridge is a global software company that uses automation and technology to enable its customers to anticipate, navigate, respond to, and recover from critical events. If we pontificate about the pivotal part of any crisis, it is the frictionless and smooth flow of accurate and reliable information, and that is where Everbridge's platform and services come in. It helps organizations and companies with storing and allocating multiple types of threat and incident data and analyze and determine whether their employees, partners, and suppliers could be adversely impacted, and if they are, what the possible resolutions or workarounds might be to keep them safe and to keep operations running effectively. It also helps with delivering relevant and pertinent information through modern technology that not only enables efficient communication in times of distress but also ensures that the information is tailored and for the intended party. The Covid outbreak has led to a WFH (work from home) environment and has made keeping track of employees and workers increasingly difficult for organizations; and so it has become equally imperative for companies to keep track of employees that are working remote or travelling and assess and communicate with the ones that they think could be impacted by an event. 

Everbridge is primarily a B2B company, that much should have been clear from the description above, and as such, sells its platform and applications "...to customers of varying sizes, including enterprises, small businesses, non-profit organizations, educational institutions and governmental agencies." Given the nature of the company's industry and operations, its customers are from all facets of the business world, from having relations and customers in industries such technology, financial services, and manufacturing to industries such as retail, higher education, and professional services. Some of the key benefits of the company's solutions and competitive strengths include the following:

• Comprehensive, Enterprise-Scale Platform
• The core of the company's offerings is its Critical Event Management platform; it provides multiple layers of redundancy to assure uptime and delivery of communications regardless of volume or throughput requirements. Everbridge's platform is unique in the sense that it is easily scalable, secure, and reliable. 
• Digital Transformation
• Company's services also help organizations and companies in digitizing and automating their operational resilience. Customers use its solutions' situational awareness capabilities to know where their people are, how to reach them, and how to ensure that they are protected during endangering times.  
• Aggregated Threat Data and Analysis
• Company's software gathers information from social media feeds and trends, from weather feeds and from public safety and threat data among others. The data is geo tagged and mapped and threat and incident data can be used to trigger simple or complex workflows. 
• Dynamic Location Awareness
• Company's services allow organizations and companies to get in touch with their employees based on their last known location rather than static locations such as work or home address. This approach quickly enables companies to ascertain which individuals may be affected by a threat and how best to aid and abet them. 
• Multi-Channel Visualization
• There are multitude of ways to get in touch with someone in times of stress, and to be able to use multiple platforms and channels at one time could prove life saving, and so Everbridge's platform allows multi-channel information to be displayed side-by-side so that different facets of a critical event can be monitored simultaneously. 

The above mentioned benefits along with a host of other abilities led to the company's explosive growth from early '20 to the tail-end of '21, due to obvious reasons. The company continuously invests heavily in building its brand name and position as the global provider of resilience solutions with critical event management, communication and safety applications. 

Growth Strategy

Everbridge has been investing, similar to any growth company, private or public, heavily in its growth, and some of the key elements of its growth strategy are as follows:

•  Accelerate Acquisition of New Customers
• One of the obvious avenues of growth is acquiring new customers. Company offers applications and services that have varied uses and could be utilized in both traditional and unorthodox manners and the management is laser focused on utilizing multiple paths of entry into new customers.  
• Further Penetrate Existing Customers
• Another path to growth for the company is further penetration and enhancement of its existing customers. Everbridge offers a software, platform and a host of other applications, and the company is invested in expanding its relations beyond one department to other sections of its customers as well as elongating the average length of contract for its existing customers. 
• Expand Partner Ecosystem
• Everbridge enjoys a healthy relationship with its partners and system integrators and potential expansion of said ecosystem and partnerships also plays a huge part in its growth. 
• Introduce New Platform Improvements and Innovation
• One of the most crucial elements of SaaS or for companies such as EVBG is to continually invest in its existing services and offerings and consistently improve and innovate, and Everbridge has been doing just that. Company is heavily vested in catering its applications and platform to the ever developing and evolving safety and operational challenges. 
• Expand Globally
• Critical or existential events are not bounded by borders or political and ideological affiliations and so one of the avenues of growth is to expand globally to other countries and foreign registered organizations and companies in regions such as the Middle East, Europe, and Asia.
• Opportunistically Pursue Acquisitions
• Another avenue of growth for the company could be opportunistic acquisitions in order to add features and functionalities to its platform in its current condition as well as acquiring new customers and penetrating new markets and geographies. 

Enough with the 10K-ish jargon, I believe we should move towards the crux of this analysis, the numbers. 

Historical Numbers

Before we can move forward to the LBO analysis, I believe that we need to look at the company's historical numbers in order to understand its past growth, its costs, and its cash flows, and in order to do that, here is a snapshot of the company's historical numbers for the past three years.

As mentioned before, even though it is publicly traded, Everbridge is still very much a growth a company and as such, it has been operating in negative territory for pretty much its entire operational history. Just looking at the past three years, we can see that the company's operating margins have been -20%, -19%, and -13% for FY '21, '22, and '23, respectively. We can also see the seismic impact that its costs, both direct and indirect, have on its revenues; company has historically reported costs of revenue margins around ~30% for all of the observed three years as well as 84%, 88%, and 89% of operating expenses margins for FY  '23, '22, and '21, respectively. At first glance, the company is either investing a lot into its operations in terms R&D, sales and marketing and SG&A or the management has not been able to control the costs with growing revenues, I, personally, believe that it is the former rather than the latter. Furthermore, Everbridge reported Net Income of -$47MM (-10% margins), -$61MM (-14% margins), and -$94MM (-25% margins) for FY '23, '22, and '21, respectively. When assessing an LBO transaction, EBITDA is more often than not a crucial metric and so perusing through the company's 8K, we see that Everbridge reported an adjusted EBITDA of ~$71MM for FY '23, yielding EBITDA margins of 16%. 

Some additional thoughts that I had when going through the data entry phase of this exercise are that (i) company's revenue growth is not exponential, in the sense that it has not been consistently growing for the past few years, but rather it is unpredictable; we can see that the company reported a 17% growth for FY '22, but then only witnessed a mediocre growth of 4% for FY '23; (ii) even though the top line growth has been fluctuating for the past few years, the costs (both costs of revenue and operating expenses) have stayed flat with minute oscillation; (iii) Everbridge has had consistently high interest expense ($2.7MM, $5MM, and $36MM for FY '23, '22, and '21, respectively) over the course of the last three years; and (iv) the company reported debt of $359MM and a cash and cash equivalents balance of $125MM for FY '23.

Moving on to its Cash Flow statement, the company reported $72MM, $20MM, and $22MM in cash from operating activities for FY '23, '22, and '21, respectively. Due to the nature of the company's operations, Everbridge reports two different types of capital investments: purchases of property and equipment ($5.2MM for FY '23) and additions to capitalized software costs ($16MM for FY '23). With all said and done, the company reported $125MM, $201MM, and $492MM (high due to debt raised) end of period cash for FY '23, '22, and '21, respectively. With historical numbers out of the way, lets move onto the analysis. 

LBO

As mentioned at the start of this post, Thoma Bravo is paying $28.60 for every share of Everbridge, yielding a $1.5BB cash payment for the transaction. I could not get any more details on the funding and so I will proceed with assuming two separate scenarios: In the first scenario, I will assume that Thoma Bravo is not taking any debt and thus is financing the whole transaction with equity; and in the second scenario, I will assume that Thoma Bravo will decide to take on debt and only put in a small amount of equity, comparatively speaking. Based on what I know about the transaction from the released press correspondence and news article, here is a quick analysis of the transaction.

As you can see, given an offer price per share of $28.60, diluted shares outstanding of 44,390MM, and a net debt of $234MM, we get an entry EBITDA multiple of ~21x, giving us a transactional value of $1.5BB. Below is a snapshot of my assumed sources and uses of funds (with and without debt):

Image1

Image 2

As you can see, if we assume that Thoma Bravo takes on debt for this transaction, then based on my assumptions about the amount/kind of debt raised, TB will have to put in $208MM of equity (image 1), but if we assume that they decide to not take on any debt and instead finance the transaction with their own wallet (image 2) then they will have to pony up ~$1.6BB, including the assumed financing and transaction fees. Moving on from transaction assumptions, I would like to talk about the drivers of this transaction (Base Case).

• Revenue Growth
• Going forward, I expect the company to grow at a moderate pace. Again, lets recap what the company does, it helps organizations and companies with navigating critical events and disruptions; couple that with the fact that COVID is in our rearview, and that the demand for critical event management is not what it was after 9/11 or during COVID, I think the company will grow at a modest pace throughout the next five years, with 8% growth in FY '28. Furthermore, the assumed growth in revenue is based on the assumptions that the new acquirers are able to increase EVBG's customer base, potentially expand its existing portfolio of customers and users, expand globally to other regions, and are successful in continually improving and innovating its offerings and platform. 
• Cost Reduction
• As mentioned before, costs (both costs of revenue and various operating expenses) have been consistent in the past, and going forward, I believe that as Thoma Bravo strives to increase EVBG's revenues, they will simultaneously be able to reduce the associated costs. This reduction of costs could come from downsizing, lower capex and investment spending, and better asset and platform utilization. I also believe that as the company grows and creates and cultivates new and existing relationships with its customers, and attains some semblance of competitive advantage, its sales and marketing expense should decrease over the next five years with positive (lower) impacts on other expenses such as R&D and SG&A. 
• EBITDA Expansion
• As mentioned in the quick analysis of this transaction, the entry EBITDA multiple- given EVBG's adjusted EBITDA of ~$71MM- is 21x, and I am of the belief that over the course of the next 5 years, Thoma Bravo should be able to expand the adjusted EBITDA margins to 27% in FY '28 from 15% in FY '23. This EBITDA multiple expansion will be driven from increased revenues and reduced costs as the company continues to operate under Thoma Bravo's platform. 
• Debt Amortization
• If we assume that Thoma Bravo will take on debt for this transaction, the calculated debt amortization would be $53MM for the next five years, with no cash flows available for cash sweeps or additional payments. This of course is assuming debt, if they finance the transaction with their own wallet, then there is no debt amortization or interest expense for the proposed holding period. 

With all of this under our belt, here is the going forward income statement (both with and without debt).

Income Statement with debt

Income Statement without debt

As you can see, if we assume debt, we get an interest expense of ~$100MM in FY '24 and its gradual decline to ~$92MM in FY '28, and with it, the negative net income for the all of the next five years, and if you remember, this is assuming all of the growth in revenue and reduction in costs mentioned above, giving us an adjusted EBITDA of $166MM by the end of FY '28. On the other hand, if we assume no debt raised,  we can see that the company starts to turn profitable somewhere in FY '27, as well as yielding positive NI by the end of FY '26, giving us an adjusted EBITDA of $166MM, if you are wondering why it is the same as the one with debt, well that is because the deal related amortization is offset by the growth in revenue and vice versa. Moving on to our going forward cash flow statement:

Going forward CF statement with debt

Going forward CF statement without debt

I think the impact of raising or not raising debt is most evident on the going forward cash flow statement. If we assume that the acquirers opt in to raise debt for the transaction (top image), EVBG does not have enough free cash flows to support the necessary debt amortization; on top of the debt raised for the transaction, the new entity might even have to utilize the revolver and then endeavor to pay down the revolver as it moves forward, yielding essentially $0 for cash sweeps or additional discretionary debt payments. But, if we assume no debt, therefore a higher net income due to no interest expense, the numbers are entirely different. We can see (below image) that the new entity could potentially have positive cash flows for the entire projected period, also yielding a higher interest income. With all of the projections and assumptions in place, lets look at the returns, and see what the IRR and MOIC might be for the parties involved. 

Returns Analysis

Below we look at what the exit might look like with debt assumed for the transaction. 

Exit analysis with debt

Returns analysis with debt

As you can see, if we assume debt, then at our exit, which I have assumed in five years and at 21x EBITDA multiple (same as the entry multiple), we get an equity value of $2.1BB, which when compared to our initial equity of $208MM, gives us an IRR of 59% and MOIC of 10.1X; returns to other providers of capital can be seen in the image above. The lower half the second image gives us an idea as to how much the sponsors can afford to offer at various hurdle rates; and as you can see, if Thoma Bravo's hurdle rate is 30%, they can afford to offer $36.65 for every share of EVBG, yielding an astounding premium of 67.6%. Now lets compare this to the returns without debt.

Exit analysis without debt

 

Returns analysis without debt

At first glance, transaction without debt might seem lucrative, but don't fall prey to that notion; look at the returns analysis down below. Even though the equity value of $4BB is higher than the equity value ($2.1BB) with debt, the returns are lower, much lower, and that is because sponsors have had to put in a lot at the offset of the transaction which, going with logic, translates to lower returns in the future. Again, taking the exit in five years and 21x EBITDA multiple, we get an IRR of 21% and MOIC of 2.6x without debt, and now compare those numbers to IRR of 59% and MOIC of 10.1x with debt, the difference is staggering to say the least. 

Conclusion

What do I think about the transaction after this excruciatingly long analysis? I think that if they choose to take on debt for the transaction, therefore having to put in a smaller amount, the deal could prove lucrative for Thoma Bravo, depending on their internal hurdle rate and expectations for the company and its future. The downside with raising debt is that EVBG does not generate enough free cash flows to support any substantial debt and its associated interest expense and amortization. On the other hand, if they choose to put in only their own cash balance and not raise any debt, they might end up with healthy NI and cash flows but much lower IRR and MOIC.  

Links:

Everbridge LBO 

2023 10K

2023 8K