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projectneon
materials for discussion pursuant to proposaljanuary 31st 2009
Table of Contents
o Industry backdrop
o An overview of the firms
o Preliminary valuation
o Synergies
o Next steps
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part 1 industry backdrop
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projectneonIndustry Timeline
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projectneonConsumer Home Entertainment Market
•In 2008, Consumer spending on home entertainment decreased by 5.7%.
•Q4 spending alone dropped 15% from 2007
•Comcast reported that sales for its premium cable packages have dropped.
•Blockbuster reported a drop in revenues and lost market share to rival Neon
•However, 2008 was an optimistic year for some…
•Neon and Argon continued to grow revenues and expand customer base
•Revenues from Internet delivered video content doubled for movie studios
part 2 an overview of the firms
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• Americas largest online retailer• Founded in 1994• Ticker: A**N• Market Cap: $21 Billion• P/E: 34.06• 2007 Revenue: $18.14 Billion • Cash Reserves: $2.32 B Sells
anything from books to furniture• Has a large international footprint
which extends to Asia and Europe• Powers and operates sites for
other internet retailers including Target and Sears Canada
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projectneonArgon-Overview
• Founded in 1997, it is America’s largest provider of online movie rental services
• Market Cap: $2.11 Billion• P/E Ratio: 30.02• 2008 Revenues: $1.36 Billion• Distributes more than 1.5 million
DVD’s per day• Catalog of over 120,000 titles• Sophisticated proprietary
software results in over half of subscribers giving 5-star rating to recommended movies
• Partners with multiple electronics companies to stream content to their products
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projectneonNeon-Overview
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projectneonIndustry trends
Neon predicts conventional DVD rentals to peak in 2013. At that time the number of people watching online video content will have grown to 941 million globally.
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projectneonDirect Competitors
NB the streaming market is estimated to be worth $1.5
billion
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projectneonIndustry trends (cont’d)
•Major growth expected to come from online video via growth in content and devices.
•Partnerships are becoming the standard for the digital delivery market
•Estimates project that the online subscription market will expand to over 20 million customers in the next four to six years
•Worldwide online video revenue is expected to reach $70 billion by 2012
•By 2012, 39% of adults in the US are expected to have purchased or rented online video, 90% of US households will have access to broadband and 94% of those individuals will be watching video online.
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projectneonNeon partners
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projectneonNeon’s management team & board
Name Title Age Total cash comp at Neon
Reed Hastings CEO and Chairman of the Board 47 $850,270 USD
W Barry McCarthy Jr CFO 54 $706,764 USD
Leslie J Kilgore Other Executive Officer 42 $706,930 USD
Ted Sarandos Other Executive Officer and DVP 43 $823,430 USD
Neil Hunt Other Executive Director 46 $677,020 USD
Patty McCord Other Executive Officer 54 Unavailable
Name Title Age Affiliation
Gregory S Stanger Director 43 Venture Partner at Technology Crossover Ventures
Jay C. Hoag Director 49 General Partner at Technology Crossover Ventures
Charles H. Giancarlo Director 50 Managing Director at Silver Lake
Timothy M. Haley Director 53 Founder and Managing Director at Redpoint Ventures
A. George Battle Director 64 Former Chairman & CEO of Ask.com
Richard N. Barton Director 40 CEO & Chairman of Zillow Inc.
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projectneonFuture developments
•Neon forecasts that it will gain an additional 700,000 to 900,000 subscribers in Q1 2009
•Neon continues to reduce the cost of acquiring new subscribers
•Continues to seek partners to deliver Video On Demand
•Plans to spend more money with movie studios and license as much content as possible
•Eventually sees the majority of revenue coming from online content
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projectneonIndustry trends (cont’d)“We named the company
“Neon” not “DVDs by Mail” because we knew that
eventually we would deliver movies directly
over the Internet. DVDs will be around a long time,
but we're building for the day when they're
not.”
Neon CEO
part 3 preliminary valuation
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projectneonMain assumptions
rf 2.30%
rd 6.47%
rm 7.00%
β 1.07
g 4.00%
D/V 3.26%
E/V 96.74%
CAPM 9.79%
WACC 9.60%
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projectneonIntrinsic value assumptions
*All as a percent of revenue, except for revenue growth
Historical Assumptions*
Year 2007 2008 2009 2010 2011 2012 2013
Rev Growth 20% 13% 12.00% 11.00% 11.00% 10.00% 10.00%
Margin 34% 33% 34.00% 34.00% 34.00% 34.00% 34.00%
Total Operating Expense 27% 27% 26.00% 26.00% 25.00% 25.00% 25.00%
Other Income & Expense 1.68% 1.68% 1.50% 1.50% 1.50% 1.50% 1.50%
Taxes 40% 40% 40.00% 40.00% 40.00% 40.00% 40.00%
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projectneonIntrinsic Value
DCF $350,225.40Continuing
Value$1,719,942.4
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Total Value$2,070,167.8
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Share Price $35.28
Despite a 5.7% decrease in home entertainment spending per US household in 2008, Netflix continues to show positive trends
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projectneonNeon’s Resiliency
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projectneonComparables
Company Revenue Market-Cap P/E EV/EBITDA
Blockbuster $5.48 Billion$256.39 Million
4.16 3.781
1-800-FlOWERS
$931.61 Million
$192.52 Million
6.89 6.362
Comcast $33.51 Billion $44.15 Billion 14.88 5.956
DIRECTV $19.26 Billion $23.38 Billion 12.83 5.488
Argon $18.14 Billion $21.4 Billion 34.72 18.592
Mean $15.46 Billion $17.88 Billion 14.70 8.035
Median $18.14 Billion $21.4 Billion 12.83 5.956
Neon $1.31 Billion $2.16 Billion 20.04 14.464
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projectneonMultiples Valuation
Ratio Mean Median Netflix
P/E $20.80 $18.16 $28.36
EV/EBITDA $22.79 $16.89 $41.03
part 4 synergy valuation
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projectneonSynergies and Growth Opportunities
• Overseas growth
• Content Offering & Negotiation power
• Cross Promotion capabilities
• Possible increase in DVD salvage value
• Consolidation of existing distribution centers
• Online movie viewing
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projectneonSynergy and Growth Assumptions
*Percentage of net sales
Assumptions*
Year 2009 2010 2011 2012 2013PV of
Synergies(thousands)
Fulfillment Synergies
1.75% 1.75% 1.75% 1.75% 1.75% $124,486
Growth Synergies -0.50% 0.00% 1.00% 2.00% 3.50% $86,486
Marketing Synergies
0.25% 0.25% 0.25% 0.25% 0.25% $17,784
Technology Synergies
1.00% 1.00% 1.00% 1.00% 1.00% $71,135
• Fulfillment Expenses- Currently 10% of Neon sales ($149 million)
• International Growth- 46% of Argon revenue came from abroad ($8.9 billion)
• Marketing Synergies- 15% of Neon sales is spent on Marketing (about $200 million)
• Technology Synergies- 6.5% of Neon sales (about $90 million)
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projectneonSynergy justifications
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projectneonNeon value with synergies
*Premium based on LP Consulting’s calculation of intrinsic share price
DCF $490,680.52
Continuing Value $2,641,474.81
Total Value $3,227,009.17
Share Price $55.00
Premium*: 55.88%
Actual Share Price $36.14
Premium on Actual 52.19%
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projectneonFinancing Considerations
• Argon using Cash vs. debt vs. equity financing
• Abundant cash level, $2.32 Billion• Low debt level• $45.18/share @25% premium
• Argon should use a 15/85 combination of cash and debt
• Avoid using all-cash, considering economic conditions• Debt rating upgrade will lower cost of borrowing• Netflix has a low debt level as well
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projectneonRecommendation
Move forward with the acquisition of Neon
• Reasons
• Argon’s distribution network• The Netflix brand and customer base• Amazon’s technology capabilities• Ability to use size and resources to your advantage• Cross-promotional abilities
questions?
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visual presentation by
LP CONSULTING