
Valuing high-tech companies - pmcpinto
http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/valuing-high-tech-companies
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hmahncke
I worked at a McKinsey once upon a time, and this is exactly how we did
valuations. But this article elides the fact that with this kind of model, you
can quite literally get any output you want from choosing your assumptions. In
my view, it was better used as a "what assumptions would you have to believe
to believe in a given valuation" rather than a valuation approach per se. It
can be helpful to know that you'd have to have untenable assumptions to
justify a given valuation. In any case, I bet the DCF model generates lower
values than the private markets are paying, so it's only interesting to such
companies in the public markets where you can act on your beliefs by going
short.

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CamatHN
Thanks for the comment. Though I am wondering, as a consulting firm not a
finance firm, why does McKinsey model and value companies? Are they brought
into double check?

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ucaetano
I worked in a different consulting company.

We're brought in to double check, but also do conduct due diligence and
valuation. There's some overlap between financial services and consulting
companies. In some deals, you might have a bank on one side and a bank +
consultants on the other.

Also, banks are good at doing standard, off-the-shelf valuations. They usually
know little about the specific industry and use one-size-fits-all models.

If you want a detailed valuation, taking in account scenarios, industry
changes, etc. you need people who know the industry pretty well, which usually
means hiring consultants (who either are industry experts, or hire external
industry experts).

In some cases, private equity firms also fill in the role of the bank in
valuations. I've worked on a multi-party investment deal where one company had
consultants (us), another had a bank, and another had a PE firm helping them.
Looking at the different approaches and models from each company was a very
interesting experience.

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kawera
Exactly. I was a partner at McK and, at the time, valuation engagements were
an important line-of-business, both for private equity firms or in tandem with
bankers (M&A, IPOs...).

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aub3bhat
The title uses the word "high-tech", while the article uses "Hot startup", I
doubt if Yelp can still be classified as a "Hot startup". Answering whether
Yelp is truly "high-tech" does not matters since the article makes no
assertion that relies on assuming Yelp to be "High-Tech".

The article is selling standard business analysis, packaged as if it was some
kind of brilliant visionary insight. This "Retro analysis"completely ignores
new streams of businesses that Yelp is getting into such as Food delivery.
These typically have much higher revenue albeit at lower margins, than just
advertising. Not factoring it is a gross miscalculation. The article also
fails to compare Yelp with Grubhub. Which would have produced a much more
realistic expectation.

The article reminds me of this video by Steve Jobs discussing how Marketing &
Sales end up destroying companies.
[https://www.youtube.com/watch?v=-AxZofbMGpM](https://www.youtube.com/watch?v=-AxZofbMGpM)

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thesumofall
I don't think their analysis "ignores new streams of business". They
specifically highlight how the different potential markets should be
approximated.

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pc86
Not only that but Yelp "getting into" a new line of business or revenue stream
does not mean you get to say "it's a $50 billion market we're getting into so
clearly we can add $5 billion to Yelp's value!"

Until it's generating something (e.g. cash on the balance sheet or some other
tangible benefit) I don't see how it would affect valuation at all.

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sadface
Totally agree in principle, but it does seem like just "getting into" the food
delivery business is a humorously quick way to get a $X00M valuation in the
private markets.

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aub3bhat
Well YELP is public. Public markets can also be quite irrational.

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teisman
> Whether this price is appropriate depends on your confidence in the
> forecasts and their respective probabilities.

Did I miss something or did the authors not mention a discount rate, or
Weighted Average Cost of Capital (WACC)? Unless I'm wrong, a discount factor
is needed to calculate the present value, regardless of using a probability-
weighted DCF or a simple DCF model.

If true, then without more information on the WACC, the price they state does
not only depend on our confidence in the forecasts and their respective
probabilities.

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alexyes
The target audience for this article is executives at corporate America, who
understand very little of tech. It is helpful to understand how the rest of
the world looks at tech.

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tryitnow
For those of you who want to learn more and don't want to waste money on a
finance text book, check out Aswath Damodoran's website. Pretty much
everything you need to know about valuation finance can be found there, along
with a lot of data.

Importantly he has a lot of sample models and calculations which will help
make the principles "real" for those of you who prefer details to simplistic
high-level concepts.

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studentrob
Do analysts ever share their data models publicly? It'd be interesting to see
the data and be able to play with numbers along with these kinds of reports.

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retanto
You'll never see any of their data models or data

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studentrob
Really? I find it very surprising that investors would follow such guidance
without being able to see the numbers. How are businesses who produce this
kind of report evaluated? Do people count the number of times they predicted
correctly or incorrectly?

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Nicholas_C
I have a good friend who worked in investor relations for a tech company that
IPO'd. He worked with these analysts and they would send him models. I'm told
that most of these analysts were juggling 5+ companies and couldn't devote
much time to any particular company without neglecting the others. Due to
this, their models were often very poor or were missing large, publicly known
items.

Something to think about.

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GFischer
Some stories are incredible, for example the Dragon horror story that was
featured here a few weeks ago:

[http://www.nytimes.com/2012/07/15/business/goldman-sachs-
and...](http://www.nytimes.com/2012/07/15/business/goldman-sachs-and-a-sale-
gone-horribly-awry.html?_r=2)

[https://news.ycombinator.com/item?id=10994707](https://news.ycombinator.com/item?id=10994707)

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xyzzy4
In my opinion, you can only value tech companies relative to each other,
because as a whole their price/earnings ratios are all too high. For example,
if you sum the value of the entire solar power industry, you get roughly the
value of Twitter. That does not make sense to me.

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forgetsusername
The money is made by being able to predict the future, be that lottery
numbers, disasters or the future earnings of companies.

Modelling startups is hard, because there is so much estimation and variance.
But the fact that it's hard is why its so important.

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gedrap
Thanks for sharing, it's quite handy to see the thought process written down,
quite educational.

