Tuesday, August 31, 2021

Valuation of Pinterest


Source: https://www.searchenginejournal.com/pinterest-has-a-new-code-of-conduct-all-users-have-to-follow/401951/

I believe in investing with conviction, and by picking the right companies which I believe in ,I can rest easy even when these companies suffer a meltdown in stock prices.

Most of the stocks which I have blogged about are not the high performing ones in my portfolio, and I chose to write about them so that when they continue to underperform the market, I can re-read my analysis to determine if my investment thesis is still valid. Investing is not following famous investors blindly: buy when they buy, and sell when they sell. I think it is alright to read their views on certain stocks, but after listening to their opinion and outlook, one should do careful research and analysis and then invest with conviction.  

As promised, I will be doing a valuation of Pinterest.

I will be using a two-step valuation model like my previous stock analysis; however, instead of using the perpetuity approach for determining its terminal value, I will be using Earnings Before Interest Tax Depreciation and Amortization (EBITDA) multiple and do a sensitivity analysis.

I will break down the exact steps.

1. Project Monthly Active Users (MAU) and Average Revenue Per User (ARPU) for US and international Users

Assumption:  MAU X ARPU= Revenue.
Q1 2021
ARPU (US)= $3.99 USD
MAU (US) = 98 mil
ARPU X MAU= Revenue (US) = $391.02 mil USD
ARPU (International)= $0.26 USD
MAU (International) =380 mil
ARPU X MAU= Revenue (International) =$98.8 mil USD
Q1 Revenue=Revenue (US) + Revenue (International) = $489.82 mil USD
Reported Revenue = $485 mil USD
Percentage Accuracy= 489.82-485/ 485 x 100% = 99.18%

Q2 2021
ARPU (US)= $5.08 USD
MAU (US) = 91 mil
ARPU X MAU= Revenue (US) = $462.28 mil US
ARPU (International)= $0.36 USD
MAU (International) =363 mil
Revenue (International) =$130.68 mil USD
Q1 Revenue=Revenue (US) + Revenue (International) = $592.96 mil USD
Reported Revenue = $485 mil USD
Percentage Accuracy= 613-592/ 613 x 100% = 96.5%

One plausible explanation for the slight imprecision could be the rounding-off effect. For instance, MAU (International) of 363 mil could mean 363.4 mil or 362.5 mil.
Since accuracy level is above 95%, I think that the current method of deriving revenue is reasonably accurate.

Once we have determined the MAU and APRU growth, we can derive Pinterest’s total sales for the next 5 years. I have assumed zero growth in US MAU for the next 2 years due to the pulled-forward effect from Covid 19. As for international MAU growth, I am projecting a 30% growth rate for the next two years, as there are still untapped opportunities in Latin America and Asia Pacific regions. Also, there is a huge potential for user growth via rolling out of Pinterest features such as Pinterest Lens and AR Try on, which is only available till date in the US regions.

2.  Derive Costs of Goods Sold (COGS), and Operating Expenses (OPEX) as a percentage of revenue
Gross Profit:  Pinterest’s gross profit margins (GPM) have been improving and the last quarter’s gross margin is approaching the 80% level. I will assume an 80% GPM and gradually increase to 90% in the fifth year.

OPEX has been steadily declining to 60-70% of OPEX due to operating leverage, and I am convinced that its operating margin will continue to improve in the next five years. I will project OPEX as a percentage of revenue to drop to 30% in 5 years’ time.(general trend for tech companies).

3. Derive Stock-Based Compensation of COGS and OPEX.
As there is stock compensation which dilutes the share count, I will subtract stock-based compensation so that I do not have to account for share issuances in the future years. It was added back from GAAP to non-GAAP to derive its adjusted EBITDA.

The past quarters’ stock-based compensation component of COGS was hovering between 0.9% to 2%. Taking the average of the past few quarters gives us 1.5%.

The stock-based compensation component of OPEX stayed in the range of 20-22% in the past three quarters. I will start with 22% for the year 2022 and progressively decrease to 15% in 2026.

4. Derive EBITDA Margin

I will be using an EBITDA margin of 29%, which is also Pinterest’s latest quarter’s EBITDA margin. It’s a conservative margin considering that Q2 isn’t Pinterest’s best quarter.

Next, I will adopt Facebook’s current EV/EBITDA multiple of 19 to calculate Pinterest’s terminal value.

5. Determining Pinterest’s Weighted Average Cost of Capital (WACC)

As Pinterest has minimal debt, as Pinteret’s liabilities consists of mainly payable or deferred revenue, I will use the Capital Asset Pricing Model (CAPM) to derive Pinterest’s WACC.

Only recently has Pinterest started to generate positive Free Cash Flow (FCF) and therefore I have a lack of historical data to determine the FCF growth. As Pinterest’s capital expenditure (CAPEX) is declining every year and cash generated from operations is growing strongly, I will use a 30% year-on-year growth. I am not too worried about the projections, as you can see in later calculations that the intrinsic value of Pinterest’s share price is mainly derived from its terminal value discounted to present value.

Summing up the next five years of cash flow and EBITDA and discounting it back to present value, we obtain the intrinsic value of Pinterest.

Next up, I will be doing a sensitivity analysis to determine where the current value of Pinterest stands. Unfortunately, even the price at lower EBITDA multiples at a higher WACC is still above Pinterest’s current price.

Hence, I took another approach by trying out different percentages of EBITDA, and keeping the WACC constant since it has less impact on Pinterest’s current equity value.

Pinterest’s current valuation assumes an EBITDA multiple of 17 at 30% discount to my projection of EBITDA.

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