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Olivia, Eric, Eric, Sean

Group #6
Rosetta Stone Case #7
Rosetta Stone brings to the market a new way of learning languages by honing in on
consumers needs to differentiate themselves from others in a way that can accommodate their
schedules and needs. The firm is the first to bring software developed specifically for language
learning without the need for a formal teacher or school. During the economic recession while
times were tough, Rosetta Stone proved themselves with some of their highest earning years
yet. The lack of jobs and the increase in unemployment enabled Rosetta Stone to prosper as
those unemployed sought out ways to differentiate themselves from other candidates seeking
employment. Rosetta Stone enables users to learn a language through various techniques in a
way that is at the pace of the user. The firm is also able to prosper, and would continue to do
so, as globalization becomes more and more apparent and firms begin to move or open
operations in countries around the world and seek employees with the ability to communicate in
multiple languages.
The firm's forecasted revenue flows for the future show astonishing numbers, but may
be overly optimistic. At the time Rosetta Stone is the first of its kind, and while barriers to entry
in the software industry are high, competitors with established software brands could venture
into the idea of language software. Competition is low for Rosetta Stone at first making it an
optimal venture for another firm to consider going into. Other firms could arise which will reduce
Rosetta Stones pricing power, especially if the competition offers similar products at lower
prices. With the rise in technological advances other forms of language learning may soon come
to be in the language market and will directly compete with Rosetta Stone. Apps for cell phones
could be offered at incredibly lower prices, and would also bring about an even more convenient
way for users to learn a language. The forecasted revenues of Rosetta Stone do not seem to
take into consideration the potential of a competitor delving into language software and thus
taking away from some of Rosetta Stone's revenues. The forecasted revenues also assume that
since the firm is doing well during the recession, it must do even better after the recession when
there is more disposable income available to consumers. However, the firm is highly dependent
upon consumer preference and despite globalization consumers may consider other ways to
learn a new language or not desire to do so at all.
When a firm goes public, the first advantage that comes to mind is an increase in capital.
In Rosetta Stones case, this capital can be used to fund a move into a different market or
product stream. Going public makes it easier to gain more capital in the future via new stock
offerings. An IPO can also be thought of as a marketing tool. This increased publicity can further
enhance Rosetta Stones recognition in the marketplace. The stature that comes with being a
publicly traded company can enhance its competitive advantage. Suppliers, vendors, and
lenders may perceive Rosetta Stone as a better credit risk. Customers may also perceive
Rosetta Stone as a better product. The recognition and stock available to compensate
employees can attract top talent to Rosetta Stone. Stockholders can also bring new diverse
views and ideas to the firm through board meetings.
There are many risks and disadvantages to consider. First and foremost, it is costly and
time consuming. It is very hard to find a perfect time to go public. The 90 to 120 days often
required to go public is a lifetime in todays financial markets. There is the risk that a new
product is released or a problem regarding management arises while preparing for the IPO.
Rosetta Stones management team must devote substantial time to the IPO and operations can

Olivia, Eric, Eric, Sean


Group #6
Rosetta Stone Case #7
suffer. Construction of an IPO is generally handled by an outside firm which is usually an
investment bank in which heavy fees are accrued. As a public company, you must file annual
and quarterly reports as well as a detailed Prospectus. The Prospectus reveals information that
it was previously able to keep private. With Rosetta Stone being such a unique product, details
are very valuable. Nobody reads a prospectus more closely than your competitors. A public
company also needs to be more concerned about short term goals than it otherwise would be if
it were private. One can become a slave to the stock price which can lead to decision making
based on short term result when a longer term perspective would be better for the company.
Furthermore, it is a difficult process of valuing the stock, without overvaluing. For example, they
could overvalue and provide a prosperous IPO. However, the financial market will equate the
value to a more conservative price over time and could dismay the shareholders and the ability
of the firm to provide growth numbers. If a company does not reach a sufficient size, it can end
up in The Orphanage. This means that it is not followed by analysts with illiquid stock and little
ability to raise capital.
The assumptions the CEO is making are positive, both about the market and about the
firm itself. For example, Rosetta Stone finds themselves as an outlier in the language software
education industry due to that fact that the competitors focus on the machine that is teaching,
not on the students that are learning. They find growth and opportunities in this innovation as
well as providing a path for others to follow. By this we mean the company is expecting to redefine the language learning process as well as how people learn in general.
Furthermore, the CEO believes that they are a technological innovator, within the
education industry, combined with strong marketing techniques which could make them
sustainable in the public offering market. On top of believing they are a technology firm, they
have set of a dynamic employee force that is structured as a laid back technology firm with a
well-rounded set of skills working toward the perfect product. Finally, there is the assumption
that the growth of their business with two major product releases, they can create more buzz
around their brand. An interesting side note, the CEO stands by calling them a technology firm,
yet managing partner at ABS Capital partners states that Rosetta Stone is education business.
However, they Partner goes on to talk about an assumption that the CEO may also have in the
public market. That being the price point being high, yet not as high as a college language
course and structured for the current financial market movement.
These assumptions by the CEO about both the Rosetta Stone going into the public
market as well as the market in general show that the company is positive moving forward. We
believe that this positive outlook could be fueled by positive growth in the worst of the recession
and believe that if they can strive in the worst of conditions, they can grow in the public market.
This of course with some seeing the light at the tunnel as far as getting away from the
recession. However, there may be the question that the light may be too bright in the eyes of
Rosetta Stone.
However, before going public, we believe that this company could sell to another entity.
This entity would most likely be either a private equity firm or a higher education firm involved in
software as well. For our example we choose McGraw-Hill. In our opinion, we believe this
venture would fit the business model of McGraw-Hill due to the fact that they are an education
firm that has already devoted capital into education software. However, within McGraw-Hill, the

Olivia, Eric, Eric, Sean


Group #6
Rosetta Stone Case #7
language education software is not comparable to Rosetta Stone due to the focus Rosetta
Stone has on language learning software. From this we believe that McGraw-Hill would greatly
benefit from the market and customer base expansion during a time where lowering costs and
keeping revenue stream at a continued growth is important to show shareholders that investing
is a stable decision. However, due to the fact that this company could be extending a bid, their
assumptions would be slightly different than ours. For example, McGraw-Hill might be more
optimistic about revenue growth. Furthermore, they would consider synergies in forms of
operating expenses and revenue growth and maybe increase capital expenditures by expanding
the product line. Moreover, based on our assumptions, they would most likely pay a minimum
of $1.2 billion with at least a 25% market premium based on: strong management team, product
differentiation and current market conditions with a need for stable revenue growth and
continued cost drops.
Our team decided to focus on solely software companies. We were able to justify
eliminating education and internet firms due to us not wanting to cross compare industries.
Additionally, internet companies operate in a mostly unrelated market in terms of products and
services. Education was tougher to eliminate due to Rosetta offering education services
however, of the given comparables none of the companies were online software education
medians. For example, Devry offers online courses but they are a tuition based university not an
online software education. This left us to just analyze software companies. With the given
software comparables, our team choose to eliminate three additional comps; ArcSight Inc,
Salesforce.com, and Vmware, Inc. The basis in which we eliminated these comparables was in
regards to their numbers in the Price/EPS and EV/EBITDA. All three of these companies offered
numbers that were at times more than 3x the average. We did an initial comparable analysis
including these three firms and compared it to an analysis run excluding these three firms and
the resulting metrics were much more friendly in the analysis excluding these firms.
After running the comparable analysis, we recorded a share price of $16.94 in regards to
EV/EBITDA running on a basis of a 17% EBITDA margin. The Price/EPS multiple resulted in a
higher $38.93 share price however it operated on a skewed Weighted Average Shares
Outstanding due to us not knowing the specifics of amount of shares sold throughout 2009. In
regards to determining a fair value price, we choose to utilize the average price of our multiples
and DCF. We used the EBITDA multiple share price of $17, the Price to EPS multiple share
price $38.94, DCF of EBITDA share price at $23.31 and finally the DCF into perpetuity share
price of $46.95. This resulted in a fair value $31.55, rounding to $32.
Based upon each of our individual analyses, we estimate an IPO share price of $30 that
we would recommend. The $30 share price values the firms at an IPO $2 short of our calculated
fair value. The price reflects our belief in Rosetta Stones ability to grow, but takes into further
consideration the risks the firm also faces as a result of an IPO. These risks, as detailed above,
include the increased transparency into the firm's inner workings as well as an expected growth
in competition in both language software and other forms of language learning tools such as
apps that we expect as a result of Rosetta Stones public success. The firm is also highly
dependent upon consumer preference, our slower revenue growth rates that aided in the result
of a $30 IPO price also take this into consideration.