The question that need to be answered: what should be the price of the IPO?

In order to answer this question, we need to use the valuation model:

-

Work on Discount Cash Flow model (intrinsic model)

Comparable valuation (relative model)

a. The intrinsic model

Discount Rate
Beta
Risk Free Rate
Market Risk
Premium
Cost Of Equity

(New Oriental Education and

1.2
Technology group)
2.96%
6.50%
10.76%

We calculated free cash flow by deducting change in net working capital and capital
expenditure to earning after tax (Please refer the excel sheet for detail calculation). Here, we
assume that the debt amount is negligible for Rosetta stone, so we only calculated cost of
equity (10.76%) and used it as discount rate to find NPV.
In term of terminal value we used following formula:

Terminal value = Final projected year cash flow*(1+long-term cash flow growth rate)/
(discount rate- long-term cash flow growth rate)
We assumed 5% growth rate of cash flow after final projected year cash flow to calculate
terminal value because the projected revenue shows the steady growth rate of 5% after 2018
onward.

b. The relative model

The assumption of the P/E ratio:
We need to analyse first the factor that make the P/E of Rosetta Stone and then, find a
comparable company to evaluate the price of the IPO?
The information needed to find a comparable company is to look at the risk, growth and DPR.
The indicators that are necessary to evaluate the risk of a company are: the level of debt, the
nature of the business and the size of it. The size can be measure in 3 different ways: whether
by calculating the market capitalization, or looking at the total assets or looking at the number
of employees.
Information about Rosetta Stone, Inc. in 2008/2009:
-

Level of debts = 9 910 000 $ (Exhibit 6, but if we compare this number to the amount
of cash (Exhibit 2), the amount of debt is extremely small. So we make the
assumptions that the level of debt is closer to 0 $).

Nature of business = Online language earning

Size of business Impossible to use the market capitalization method because the
company does not yet have shares on the market. The total assets = 138 818 000 $

Information about New Oriental Education in 2008/2009:

-

P/E = 24.5 (Exhibit 9)

Level of debt = 0 $

Nature of business = Foreign language training and test preparation courses in the
USA and China, primary and secondary educational content and technology.

Size of business Total assets = 396 743 000 $

So, what would be the price of Rosetta if we use the P/E of New Oriental Education?
P = EPS x P/E
In order to calculate EPS we use the total number of shares and the earnings reported in the
fiscal year 2008. The number of shares were 17,189,500 (Exhibit 8). The earnings in financial
year 2008 was 13,892,000 $ (Exhibit 1). This net income was attributable to common
shareholder so the dividends which are attributed to preferred stockholder is already adjusted
for.
Therefore,
EPS = (Net Income attributable to common stockholder)/Number of shares
EPS = 13,892,000/17,189,500 $/share
EPS = 0.81 $/share
Using this value to calculate the value of each share of Rosetta Stone, we get
P = EPS x P/E
P = 0.81 x 24.5
P = 19.8 $/share

Recommendation:
After valuating the firm using both the ways we suggest them to issue share price should be in
the range of $19/share to $23/share.

Sources
1. http://investor.neworiental.org/mobile.view?
c=197416&v=202&d=3&id=aHR0cDovL2FwaS50ZW5rd2l6YXJkLmNvbS9maWxp
bmcueG1sP2lwYWdlPTU5MzUzMzgmRFNFUT0xJlNFUT04NyZTUURFU0M9U0
VDVElPTl9QQUdFJmV4cD0mc3Vic2lkPTU3
2. http://financials.morningstar.com/ratios/r.html?t=EDU&region=usa&culture=en-US
3. http://www.wikinvest.com/stock/Rosetta_Stone_(RST)/Data/Key_Metrics#Key_Metri
cs
4. http://www.gurufocus.com/financials/RST
5. http://www.valueinvestorsclub.com/idea/ROSETTA_STONE_INC/23976