Hi,

Please excuse the long gap between newsletters...this hasn’t been a focus during the pandemic. What has? Well, I found that I worked a lot more last year, since we weren’t going out. Regular exercise gets me out of my head most days. And since last fall I’ve been studying Math again, which I’ve very much enjoyed.

I’m looking forward to getting vaccinated soon and, someday, opening up to socializing and travel.

Hoping you’ve weathered this storm with elegance.

Best regards,

David

Friends & Family Spreadsheet Help Offer

I regularly get calls from folks who are stuck on some Excel problem. They range from very basic to quite advanced, and I enjoy helping out. I’d like to extend that offer to you, since you subscribe to the newsletter. I like hearing from people randomly and I find the issues to be like a little puzzle I get to solve before getting back to work.

The “One Microsoft” Metric

Value High-Flying Companies With The “One Microsoft” Metric

It’s easy to see these deals as financial success stories for the acquirer.

And, of course, these results weren’t guaranteed. The owners of Instagram probably wouldn’t have sold if they thought they’d have a good chance of running a $10B company today. Clearly, there’s risk in these deals.

Were these cases driven by (often-elusive) synergy gains? You notice you don’t see hedge funds putting together enormous bids to take these companies out.

But YT, Insta, and WhatsApp were all private companies. By contrast, Zoom ($56B) and Slack ($28B) are public and commanding serious valuations which are disconnected from their fundamentals. With GAAP accounting, both companies are unprofitable. With their preferred Adjusted EBITDA metric, Zoom barely ekes out a profit.

Valuation	$99B	$24B
Revenue mult.	160X	38X
EBITDA mult.	7,645x*	nmf -- EBITDA <0
*Based on non-GAAP measure.

To think about them, I propose a new unit: ONE MICROSOFT, defined as cash flow growth similar to what Microsoft has pulled off over the last thirty years.*

The implications of ONE MICROSOFT are:

1. You’re huge.
In revenue terms you grow on average for 30 years at 17% per year and become one of the 50 largest companies in the world. That is, you have an embedded call option on many new network-effects-driven future markets which will drive sustained and rapid growth. Microsoft was already a billion-dollar company; Zoom and Slack aren’t far behind.

2. You’re tremendously profitable.
In fact, in 2020 Microsoft had the fifth highest net income of any company in the world, behind only Saudi Aramco, Berkshire Hathaway, Apple, and China’s state-owned commercial bank. There are 37 companies with higher revenue, but Microsoft’s profitability is nearly 4x the average of that group. Microsoft delivered cash to shareholders of $35B in 2020.

3. The market believes you’re still a growth story.
Even after all this growth, the market currently values Microsoft at 49x cash flow.

In short, it’s a pretty wild ride. I hope we can agree that this kind of performance doesn’t happen very often. It’s a serious yardstick to measure yourself against.

(Impressively, Microsoft also had proven profitability when they IPOed: their 1985 net income was 17% of revenue. They always generated cash and never required significant capital.)

To simplify this discussion, let’s focus on Zoom. We can start out being generous and grant them:

- Full Microsoft profitability (37% Operating Income margin) throughout the 30 years from 2021-2050 and

- Full Microsoft market valuation (at 49x 2020 cash to shareholders) in 2050.

Then it seems fair to account for the risk that those two assumptions don’t work out perfectly by varying the discount rate. I start with a 6% discount rate because the CAPM calls for that for the market overall. Now, I’d argue the beta (volatility) of Zoom is higher than that of the market as a whole, and that’s a reason to increase the discount rate as well. Also, I’ve rarely seen large deals get evaluated at even 10%, so a 12%-15% discount rate may be more common. I wonder if we’re used to using the rates we’ve used historically, but that’s another discussion. In the end, we’ll consider a range of discount rates.

Next let’s vary whether Zoom really can achieve the full ONE MICROSOFT growth rate or if they have to take a slight haircut on that.

Finally, given our assumptions, we can normalize the valuation we get from the NPV of the resulting cash flows by comparing the current $99B market cap to the resulting NPV.

And that sets up this table:

So what does this mean?

- Here, lower numbers are good for an investor today. In each case we’re comparing today’s $56B market capitalization to the NPV we calculate using our “ONE MICROSOFT” cash flow calculator.

- The Yellow cells show what it takes to justify Zoom’s market cap. Either over 1 full Microsoft revenue growth (103%) and a 10% discount rate or 90% of one Microsoft with an 8% discount rate or 115% of that growth with an 12% discount rate.

- The Green cells show what you need to believe to think the stock value will continue to rise.

- The Red cells assumptions suggest the stock is overpriced.

In all, given how impressive ONE MICROSOFT is, you have to believe some aggressive assumptions to support the Zoom valuation.

Finally, getting back to Slack, the $24B valuation was based on an offer from Salesforce. Maybe part of this phenomenon is that Salesforce itself is trading at 12x 2020 revenues and 400x 2020 EBITDA, though if you look at pre-pandemic EBITDA in 2019 that’s a 89x multiple. Since they have their own path to travel to justify their valuation, why not diversify and use the stock currency they have to roll the dice on Slack? It’s like playing with house money. As long as investors buy the synergy story, then it’s sorta kinda free.

Note: If you want to dive into the data and process, see this analysis in Google Sheets. Because Data Tables are not supported in Sheets I wrote my own Google Apps Script code to run that. See that in the Script Editor.

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*I showed Revenue for this data, but cash flow numbers work out the same way: MSFT Op Mgn (like EBITDA) was 36% in 2010 and 37% in 2020. Their data nicely relates Op Inc to NI and CF to shareholders.

Somehow these never go out of style. :-)

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In Excel:

- Ctrl-D: Copies Down, i.e. the formula in the top cell is copied to the row(s) below

- Ctrl-R: Copies Right, i.e. the formula in the first column is copied to the columns to the right

- Shift-F9: When recalc is set to manual, this recalcs just the active sheet.

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In Windows:

- If you have multiple monitors, you can easily move the active window to a different monitor with :

- Win-Shift-[left arrow]: moves window to the next monitor to the left

- Win-Shift-[right arrow]: moves window to the next monitor to the right

Note: these follow video game rules, so if you are on the rightmost monitor and move right, it winds up on the leftmost monitor.

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