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Its a report written during my Post graduation studies.

Its a report written during my Post graduation studies.

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    Financing plan for mymuesli 1 14 Financing plan for mymuesli 1 14 Document Transcript

    • Financing Plan for mymuesli Lennart Einemann (92050@student.hhs.se) Hossein Khanaki (khanaki@kth.se) Santhakumar Mettampalayam Vaduganathan (skmv@kth.se) Course Assignment Finance for Start-ups 2010 Instructor: Anna Söderblom Stockholm School of Economics March, 12th 2010 1
    • ContentIntroduction .................................................................................................................................................. 31. Mymuesli............................................................................................................................................... 32. The market ........................................................................................................................................... 43. Business model .................................................................................................................................... 74. Financial situation ............................................................................................................................... 95. Valuation techniques......................................................................................................................... 10 5.1. Discounted Cash Flows (DCF) valuation ................................................................................... 10 5.1.1. Cash Flows to Entity model or WACC ............................................................................... 11 5.1.2. Cash Flows to Equity Valuation ........................................................................................... 12 5.1.3. Adjusted Present Value technique (APV) ........................................................................... 12 5.2. Relative Valuation/Multiple Valuation ....................................................................................... 12 5.2.1. Price/Earnings (PE) Multiple ............................................................................................... 13 5.2.2. Price Book Value (PBV) Multiple ........................................................................................ 13 5.2.3. Price/Sales (PS) Multiple ....................................................................................................... 14 5.3. Dividend Discount Model (DDM) .............................................................................................. 14 5.4. Net asset valuation ......................................................................................................................... 14 5.5. Real Options Valuation ................................................................................................................. 156. Valuation approach for mymuesli........................................................................................................ 15Summary and Recommendations ............................................................................................................ 18 2
    • IntroductionThe content of this work is an evaluation and a finance plan for a young German start-upcompany, called mymuesli. First we will describe the firm itself and the market they are engagedin. Afterwards the business model will be explained and evaluated. Than the little given financialinformation will be assessed and projections about the potential financial need and sources offinance in the future will be made. Furthermore different valuation techniques will be describedand used for mymuesli. Finally there will be a DCF valuation for the company and possiblerecommendations will be made.1. MymuesliThe story of mymuesli begins back in the summer of 2005. Three students from Passau, a citynear Munich in Germany, are on their way to the beach and listening to a famous radiocommercial from a big cereals and cornflakes producer. Then the idea was born to offercustomized “muesli” where people could choose their favorite ingredients on their own. Somepeople like fruits in their cereals, other are more into wheat instead of corn, some preferchocolate in there. So the idea to offer a “breakfast 2.0” was born. Using the global trend of masscustomization and the customer need of multiple options, they had the idea to distributecustomized muesli ordered and chosen on the internet. This was all matched with the strongtrend in Europe and Germany in particular of sustainable ecological ingredients. Biological foodis a very big trend there with a huge demand. So the young company, founded in 2007, started toprovide the customers with a variety of 60 ingredients which could be mixed up to 566 billiondifferent combinations of cereals. The product is rather expensive, but the high demand showspeoples willingness to pay for a healthy and tasty breakfast, designed on their own. The founderswere able to finance their activities in the beginning without venture capital. Using their ownmoney and savings as well as family funds, the type of financing can be described asbootstrapping. This was possible since there were no big investments needed for the webpageand the warehouse to act as a reseller and distributor of the customized cereals. The demand wasvery high, so that they were in trouble to fulfill all the orders, but with over 30 short-termemployees (90 by the end of 2009) the problem was solved. This ongoing rapid growth is due tothe viral marketing strategies through blogs, social networks as facebook and very positive mediareports in general. Over the time two successful founders of a t-shirt customization startup firm 3
    • entered the company as venture capitalist. They were able to bring in fresh money, needed for thefurther expansion, as well as their own experience as successful founders and youngentrepreneurs in the internet based customization market. In 2008 the company expanded to theAustrian, Netherland, UK and Swiss market. They even built a small production facility inSwitzerland.2. The marketThe market for breakfast cereals in 2008 was around 24.2 billion USD and it is expected to growto 28.7 billion USD in the year 2013 which accounts for a growth rate of around 17 %. Thevolume of the global breakfast cereal market in 2008 was around 3.9 billion kilograms and it isexpected to grow up to 4.4 billion kilograms by 20131. In Europe, the breakfast cereal industry isworth € 4.5 billion. Every year around 1.1 billion kilograms of breakfast cereals are produced andthe sector employs around 11000 people2.The breakfast cereal market in the US is roughly two third of the world‟s market. They accountfor 64.9% of world‟s market. The industry is well established in the US and it is dominated by afew giants like Kellogg‟s, General Mills, Post Foods and Quaker Oats. The success in thisestablished market largely depends on the pricing of the product and also on the brand image. Itis very important to do extensive marketing to gain market share in this segment dominated byestablished companies.Top Cereal Producers3Market share for 1999, 2005, and 2008. Manufacturer 1999 2005 2008 Kelloggs 32% 32% 33% General Mills 31% 26% 25% Post 16% 15% 15% Private Labels 8% 14% 14% Quaker Oats 9% 6% 7% Malt-O-Meal 3% 5% 5% All Other 1%1 http://www.the-infoshop.com/report/dc108460-breakfast-cereals.html2 http://www.ceereal.eu/documents/bw_flyer.pdf3 http://www.lavasurfer.com/cereal-stats.html 4
    • The market of hot cereals grains which have to be soaked or boiled to eat, accounts for just over10% and the market is clearly dominated by ready to eat cereals, which accounts for 88% of totalrevenues. Even though the growth rate of the overall cereal market is low in recent years, thecompanies have to bring in new products every now and then to retain their market share. If wesee the trends in the cereal industry, some of the new products have grown considerably incapturing the market share even though the overall market remains the same. This is one of thewelcome signs for new products and companies entering the industry. Brand extension is donefor the established brands. New products are introduced under the same brand label and thebrand is broadened with the specific line of products.Most Popular Cereal Brands4Market share for 1995, 1999, 2005 and 2008. Cereal 1995 1998 2005 2008 General Mills Cheerios 6.5% + 7.6% + 11.30% 12.60% Kelloggs Special K < 2.0% < 2.0% 4.00% 5.40% Post Honey Bunches of Oats < 2.0% < 2.0% 4.10% 4.90% Kelloggs Frosted Flakes 4.20% 3.90% 4.10% 3.80% Kelloggs Frosted Mini Wheats < 2.0% 2.90% 3.20% 3.50% Kelloggs Raisin Bran 2.70% 2.70% 2.90% 3.00% Kelloggs Froot Loops < 2.0% < 2.0% 2.50% 2.60% General Mills Cinnamon Toast Crunch < 2.0% 1.90% 2.60% 2.40% General Mills Lucky Charms 2.00% 2.20% 2.40% 2.40% Quaker Oats Capn Crunch < 2.0% < 2.0% 2.40% 2.40% Quaker Oats Life < 2.0% < 2.0% 2.30% 2.30% Kelloggs Rice Krispies 2.80% 1.90% 2.10% 2.30% Kelloggs Corn Flakes 3.00% 2.60% 2.10% 1.90% All Others Combined 72.20% 74.30% 54.00% 50.10%4 http://www.lavasurfer.com/cereal-stats.html 5
    • Mymuesli has a clearly identified market segment. They sell premium quality, organic muesli andthe customers can customize the product according to their wishes. As of now, the companyconcentrates on people who are either interested in customizing their own cereals or people whoare interested in buying organic food. Both the customization industry and the organic foodindustry are growing in recent times.The total amount of organic food sold in the US in 2006 was about 3.6 billion USD which isdouble the amount compared to 2000. And also from 2004 to 2006, sales of organic food insuper market and mass merchandisers (e.g. Wal-Mart) were grown 38.4%5. It is also estimatedthat the sales of growth in organic foods will increase by 71 % from 2006 till 2011. If we take theorganic bread and grain market, the sales increased from 422 million USD to 551 million USD intwo year period from 2006 till 2008 and it is estimated that the growth will continue and by 2011the sales will be around 859 million USD. The breads and grains share of market out of wholeorganic food market is shown in the figure below6. In Europe, the organic cereal marketpenetration is very low with only about 0.06 % in UK7 and with the current mindset of people,there is a big scope of opportunity to grow in this sector.5 http://www.productcenter.msu.edu/documents/Working/organicfood1.pdf6 http://www1.agric.gov.ab.ca/$department/deptdocs.nsf/all/sis84347 http://hgca.com/publications/documents/Breakfastcereals_REVISED_JULY_2007.pdf 6
    • Another important component of their product is customization. Research has shown thataround 75% of American adults like to have customized products and they are willing to paymore money for a customized product (R. Gardyn, „Swap meet‟, American Demographics, July2001). A lot of companies started selling customized products recently. For example companieslike zazzle, cafepress and spreadshirt (whose founder joined mymuesli as a venture capitalist inthe first round of finance and is now holding 5% of the company) sell customized T-shirts onlineand a company called misterspex.de sells customized spectacles. The trend towards customizingthe product favors the company and its business model well.The penetration of the cereal market in developing countries in Asia and other parts of the worldis very low. The sale of cereals in Russia and China is small compared to global terms with 263million USD and 71 million USD of sales8 in a 24 billion USD cereal industry. These markets aregrowing fast and have a huge potential lying ahead. As of now the company is selling cereals onlyvia its website and it is delivered to the customer‟s home. They have a partnership with DHL, ahuge logistics company for the delivery. Considering the fact that 77.5% of cereals are distributedvia supermarkets and hypermarkets9, the company should concentrate on adding another valuabledistribution channel like supermarkets. So we think it was a great step that mymuesli started tosell their products in trendy coffee shops in Berlin. This is a good step to test and developanother distribution channel. If the sales turn out to be a success they could easily expand thisstrategy. Possible partnerships with huge coffee store chains like Starbucks or Waynes Coffeecould be a step towards supermarkets and other distribution channels.3. Business modelThe business model of mymuesli is very innovative. People can mix, customize and order theirdesired muesli online. One can choose from 60 different ingredients and mix billons ofcombinations. After the order online the customized product is delivered via mail to thecustomer. This simple so called build-to-order principle is very rewarding. First of all there are nolarge investment costs for production facilities. Since the ingredients are ordered from varioussuppliers the company just needs small space for mixing the product in the desired way. Themarketing is highly innovative and rather cheap as well. There were no high costs for8 http://www.euromonitor.com/Cereal_Partners_Worldwide_exploits_developing_markets9 http://www.the-infoshop.com/report/dc108460-breakfast-cereals.html 7
    • commercials on national TV, radio or newspapers at the beginning. The “Web 2.0” was used veryeffectively through various social media channels such as blogs and youtube or social networkslike facebook. This viral marketing turns out to be quite successful and to popularity wasincreasing exponentially. The distribution process is efficient, rather cheap and fast. The valuethey add to the product is the mixing of the ingredients as well as a trendy and nice package.This business model gained several rewards and from the success of the first 3 years we knowthat it develops very successful. In general the idea of customization is not entirely new. It ismore the specific product the founders chose. In an interview one of the founders said theymade a survey in order to estimate the demand for customized muesli with 450 persons.Although the results are not published in detail, we know from him that they should rather nothave founded the company if they had followed them. But in general the market is tremendouslybig, if we expect that almost everyone on earth is eating breakfast. A large proportion is eatingcereals and since global trends like biological, functional and healthy food products as well as thedesire of people to customize products to their specific needs are more and more evolving theyfound a niche to the right time. The uniqueness of this idea is still a problem since it can easily becopied. So it depends on whether they are able to build such a strong brand during the first yearsthat they can preserve a competitive advantage over the time. At the moment there are no realcompetitors but this is subject to be changed for sure. For example if a big supplier like Kellog‟swith its multibillion marketing budget is starting to build an online shop, offering a customizationopportunity we can‟t predict for sure how mymuesli could compete. Maybe they are morecomparable to other startups which are offering chocolate, coffee or juice mixed and customizedfor the specific needs of potential buyers. Since these businesses are all rather new and young wecan‟t project if they have a place in the market in the long run. But overall the business model ofmymuesli is viable and fundable. The entrepreneurs all have a strong personality and with thesuccessful venture capitalists from a former startup company on board the management teamseems to be able to be successful in the future. In addition the business model generates positivecash flows right from the beginning because of the high prices and the build-to-order principle.Moreover the awards they got for their business model are an indicator that the venture capitalistscene in Germany and Europe believes in that business. 8
    • 4. Financial situationFrom an interview with the founders of mymuesli we know that they were able to start thebusiness in 2007 without external funding and without the help of venture capitalists. Somehowthey managed to raise the funds necessary on their own with the so called bootstrapping method.This was possible since the initial investments were not that high. The founders developed thewebsite which was not too expensive and started packing the ordered muesli in the basement of asmall store in Passau, Germany. This was mostly done on their own handcraft. The marketingcosts were not too high either, since they used social media in a smart way. But all in all we haveonly very little financial information given about the company. This is kind of an advantagesometimes but also a bit complicated for the stakeholders. Since they are unlisted they don‟t haveto publish financial information, which makes it quite complicated to evaluate and valuate thebusiness from a financial perspective. The policy not to disclose too much financial data might bereasonable for them at this stage, since the company is still growing and already profitable. It waskind of a special situation, that they were generating positive cash flows right from the beginning.This must be due to the special business model with the build-to-order principle. The customershad to pay the orders in advance and it was delivered after roughly one week. This is part of thebootstrapping finance method and one of many reasons of the early success of mymuesli. Afterventure capitalists joined the company in 2008 in order to finance the expansion to otherEuropean countries like Great Britain, Switzerland and Austria they published at least some basicincome and expense numbers. At this stage of development the next financial steps should beraising more money in a second round from venture capitalists. Since the first round investors areformer successful entrepreneurs themselves, engaged in a similar business (T-shirt customization)they somehow have character of business angels in terms of the region in Germany as well as theamount of money they can be expected to be engaged in the company (ca. 1 mSEK). So althoughwe don‟t have enough concrete data we can say that it is too early for private equity buyout fundto invest and hence too early as well to think about an IPO. But to finance mymuesli‟s furthergrowth and expansion plans there will be needed fresh venture capital. We estimate the financialneed for the upcoming three years with roughly 1 million Euros (10 mSEK). This money isneeded for further market penetration through traditional marketing methods such ascommercials to build a strong brand. Moreover some packaging facilities will be needed in thefuture to mix, pack and deliver the orders faster. Since the brand is already quite strong inGermany, we know that they sell a couple of different pre-mixed mueslis to go in some coffeeshops in Berlin. This new distribution channel as well as acquiring and developing more of themis capital intense as well. But with respect to the positive cash flows right from the beginning 1 9
    • million Euros of external funding should be sufficient for the second financing round becausethere is the possibility of organic growth through retained earnings and internal financing fromthe revenues.5. Valuation techniquesIn this section we want to describe some valuation methods in theory before applying one ofthem on mymuesli later. This will be a difficult task since there is only very little financial datagive from 2008, so that we have to project and estimate the future free cash flows (FCF) derivedfrom the earnings before interest and taxes (EBIT) on our owns.There are three dominant models to value target companies including simple to elaborate models.5.1. Discounted Cash Flows (DCF) valuationSince expected future cash flows are one input of this valuation technique, this model isappropriate for companies whose future cash flows can be estimated reliably. Moreover, theestimated cash flows should be essentially positive. Furthermore the so called discount rate isanother input of this technique and the risk contributes in the discount rate calculation.Implementing this technique for the valuation of distressed companies (with negative cashflows/earnings), cyclical companies (whose earnings are a function of economic and businesscycles, hence with a high elasticity) and companies with unrealized assets, properties, patents orproducts can be misleading.The Cash Flows to Entity model or WACC (weighted average costs of capital) is the most widelyused method that implements the discounted cash flows approach for the valuated companies.The Cash Flows to Equity model is another method implementing DCF (discounted cash flows)to valuate companies, which initial endowment or investment was financed just by equity. Forcompanies with dynamic capital structures the adjusted present value (APV) is the mostappropriate method. The DCF approach relies on the analysis of the company and the market itoperates in, so it can be very subjective since it depends on the person who prepares the DCFspreadsheet. 10
    • 5.1.1. Cash Flows to Entity model or WACCExpected future free cash flows (FCF) are the most important parameters that should becalculated in advance to be used for valuating a company by WACC. Free cash flow is defined bythe EBITDA (earnings before interest, taxes, depreciations and amortization), minus taxes onEBITDA, plus/minus capital expenditures, plus depreciations, adjusted by the change in workingcapital and other net assets. The WACC is the weighted average cost of capital that defines theyearly discount rate. 1 2 = + 2 + ⋯+ 1 + (1 + WACC) 1 + + ∗ (1 + ) = (1 + ) ∗ ( − ) = . ∗ 1 − ∗ + . ∗ The costs of equity can be calculated by the formula below, called Capital Asset Pricing Model(CAPM): . = + − ∗ is the risk-free interest rate is the return of the market index (market portfolio)β is the risk factor calculated based on the market and equity risk of the company = − ( − − ) 11
    • 5.1.2. Cash Flows to Equity ValuationThis model can be implemented whenever the only source of finance for company is equity thatresults in the simplest form of DCF. Here, Cash Flows To Equity (CFTE) should be used asinput instead of Free Cash Flow (FCF). 1 2 = + 2 + ⋯+ 1 + . (1 + r. equity) 1 + . + ∗ (1 + ) = (1 + . ) ∗ (. − )CFTE is measured as what the company can pay out to the equity owners and is calculated asfree cash flow, plus the tax shield, plus new debt issues, minus interest and debt payments. Sincemost of the free cash flows at first years of the investment are allocated to cover debt andinterest, a result of CFTE will be close to zero for first years. Consequently, the usage of CashFlows to Equity Valuation for leveraged buyouts (LBO) should be questioned. Furthermore,based on this formula the value of the company is affected by changes in financing issues. Forexample, based on this model issuing new debt will increase the value of company inconsistentlyand incorrectly.5.1.3. Adjusted Present Value technique (APV)Unlike the WACC technique, that takes the tax shield into consideration by adjusting debt costswhen calculating the WACC, the APV technique discounts future taxes directly to adjust taxissues through interest payments.5.2. Relative Valuation/Multiple ValuationIf we suppose that capital markets value companies correctly and there are lots of companies thatare listed on the financial markets, the relative valuation technique is the quickest way to value acompany and its assets. Since there are no companies that are completely similar in the terms ofrisk and growth, the definition of “comparable” is subject to biased judgment. Hence, relative 12
    • valuation relies on some assumptions that sometimes left unstated, while the DCF approachalways tries to state every assumption clearly to avoid manipulation. However for simplicityreasons, the relative valuation technique is a part of all valuation procedures. The multiplevaluation can be very subjective since it is based on the selection of comparable companies. Thatmeans for example, exaggerated parameters of the chosen competitors will result in a wrongvaluation of the target company itself.5.2.1. Price/Earnings (PE) MultipleThis ratio depends on the payout ratio, the forecasted growth rate (g) and the consistent discountrate (r). ∗ (1 + ) = = ( − )Obviously, an average amount of earnings should be used to calculate the payout ratio.Otherwise, companies with temporary negative earnings or cyclical companies with volatileearnings will be valued incorrectly. When the discount rate and the growth rate are close to eachother this multiple will be useless.5.2.2. Price Book Value (PBV) MultipleThe difference between the book value of a company‟s assets and liabilities yields to the bookvalue of the entity. The book value of assets is the purchase price of assets minus depreciationbased on accounting convention or method. The advantage of this multiple is the ability to valuecompanies even with negative earnings. However, this multiple is not applicable to value servicescompanies that don‟t have considerable assets. Here the concept of valuation is to measure amarket value of a company by comparing its book value with those of other companies in thebusiness. ∗ ∗ (1 + ) = = ( − )A high PBV with a low ROE (return on equity) indicates an overvaluation. Similarly, a low PBVwith high ROE implies an undervaluation. 13
    • 5.2.3. Price/Sales (PS) MultiplePS is the most reliable valuation multiple that uses revenues (sales) instead of earnings and bookvalue in PE and PBV. Hence, the result of the PS multiple is applicable even if the company hasnegative earnings or doesn‟t have significant assets. However, the negative side of PS is theinability to detect cost control problems that probably exists. ∗ ∗ (1 + ) = = ( − )5.3. Dividend Discount Model (DDM)This model is used to value the price of a stock by discounting the predicted dividends back tothe present value. Here the net present value of the expected dividends is used to value thecompany. If the value calculated by the DDM is higher than the price of the outstanding shareswhich are currently traded, then the stock is probably undervalued. = ( − )5.4. Net asset valuationThis valuation technique relies on the assumption, that the value of a company is the book valueof its assets minus the book value of its liabilities. This method is similar to the PS multiple;however the Net Asset Valuation will not work compared with other comparable companies.Here, the core idea of the business is supposed to be worthless. This technique cannot be used tovaluate start-up companies relied on entrepreneurs‟ ideas or intellectual property rights. 14