BLUF: it might be!
The BBC reported recently that Amazon buys video-game streaming site Twitch for $970M. The question is, of course, how can a game clips company be worth $1b? Has Amazon lost its mind in a fit of hubris and tech-euphoria, or might there actually be some grounded basis in their valuation logic.
Twitch is clearly a “growth” story, and value investors will no doubt scoff at the numbers I am about to throw out there. But here goes anyway.
Over a 1-year period, Siteanalytics reported that the number of unique visitors to twitch.tv went from 1.85M to 3.57M (http://is.gd/y1nai6). That’s a growth rate of 93%. Starting from a small base, one might argue that it could double its unique visitors every year for the next five years, especially now that Amazon is on board.
But let’s be modest, and say that it can grow revenues at 50% pa for the next five years, and that revenue growth will taper linearly to a risk-free rate of 2.5% over the subsequent five years. So its revenues will be up about 15X over that 10-year period.
Sounds implausible? Not necessarily. Google’s revenues went from $3189m in Dec 04 to $63,126m TTM, an increase of nearly 20X
(http://is.gd/Fq6eGw). These are actual revenues, not projections. Twitch is starting from a smaller base. So I think the 50% pa over 5 years that I am using for Twitch will turn out to be conservative.
Next up, how much revenue is Twitch generating? Well, I couldn’t find an answer to that, but I’ll take a stab at some numbers. The reports on number of users vary, but I will use the figure of 45M
(http://is.gd/e81yn9). What’s the revenue per user? I don’t know, but Facebook has an ARPU (Annual Revenue Per User) of $1.63, LinkedIn $1.53, Yahoo $1.81 and Google a massive $10.09 (source:
http://is.gs/nHOLe0). Assuming Google is an outlier, let me ignore it an take an average. So maybe Twitch is generating $1.60 per user. A complete guess on my part, admittedly. So it’s probably generating revenues of $72m, which will be expected to grow to over $1.4b over a decade, if you use my assumptions about revenue growth.
Next, we need to make some assumptions about operating margins. It’s very tricky this one. They could be making a loss, they could be making a profit. I don’t know. I’m going to assume that the operating margin is 0%, and will ramp up linearly to a “sector norm” in a decade. I’ll use a terminal operating margin of 20%. Some tech companies are reporting 15%, some 25%. So I’ll take 20%. The intermediate operating margins I have used are probably fairly low for an extended period, so I suspect that Twitch will be able to generate better EBITs than I have put into my computations.
Producing that revenue growth will require capital. How much? Well LinkedIn has an SCR (Sales Capital Ratio) of 2.14, and Twitter is 2.50. So let me use 2.30. I might be being too generous here, as Twitch uses a lot of bandwidth so their SCR might well be much lower than most tech companies.
I have made some assumptions about tax rates. I don’t know how much capital has already been invested in Twitch, or how much cash or debt they have. So I have swept this under the carpet.
Cost of capital needs to be estimated. I just used the figures that Aswath Damodaran did in his recent valuation of Twitter – which is 10.9% tapering down to 8%. People might take issue with that, especially seeings as it is not a public quoted company.
I think I’ve covered most assumptions, now.
When you grind the numbers, you actually come up with a valuation of Twitch of $950m – remarkably similar to the price that Amazon paid. Most of the value is tied up in the PV of the terminal value: $956m. The PV of the cashflows over the next 10 years I estimate as negative $6m. It is not until year 8 that Twitch goes cashflow positive. A lot of investment is required to fuel growth.
So there we have it. $970m for a company that is possibly generating only $72m in revenues might actually be worth it. Arguably, my assumptions about revenue growth rate and EBIT operating margins are too low, at least intially, meaning that the company is actually worth a lot more. The Sales to capital ratio might be too high, in which case you would need to moderate the value.