Rosetta stone inc case study

ROSETTA STONE: PRICING THE 2009 IPO We are changing the way the world learns languages. —Tom Adams Introduction In April 2009 Rosetta Stone management was considering an initial public offering of Rosetta Stone stock during one of the most difficult periods in market and capital-raising history. Rosetta Stone provides an unique language-learning strategy and was a pioneer in developing a whole new market in language-learning. Their strong financial performance allowed them to consider going public during a difficult financial period. At the time of this case, managers are in the process of valuing the stock using various corporate valuation strategies, and making the decision on whether to go public. Purpose In development of this case, students will review the institutional aspects of the equity issuance transaction, explore the costs and benefits associated with initial public share offerings, develop an appreciation for the challenges of valuing unseasoned firms, develop corporate valuation skills, specifically using market multiples, and evaluate related the financial anomaly of IPO underpricing. Case It was mid-April 2009. Tom Adams, president and CEO of Rosetta Stone, Inc. (Rosetta Stone), the language learning software company, reached for his iPhone to contact Phil Clough of private equity fund ABS Capital. Adams and Clough had been discussing plans to take Rosetta Stone public for some time. The wait was finally over. In the wake of the 2008 financial crisis, the market for initial public offerings (IPOs) evaporated. By early spring the market was showing its first encouraging signs. Just a week prior, Chinese online videogame developer Changyou.com had listed on the NASDAQ at a price to EBITDA of 6.5 times followed by a one-day jump of 25%, and the online college Bridgeport Education was currently circulating its plans to go public at a range of 10 to 12 times EBITDA. Having received preliminary approval of its registration filings with the U.S. Securities and Exchange Commission (SEC), Rosetta Stone was authorized to sell 6.25 million shares, a 30% stake in the company. Exhibits 1 and 2 provide financial statements from Rosetta Stone’s IPO prospectus, required by the SEC to inform investors about the details of the equity offering. Half of the shares were to be new shares and the other half were shares to be sold by existing shareholders. Rosetta Stone management had circulated an estimated price range of $15 to $17 per 1 share, representing a price to EBITDA of about 8 times. Demand for the shares was strong, and some analysts believed that Rosetta Stone was leaving money on the table. Yet with world financial and product markets still in turmoil, there was a strong case to be made for prudence. Economic Conditions The previous year had been a dramatic one for the world economy. Prices on global credit and equity markets had been in free fall. The U.S. equity market was down over 50% from its peak in October 2007 (see Exhibit 3 for details of the recent price history of U.S. equity market returns in total and for select industries). The collapse of world financial markets had preceded deterioration in economic activity worldwide, including dramatic shifts in real estate values, unemployment levels, and discretionary consumer spending. The severity of economic conditions had prompted massive intervention by world governments with dramatic policy changes, particularly by the U.S. federal government. The economic and political conditions were frequently compared with those of the Great Depression of the 1930s. In February and March of 2009, there had been some evidence of improvement in financial and economic conditions. Wholesale inventories were in decline. New-home sales were beginning to rise. The equity market had experienced a rally of over 20% in recent weeks. Yet many money managers and analysts worried that such economic green shoots were only a temporary rally in a longer-running bear market. There was strong concern that the magnitude of government spending would spur inflation in the U.S. dollar. GDP growth was still negative, corporate bankruptcy rates and unemployment were at historic highs, and many believed the economic void was just too big for a quick recovery to be feasible. A Wall Street Journal survey of U.S. economists suggested that the economy was expected to generate positive growth in the last half of 2009.1 In contrast, a survey of U.S. corporate executives stated that less than a third of respondents expected to see an economic upturn in 2009.2 The debate regarding the economic future of the world economy raged on.