Private Company Valuation / IPO Case Study: Kakaos Potential IPO

and Reverse Merger with Daum

Emoticons Gone Wild?

Your bank has been called in to advise Kakao Corp, maker of South Koreas leading mobile
messaging application, KakaoTalk, on its strategic options.
It is similar to other mobile messaging applications such as WeChat, WhatsApp, and Line, but it
has complete dominance in South Korea and is attempting to expand into Southeast Asia.
The app has approximately 87 million monthly active users (MAUs), and the company recorded
242 million of revenue and 88 million of EBITDA in the last twelve months.
The company had previously been considering an initial public offering (IPO), but recently it has
been approached by 2 separate entities about potential M&A deals.
One entity is Daum Communications, a publicly traded Korean search and web portal company,
and the other is a privately family-held consortium that wants to enter the mobile messaging
business.
They have both submitted preliminary, non-binding merger / acquisition proposals, with very
different terms and deal structures.
In this case study, you will build a financial model and valuation for Kakao and use those to
advise the company on its best option: Should it go public? Or should it accept an acquisition
offer? Or should it approach different acquirers? Or should it continue to grow organically?
You will have to explain how key accounting, valuation, and M&A methodologies differ for
Kakao since it is a private company.
You will also have to consider how different entities Daum vs. a private consortium vs.
institutional investors might value the company very differently.
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Evaluating the IPO vs. the Acquisition Offers

Daum has indicated that it is interested in pursuing a reverse merger transaction, where
Daum issues stock to acquire Kakao, but Kakao ends up owning the vast majority of the
combined company.
A reverse merger can be a faster route to going public, but it also carries with it regulatory and
market risks not present in IPOs.
Daum has proposed an exchange ratio of 1.5557456 with approximately 43 million new shares
to be issued, which equates to a Purchase Equity Value of approximately 3.1 trillion
(approximately $3.1 billion USD). Kakao would own approximately 76% of the combined entity
afterward.
The private consortium, meanwhile, has indicated that it would be willing to pay between
3.1 trillion and 3.6 trillion for Kakao, pending further due diligence.
It is unknown how much additional due diligence will be required, given that this is the private
consortiums first transaction in this market.
Kakaos valuation in a potential IPO is unknown, but preliminary indications said the company
might be valued at more than $2 billion USD and might raise as much as $1 billion USD in the
transaction.
However, other reports argue that it might be worth as much as 5.0 trillion ($4.9 billion USD)
when it goes public, depending on its financial performance this year.
In this case study, youll determine what the company might be worth in these 3 different
transaction scenarios, and determine what its best option is.
Part 1: Data Gathering and Financial Statement Projections for Kakao
Normally it is extremely difficult to gather data on private companies because they are not
required to disclose their financial statements.
In this case, however, Kakaos financial statements became available because of the acquisition
offer it accepted shortly after the time of this case study.
Please create quarterly financial projections for Kakao for 2Q FY14 through 4Q FY15, and then
build annual projections for 2016 through 2019.
Since the company has not provided historical Cash Flow Statements, you should build your
own version for future periods based on your Income Statement and Balance Sheet projections.
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You should divide the companys revenue into its main segments: Advertising, Games,
Commerce, and Others, and link revenue to key drivers such as MAU (Monthly Active Users)
and average revenue per user (ARPU) or revenue per MAU.
Expenses should be linked to the # of employees or to total revenue.
Part 2: Valuation of Kakao
Once you have built these quarterly financial projections for Kakao, please value the company
using comparable public companies, precedent transactions, and the DCF analysis.
Make sure your valuation allows for the 3 different cases mentioned above: an IPO, a reverse
merger with Daum, and an acquisition by the private consortium.
Note that individual components of the valuation such as Cost of Equity and WACC may also be
different for different buyers or transaction types.
Its up to you to decide which public companies and M&A transactions are most relevant, but
you should almost certainly look at global companies and deals (i.e. do not limit the set to
South Korea) because of the global nature of this market.
You do NOT need to scrub the comps for non-recurring charges or spend days/weeks finding
the information: automate the process via a tool such as Capital IQ, Factset, or even Google
Finance.
Put together your results into a Football Field chart at the end, and make sure you create
different charts for each different scenario.
Part 3: Reverse Merger with Daum Communications
In this segment of the case study, you will build a merger model for Daums proposed reverse
merger with Kakao, wherein Daum will issue approximately 43 million shares and become a
minority owner of the new company.
The bankers advising Daum have already provided brief, incomplete financial projections for
the company.
Do NOT attempt to build your own projections or make these more flexible just go with
what they have.
They have declined to provide detailed assumptions and information, and you are not advising
Daum in this deal, so please use the provided information as-is.

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In the merger model itself, make sure you complete all the standard sections such as the
Transaction Assumptions (based on the exchange ratio), the Sources & Uses schedule, the
Purchase Price Allocation schedule, and so on.
Assume that the transaction closes at the end of Q3 of the year in which it was announced.
Refer to the precedent transactions to get an idea of the figures to use in the Purchase Price
Allocation schedule.
For the synergies, you can assume that Daum is much more likely to benefit via additional
revenue than Kakao is. Think about the following areas:

Can Daum improve its advertising revenue per unique visitor, based on Kakaos
platform?
Can Daum improve its game revenue per unique visitor, based on Kakaos platform?
Can Kakao and Daum consolidate buildings and save money on leases?
Both companies are spending a significant amount on advertising agencies and
outsourced services could they cut spending in these areas by consolidating accounts?

Assume modest percentages for these synergies; the total Income Statement impact of
synergies in FY15 should be considerably less than $100 million USD.
In the final segment of this case study, youll complete 2 exercises that you may not be familiar
with: a relative contribution analysis and an exchange ratio analysis.
The contribution analysis should show the amount of revenue, EBITDA, EBIT, Net Income, and
MAUs that both companies are contributing to the new company in FY14 and FY15.
Calculate the implied Enterprise Value and Equity Value for the entire company based on these,
then Kakaos implied value, and then the implied ownership split and the per share offer price
that Kakao should receive. You can create graphs and charts for this if you have time as well.
In the exchange ratio analysis, youll show how the ownership percentages and purchase
equity value change with a fixed exchange ratio (hold the 1.5557456 ratio constant) vs. a
floating exchange ratio (hold the purchase equity value constant). Let Daums share price vary
by 20-30% above and below its current share price.
Then, youll add in support for collars that constrain the purchase equity value above or below
certain buyer share price values (for the fixed exchange ratio case) or the exchange ratio above
or below certain buyer share price values.

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Its up to you to decide on the appropriate floor and cap for these collars. Remember that the
purpose of collars is to limit risk for the buyer and seller in all-stock deals by limiting how much
the purchase price can change when the buyers share price changes.
Part 4: IPO Model for Kakao
In this part of the case study, you will complete an IPO valuation model for Kakao to estimate
the companys value when it goes public, as well as the net proceeds and the percentage of the
company that will be sold in the deal.
Please use the following assumptions for this segment:

Assume a listing on a US-based stock market, such as the NASDAQ exchange.

Start by linking the companys valuation to the most relevant multiples from your
analysis of the comparable public companies. You typically use 1-year forward P / E
multiples for this.
Assume a deal size of $1 billion USD, with a 75% / 25% split between primary and
secondary shares.
Assume a Greenshoe Provision of 15%, split 75% / 25% between primary and secondary
shares, an IPO Discount of 15%, and an Underwriting Discount of 5%.
Assume approximately $10 million USD in Offering Expenses, including registration and
filing fees, legal fees, printing fees, accounting fees, and other miscellaneous fees.

Based on these assumptions, please create a simple model that shows the following figures
across a likely range of valuation multiples:

The total # of shares issued and sold in the IPO.

The pro-forma diluted shares outstanding for Kakao after the IPO takes place.
The total offering size, including overallotment provisions.
The gross primary proceeds and net primary proceeds to Kakao.
The valuation multiples implied by this deal, for other multiples you have not used to
price the deal. These should also be 1-year forward multiples.

Part 5: Case Study Discussion Questions & Answers

Once you have finished all 4 parts of the case study above, please draft a 20-slide presentation
to Kakaos management team that answers the following questions:
1. What is the companys best option? Should it accept the Daum offer or the offer from
the private consortium? Should it go public? Or should it do something else?

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2. What are the companys key financial strengths and weaknesses, as represented by your
3-statement projections?

3. What type of valuation might Kakao receive in a reverse merger with Daum vs. an
acquisition by the private consortium vs. an IPO? In which case would it receive the
highest valuation?

4. If Kakao does accept the reverse merger with Daum, should it push to negotiate the
exchange ratio or other terms? For example, would you recommend a collar with a floor
and cap on Daums share price?

5. Normally private companies are valued at a discount to similar, publicly-traded

companies for several reasons (lack of liquidity, smaller size, looser governance, viability
as a going concern, etc.). Should Kakao also be valued at the typical private company
discount?

6. What qualitative factors play into your decision and recommendation? For example,
would one strategic alternative help the company expand more effectively into
Southeast Asia or other regions without a dominant mobile messaging app?

7. Do you agree with the decision Kakao made in real life? Why or why not, and why do
you think it made the decision it did?

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