Valuation and Strategic Analysis of Rosetta Stone's IPO Initiative

This project provides a comprehensive financial and strategic analysis of Rosetta Stone's Initial Public Offering (IPO). It begins by describing the key features of Rosetta Stone's business model, including its cloud-based approach to language learning solutions and its strategic acquisitions. The project then evaluates the advantages and disadvantages of the company undertaking an IPO, considering factors such as capital raising and increased public scrutiny. Furthermore, it applies both the market-multiples approach and a free cash flow valuation model to determine a suitable share price for the IPO. The analysis includes an assessment of the reasonable rate of return on an investment in Rosetta Stone and concludes with recommendations on deciding an offer price for the IPO, providing a well-rounded evaluation of the company's financial prospects and strategic positioning. The project is a detailed examination of the key elements involved in the IPO process and the factors influencing the valuation of the company.

Financial entrepreneurial
initiatives
1

Table of Contents
Rosetta Stone .......................................................................................................................................3
1. Describe the key features of Rosetta Stone's business model and its strategy............................3
2. Advantage and disadvantage of Rosseta stone undertaking an IPO............................................4
3. Market-Multiples approach to identify range of prices for an IPO.............................................6
4. Application of Market-Multiple approach to arrive at a suitable share price for IPO.................7
5. Reasonable rate of return on an investment in Rosetta Stone......................................................8
6. Apply a Free Cash Flow model to Rosetta Stone to arrive at valuation......................................9
7. Deciding an offer price for Rosetta Stone's IPO........................................................................11
REFERENCES...................................................................................................................................12
2

ROSETTA STONE
Initial public offering refers to business initiatives which is carried out to list its stock on a
public stock exchange for the first time. In other words, it can be said that first sale of stock made
by the company to the public is known as initial public offerings (Boulton and Campbell, 2016).
Present project report will apply both market-multiple approach and free cash flow valuation model
to decide suitable share prices for Rosseta Stone's IPO. It is a public company which operates in
software development industry. Company develops language, software and other language-learning
solution products for the customers.
1. Describe the key features of Rosetta stone’s business model and its strategy
Rosseta Stone's has cloud-based business model in which company focuses to develop
language learning solutions and software to provide deeper knowledge into the education
technology. It comprises both C.D Rom and online services to consumers, corporate clients, foreign
institutes etc. It use advanced and upgraded technologies to help learners to learn different kind of
languages. Key acquisition of Rosseta Stone are Vivity Labs Inc, Tell Me More, Livemocha and
Lexia Learning which helps to increase its revenue to a major extent (Crook, 2013). Acquisition of
Lexia enhance Rosetta Stone's potential by adding more on literacy products and expertise (Sohn,
2013). Over the time, its model relies upon its sales force to maintain strong relationship with the
corporate clients and enhance their satisfaction level. It expands its market with the key partners,
Books-A-Million and London Drugs, Sprial Toys etc (Rosseta Stone expands North American retail
presence with the key partners, n.d.). Recently, it creates a partnership with Speak for the future
period (Rosetta Stone becomes key partner of Speak to the future, 2014). It drive value by recruiting
skilled and highly experienced sales force and providing innovative language-learning solutions to
the corporate clients. Its customer segments includes individual, governmental agencies, armed
forces, educational institutions and corporate clients as well. Its revenue stream includes sales of
innovative and language learning software of latest version and licensed the products. Till 2009,
Rosseta Stone's business model is to provide interacting language learning software to the domestic
(US clients) as well as foreign customers and international institutions. The model focuses on
selling language-learning software which comprises both online and CD Rom to the consumers. Its
online subscriptions enable company to charge very high prices so as to increase their revenue,
market share and profitability to compete effectively.
Porter’s 5 forces:
Bargaining power of suppliers: Similar kinds of inputs are used by all the companies in
their operations while distribution channel is diverse. However, suppliers are competing with each
3

other to deliver their goods and services; therefore, bargaining power of suppliers is high.
Bargaining power of customers: Customer prefer Rosetta Stone’s product because of best
quality and also they have limited choice available; henceforth, their bargaining power is
comparatively low.
Threat of rivalry: Rosetta Stone has very less number of competitors such as Memrise,
Fluenz, Livemocha etc. therefore, it can be said that company is not facing intense level of
competition in the market.
Threat of substitutes: Substitue that are providing by the other companies is of inferior
quality and also limited in number. Thus, it becomes clear that threat of substitute is low.
Threat of new competitors: Geographic factors limit the competition level in the industry,
henceforth; threat of new entrepreneurs is less.
Contrary to this, its strategy is to enhance its competitive strength by developing new and
innovative products and software which enable people to learn new languages. Moreover, it makes
continuous improvement through investment in research and development activities. Along with
this, Rosetta Stone focuses on the most prolific devices like Samsung, Chrome Book, iPhone, iPad
etc. to grab larger market share across the globe (Seave, 2014). Its strategy is highly concerned with
increasing business turnover and yield as well to compete effectively in the market place. Its
strategic focus is to maintain better control over material, cash availability, and relationship with the
clients, introduction of new software and learning solutions and making growth of Kiosks,
Enterprise and Education business (E&E), etc. Moreover, it focuses to distribute services more on
online and expand its product portfolio (Hall, 2015). Recently, it launched Kids reading, brain
fitness, innovative devices, apps etc. to increase its product offerings and increase its customer base.
Its market strategy is to focus on enhancing the level of consumer satisfaction by advertising on
Google, display ads and other search ads. Contrary to this, its competitive strategy is focuses on
enterprise resource centre and attracting high number of multinational institutions and foreign
clients (Four reason for a business language strategy, 2015). Moreover, its strategic focus is to
deliver value to the shareholders by the use of share buy-back program.
4

5
Illustration 1: Rosseta Stone's business strategy

According to the presented chart, it can be seen that Rosseta Stone give highest priority to
innovative platform, expand distribution and leverage brand to reach success. In such respect, its
leverage brand pay focus on bringing awareness in the selected market and strengthen the brand
position. However, its innovative platform greatly focus on improvement of customer benefits
through taking into account rich data, integrated live, multi devices, adaptive and community as
well. On the contrary to this, its distribution strategy aims at gathering larger revenue through new
alliances in various market segments, online and mobile services as well. Apart from this,
Pedagogy, Widgets, Speech, community and live features are the core competencies of Rosseta
Stone.
From the presented diagram, it can be seen that quality consumer services, online
experience, institutional services and digital services are the main area of strategic focus of Rosseta
Stone which enable firm to accomplish their target goals.
2. Advantage and disadvantage of Rosseta stone undertaking an IPO
Initial public offering, shortened to IPO is regarded as the process of offering its equity
shares to the public for the first time, hence, can be said as process of going public. It is a process
through which an unlisted company list its stock and thereby, it can issues shares in the market for
the public subscription. The process to listing Rosetta Stone's equity shares on a recognized stock
exchange to trade it publicly, requires a number of stages which company needs to undertake,
6

described below:1. Creating pitch: At the initial stage, Rosetta Stone has to fulfil prerequisites requirement
about generating a credible plan, recruiting a qualified management team, create board of
directors (BOD), construct financial statement and audit it, measure performance, financial
projection, develop relationship with the lenders, investment bankers, accountants and
lawyers as well (Boone, Floros and Johnson, 2016). Further, bake-off meeting are conducted
to recruit underwriter for the sale of its stock. In this regard, important discussion regarding
proposed commission, historical track records and distribution abilities of the underwriters
etc. are analysed by Rosetta stone.2. Kick-off meeting: After fulfilling the prerequisites, company has to organize a meeting in
which all the parties such as management, auditors, directors, accountants, investment bank,
legal counsel etc. will be invited to take decisions for underwriter and issuing firm. At this
stage, legal contracts or agreements are framed with specific terms and conditions. With
regards to prospectus, it is the legal obligation on Rosetta stone to not publish any
information which are outside the prospectus (Filatotchev, Chahine and Bruton, 2016).
Moreover, it cannot advertise the information to increase public awareness about its name,
products, services, market segments etc. to create a positive image toward its equity stock. If
it happen, that will be consider illegal activities and SEC prohibited such acts and mistakes,
also called quiet period.3. Filling registration statement and due diligence: At this stage, SEC required registration
statement, of which, Part – I is preparation of prospectus whilst Part- II includes
underwriter agreements, Rosetta Stone's charter, laws and a specimen of security as well.
Contrary to this, due diligence refers to restriction of disclosing untrue and material
misstatement in the prospectus. In this, tax return, contracts, necessary documents etc. are
provided to the SEC. Beside this, underwriter prepare syndicate which includes various
investment bankers which are agreed to buy shares at price less underwriter discount.4. SEC review: In this, SEC review all the filled documents whether it complied with the
Security Act, 1933 or not. Registration statement will be effective after 20 days of the
filling date. While, if any untrue information has been disclosed in the statement than SEC
will sent letter of comment to the company and gives 20 day warning period to file amended
statement (Esfahanipour, Goodarzi and Jahanbin, 2016).5. Road show: In this, Rosetta stone’s managers will meet potential investors to assess market
demand about the new issues and increase their interest. 1-2 week road shows are organized
by the underwriter to enable manager to discuss their investment plan across the country
7

(Blum, 2011).
6. Pricing meeting: In this stage, company management will negotiate the final offering price
and the underwriter discount on the basis of investor demand and external market conditions
(Boulton and Campbell, 2016).
7. Allocation: Once the price decided, syndicate member will sell share to the potential
investors and final copy of the prospectus and sales confirmation also will be provided to
them. In this, underwriter will cancel the deal if payment is not receive in 5 days after
delivering confirmation of sale.
8. Trading: After finalising the allocation, trading get started hence, public can buy and sell
the shares. According to the rule of SEC, 10b – 7, underwriter has no right to get involve in
price stabilising activities while distribution securities. Offering settlement will be closed
after 10 days of the effective date, which is mentioned in the underwriter agreement (Boone,
Floros and Johnson, 2016). Security certificate will be delivered to the underwriter and
updated comfort letter will be given to the individual accountants.
From the above analysis, it becomes clear that the IPO process very length which consume a
lot of time of the managers because they are required to conduct meetings, necessary
documentation, conduct road show, organize price meeting, appoint underwriter etc. Along with
this, underwriter commission, preparation of documents such as registration and filling of tax
return, contracts etc. impose cost to the business and results in lower yield. Therefore, it can attract
high managerial focus on the IPO process for listing of shares, which in turn, may reduce the focus
of managers on the effective administration of daily business operations and activities.
Advantage of IPO Disadvantage of IPO
 It helps to raise money for the business
expansion, research and development,
capital expenditures and pay back long
term debts and loans of Rosetta stone
by attracting high number of investors.
It is an advantage because through
using this facility, Rosseta Stone can
meet their capital requirement and run
operations successfully in the
competitive market.
 Rosetta Stone will need to disclose its
audited financial reports in the front of
shareholders to communicate its business
performance. It will be a disadvantage
because company will be liable to audit its
annual financial account timely thus,
confidentiality cannot be maintained.
Moreover, organization has to pay fees to
the auditor which increase cost and decline
net yield.
8

 It also creates positive image of
Rosetta stone by trading its securities
publicly. The reason behind this is it
helps to attract more suppliers,
customers and bank also will be
willing to lend funds to the listed
companies rather than unlisted
(Mantell, 2016).
 It facilitates Rosetta stone to carry out
mergers and acquisition by driving
larger market. Rosseta Stone can
acquire and merge with other
organizations, by this, it can increase
its revenue, profitability and market
share as well. This in turn, company
will be able to gain competitive
advantages and reach success.
 Company will be obliged to comply with
the rules and regulations of SEC and
Security Act, 1933, which may incur high
cost (Boone, Floros and Johnson, 2016).
The cost of IPO in USA is approximately $1
million which includes listing, printing and
legal fees etc.
 Investors also have controlling power
through which they can take part in the
decision-making hence, dilution of control
is also a disadvantage of going public.
 Listing the shares enable entrepreneur
to maintain liquidity because it allows
venture capitalists to liquidate their
holdings.
 It also imposes reporting requirement on
Rosetta stone through which, it has to report
its operations, financial position etc. to the
investors. In case, when Rosseta Stone does
not have profitability and running in loss,
then it will create negative impact on the
shareholders and they can sale their
investment. Moreover, it will be very
difficult for the company to take borrowings
from banks because financial institutions
only provide money to the profit gaining
enterprises for their fund security.
 The success and growth of the business
is also based upon shareholder’s value
 Company will have to pay return to the
shareholders in the terms of dividend which
9

(Esfahanipour, Goodarzi and Jahanbin,
2016). Henceforth, by providing larger
the return to the investors out of its
earnings, enable firm to enhance
shareholders worth and build a strong
market image.
increase cost and decline net yield
(Filatotchev, Chahine and Bruton, 2016).
On the basis of above discussion, it can be said that Rosseta Stone has to list its shares
because although the cost of going public is approximately $1 million but still, it offers wide range
of advantages to the Rosseta stone as compare to the cost of gathering funds through external
borrowings. Hence, it becomes clear that manager has to go for IPO process to list its shares on a
recognized stock exchange.
3. Market-Multiples approach to identify range of prices for an IPO
Market multiple approach is a valuation model, according to which, stock prices can be
decided by taking into account the similar kind of assets at similar prices. The term “Market
Multiple” is a generic term which use number of components or indicators to value the stock of the
Rosetta stone. For instance, price to earnings (P/E) ratio is one of the multiples which can be used
by the businesses to decide offering prices for their IPO (Pinto, Robinson and Stowe, 2015). Out of
this, P/E ratio is often use factor which indicates the ratio between market price (MP) and earning
per share (EPS). According to this multiple, if Rosetta stone has less P/E ratio than, it will be
consider as undervalued firm than its competitors. In this method, valuation is based upon the
competitors which are operating in same industry (Cornell and Gokhale, 2016). With regards to
Rosetto Stone, Apollo Group Inc, American Public Education Inc, Corinthian Education Corp,
Capella Education, Strayer Education, DeVRY Inc, ITT Educational Service Inc. K12 Inc., Grand
Canyon Education, Inc. and New Oriental Ed. & Tech. Group Inc are its major competitors.
Another multiple of this approach is enterprise value which refers to the market
capitalization of Rosetta Stone by eliminating the impact of its financial assets and liabilities
(Moghaddam and Talebnia, 2016). As per this factor, enterprise value can be determined through
using following formula:
Enterprise value (EV) = Market capitalization + Debt fund + Minority interest – Cash and
equivalents – investment
Apart from that, this approach also use EV to EBITDA (Earnings before interest, tax,
10

depreciation and amortization) multiple to decide share price for going public. This method is
considered as more realistic method as compare to DCF valuation. The advantage of this method is
that it use investors ratios like earning per share, price-to-earnings ratio etc. to decide share price
(Reed and Rocholl, 2010). Contrary to this, the limitation of this method is that it does not provide
assistance to value share price in changing and competitive business era. Moreover, if competitors
valued their share price incorrectly than it may provide misleading results.
Questions with market-multiple approach:
One of the key problems that come first when applying market-multiple is to select the
correct comparables. It is because, there may be number of competitors operating in the market, in
such case, it is essential for the analyst to determine the most suitable and appropriate comparable.
In such respect, company has to select those peers which have similar return on capital employed
and growth rate as well. Moreover, as said earlier, that there are number of multiples henceforth,
business has to select the best multiple to determine the share price for Initial Public Offering (IPO).
In such regards, business has to select forward-looking multiples rather than historical results.
Movements in balance sheet:
Movement in balance sheet also affect the share pricing by market-multiple approach. For
instance, price earning multiple is greatly affected by the changes in capital structure and P/E is
usually higher in unlevered firm and lower in levered. Further, analyst also has to make necessary
adjustments regards to excess cash, non-operating assets, pension, employee stock option etc so as
to identify the correct price for IPO listing.
4. Application of Market-Multiple approach to arrive at a suitable share price for IPO
The market multiple approach emphasizes on ascertaining market value of the organization
on the basis of performance of company’s competitors. As per the cited scenario, Rosetta Stone is
desiring to list its share for IPO in 2009. Many of the analysts mostly prefer EV/EBITDA or
Enterprise value as their market-multiple of comparable firms who are operating in the industry to
value their share price. In such respect, EV/EBITDA states that how much amount of money, buyer
is required to pay in order to acquire the proxy cash flows (Caution, Platt and Platt, 2011). The main
benefit of this multiple over price-earning ratio is it does not affected by the capital structure of the
company as it is a measure of capital intensity. With regards to the current scenario, the sample of
companies are extracted from the industry to which Rossetto Stone belongs to. There are two
multiple will be use that are price earning ratio and EV/EBITDA to identify the stock price of IPO
for Rosseta Stone. Here. The formula of P/E multiple is as under:
11

Price-earning multiple: Stock price per share / Earning per share(EPS)
Another multiple – Enterprise value / Earning before interest, tax, depreciation and amortization
Enterprise value – Market capitalization – long term debt+minority interest – cash and cash
equivalents – investment
Profit educations
Profit educations
12
Appolo Group Inc.
American Public Education Inc.
Corinthian Colleges, Inc.
Carrer Education Corp.
Capella Education
Strayer Education
DeVry Inc.
ITT Educational Services Inc.
K12 Inc.
Grand Canyon Education Inc.
New Oriental Ed.&Tech. Group, Inc.
0
5
10
15
20
25
30
35
40
45
19.2
42.4
28.7
19.5
31.5 33.2
23.2
19 18.3
32.9
14.5
29.3
18.1 20
23.4 25.8
17.5
13.6
35.4
24.3 24.5
PE ratio (2008) PE ratio (2009)
Appolo Group Inc.
American Public Education Inc.
Corinthian Colleges, Inc.
Carrer Education Corp.
Capella Education
Strayer Education
DeVry Inc.
ITT Educational Services Inc.
K12 Inc.
Grand Canyon Education Inc.
New Oriental Ed.&Tech. Group, Inc.
0
5
10
15
20
25
30
35
9.7
20.5
11.6
6.8
13.4
17.8
12.5
10.1
13.4
30.2
23.8
7.2
13.8
7.8 6.8
10.3
14.1
9.6
7.4 8.7
11.5
17.2
Ev /EBITDA (2008)
Ev /EBITDA (2009)

Internet
Internet
Software
13
Activison Blizzard Inc.
Amazon.com, Inc
Dice Holdings Inc
Drugstore.com, Inc.
eBay
Google
GSI commerce
Tech Target Inc.
WebMd Health Corp.
Electronics Arts Inc
yahoo!Inc!
0
10
20
30
40
50
60
18.5
53.8
12.3 12.8
23.6
45.8
32.6
17.2
47.9
25.7
17.1
20.7
46
24.1
37.3
Price/EPS (2008)
Price/EPS (2009)
Activison Blizzard Inc.
Amazon.com, Inc
Dice Holdings Inc
Drugstore.com, Inc.
eBay
Google
GSI commerce
Tech Target Inc.
WebMd Health Corp.
Electronics Arts Inc
yahoo!Inc!
0
10
20
30
40
50
60
70
80
90
100
6.9
27.1
4.5 7
13.2 12.2 8.8
18.1
10.2
6.9
23.6
6.9
91.1
8.1 11.3 10.6 11.3 16.4 11.5 10.3
EV/EBITDA (2008)
EV/EBITDA (2009)
Price/EPS (2008)
Price/EPS (2009)
Adobe systems
ArcSight Inc.
Intruit
Microsoft ft
Omniture
Sales force.com
Sysmantec
McAfee Inc
Vmware Inc
0
10
20
30
40
50
60
70
14.9
19.5
10.2
0 0
9.4
26.1 27.1
22.9
52.8
16.2
12
0
57.7
9.5
24.1
33.9

Software
Calculations of both the market-multiple that are price/EPS and EV/EBITDA has been done
in Appendix 1.
According to the table, average industrial price/EPS for the year 2008 and 2009 are 22.98
and 25.41 whilst its median value is 19.5 and 23.75 respectively. On the other hand, another
multiple which is EV/EBITDA, their mean values are 14.831 and 14.21 for both the year. However,
the middle values are 12.3 and 10.3. Henceforth, it is clear that multiple price/EPS and EV/EBITDA
for the Rosseta Stone's IPO price calculations in 2009 are 22.98 and 14.21.
IPO price calculations on the basis of EV/EBITDA and price/EPS are done below:
Calculations of IPO price on the basis of EV/EBITDA multiple
Particulars Amount
EV/EBITDA multiple 14.2129032258
Rosseta Stone's EBITDA 34625
Enterprise value of Rosseta Stone 492121.774193548
Less: Net debt 9910
Equity capital 482211.774193548
Number of outstanding shares 17189.5
IPO share price 28.0526934578
Calculations of IPO on price/EPS multiple
Particulars Amount
14
EV/EBITDA (2008)
EV/EBITDA (2009)
Adobe systems
ArcSight Inc.
Intruit
Microsoft ft
Omniture
Sales force.com
Sysmantec
McAfee Inc
Vmware Inc
0
5
10
15
20
25
30
35
40
45
8.6
39.2
9.2
5.9
16.4
35
4.7
12.3
21
12.6
21.8
7.9 6.8
9.6
20.7
4.9
10.1
23.8

Price/EPS multiple 25.4107142857
Rosseta Stone's EPS 0.8081677768
IPO share price 20.5361204722
According to this, Rosseta Stone' EV has been founded by multiplying the industrial
average of EV/EBITDA multiple of 14.21 to target company's EBITDA of $34625. Thereafter, its
net debt amounted to $9910 has been subtracted to find out the total equity capital. With regards to
company, it has been determined to $482211.77. In end, in order to identify the price for IPO, total
equity capital worth $482,211.77 has been divided by the number of equity shares of 17189.5 and it
comes to $28.05. Henceforth, it becomes clear that Rosseta Stone is require to list their equity share
at the price of $28.05 on the basis EV/EBITDA market multiple.
However as per price/EPS, industrial average price/EPS multiple of 25.41 has been
multiplied by the current EPS of Rosseta Stone to 081 hence, IPO price founded to $20.536. It is
comparatively lower by $7.516 than IPO price under EV/EBITDA multiple.
Increase or decrease in price offering:
Increase or decrease in prices directly impact the shareholders decisions because if share
will be available at high prices than it may be possible that investor will not be willing to buy share.
However, if share will be available at lower prices than Rosetta Stone can receive adequate amount
of funds through selling their stock. It must be noted that if investor think that by investing funds in
Rosetta Stone they can receive good return than they will definitely invest their money in the
organization and in such case, prices do not impact them to a major extent. In such respect, if
company provide better return to the current shareholders than future shareholders also will be
desire to put their money so as to get maximum return on their investment or vice-versa.
Apart from this, according to Strauss, financial professionals faced numerous challenges in
the accurate valuation of share price especially when they apply conventional methodologies.
Moreover, in the present age of financial crisis, enterprises face challenges and difficulties from
Asian equities to mortgage-backed securities and financial services firms as well (Stross, 2012).
5. Reasonable rate of return on an investment in Rosetta stone
The expected rate of return indicates the percentage of return that can be earned through
investment in Rossetta Stone. The expected rate of return for investment in Rossetta Stone is
calculated through application of CAPM model. CAPM is a model which reflect the rate of return
that an investor must earn for the risk he take in the investment.
15

Here, the difference between market return (Rm) and return on risk-free securities (Rf)
indicates the risk premium. As per the case study provided, it has been stated that general market
risk premium on long term and short-term government yields are 6.5% and 8.5% respectively. It
will use for calculation of expected or reasonable rate of return on business equity. However, the
risk free rate indicates the minimum return that an investor can earn without assuming any risk and
it indicates the return rate on US treasury bill. According to the exhibit 4, on 1/30/2009, the yield
rate for a longer period of 10 year is 2.87% which has been taken into consideration for calculating
return on equity. On the other hand, the market rate of return on stock represents rate of return of
indices. This rate suggests the total return that is generated within that market. The CAPM model
considers volatility & return of both stock and market to ascertain expected rate of return.
With reference to Rosseta Stone, the value of beta has been extracted from the financial
times to 0.8120. It indicates the level of volatility or risk associated with the investment into certain
organization. The cost of equity or expected return has been founded using following formula:
K(e) = Risk -free return + beta (Rm-Rf)
k(e) = 2.87% + 0.8120 (6.50%)
k(e) = 8.15%
Calculations of expected or reasonable rate of return
CAPM Assumptions
K(e) 8.15%
RFR (US yield curve data for 10 year on 1/30/2009)) 2.87%
Beta 0.812
Rm-Rf (Risk premium for long term yield) 6.50%
It can be seen from the attached table that required rate of return is 8.15% for the risk taken
by the investor. Here it can be seen that risk is denoted by 0.8120 henceforth, it can be said that at a
level of 0.8120 risk, there is possibility of 8.15% return to the investors.
6. Apply a Free Cash Flow model to Rosetta stone to arrive at valuation
Free cash flow method is considered to be one of the efficient methods to ascertain value of
16

the organization. It is through consideration of financial information for the last few years that the
future performance is estimated. The free cash flows for Rosetta stone is estimated in the table
underneath. The future cash flows are then discounted at weighted average cost of capital. It is
assumed that the business unit is going to bear minimum weighted average cost of capital in order
to acquire funds. Henceforth, the same is taken into consideration for estimating the enterprise
value. While, WACC shows the rate that Rosseta Stone is expected to pay on an average to their
security holders. On the contrary to this, enterprise value refers to the firm value which is an
economic measurement and reflects the market value of the business. It can be computed by
identifying the sum of market capitalization, debt, preference capital and minority interest, net of
total cash and its equivalents.
Stock price = Enterprise value/ Diluted number of shares
Stock price = 2,47,575/17189.5
Stock price = $14
Assumptions:
 Risk free rate has been assumed to 2.87% as in the exhibit 4, it has been stated that yield
percentage for 10 year on 1/30/2009 is 2.87%.
 Interest rate has been taken to 7.5% as it is already mentioned in the case study of Rosseta
Stone.
 Estimated revenue, general and administrative expenses has been taken from the provided
case study of Rosseta Stone.
 Other figures like interest income, expenses and taxation has been estimated by taking the
average of historical growth rate in three years from 2006 to 2008.
Free cash flow valuation (FCFV): This model calculates stock price on the basis of
estimating operating free cash flows through the operations and discount it through an appropriate
discount rate (Pinto and et.al., 2015). OFCF reflects Rosetta Stone's cash generating ability before
interest and other non-cash affecting transactions. According to the approach, FCF can be
determined on the basis of following formula, given below:
17

OFCF = EBIT( 1 – T)+ depreciation – Capital expenditures – working capital – any other assets
In this, weighted average cost of capital (WACC) can be calculated by assigning weights to
both debt and equity in the business capital structure (Najmi, Sarraf and Darabi, 2015). In the given
case, WACC is 7.76% which helps to determine the potential values of projected cash flows. In this,
cost of equity (Ke). Market capitalization and Enterprise value (EV) are determined using following
formula:
Ke = Risk free return + beta (Market risk – risk free return)
WACC = (W1*ke) + interest*Kd(1- corporation tax rate)
Market capital = Issued share*current market price
EV = Market capitalization + Long term debt – cash and its equivalents
Calculations of Free Cash Flow (FCF) and Present value of FCF are attached in Appendix 2.
Calculation of Weighted average cost of capital
Debt Equity Weightage
Weight of debt 11.14%
Weight of equity 88.86%
Cost of equity (ke) 8.15%
Interest Rate (%) (Kd) 7.50%
Tax Rate (@) 0.38
WACC Calculation
WACC 7.76%
Calculations of stock price
Enterpsire Value (EV)
Current Market Price 12
Number of oustanding shares 17189.5
Market Capitalisation 2,26,825
Add: Long Term Liabilities 9,910
Less: Cash & Cash Equivalents 30,660
Enterprise Value (in lacks) 2,06,075
EV = 226,825+9910-30,660
= 206,075
Intrinsic value (IV) = Equity value/Diluted shares
IV = 2,06,075/17189.5
= $11.98 OR $12 (Approx)
18

7. Deciding an offer price for Rosetta Stone's IPO
The intrinsic value that is reflected by the DCF model will be taken into consideration and
offer price is $12. However, on the basis of EV/EBITDA market-multiple is $28.05 whereas in the
case of price/EPS, it is $20.54. It can be said that market multiple on the basis of price/EPS is
considered more suitable for IPO listing of Rosseta Stone. The reasons for different results are
market-multiple approach take into account industry based information whilst DCF method use
FCF instead of net earnings (Najmi, Sarraf and Darabi, 2015). The discounted cash flow technique
emphasizes on estimating share price on the basis of previous year performance of the organization.
The future data is estimated on the basis of past performance of the business unit. However, the
market value of the organization is dependent on list of other factors.
With regards to the given case, it can be advised to the Rosseta Stone that Price/EPS is
considered best because it used average industrial data. Moreover, this multiple also take into
account both the share price of company's competitor and their investors yield by determining EPS.
Therefore, it will definitely provide more authentic and valid results for listing the Rosseta Stone's
shares on a recognised stock exchange so that shares can be traded publicly. Henceforth, it becomes
clear that suitable price is $20.54.
19

REFERENCES
Books and Journals
Blum, R., 2011. IPO timing determinants. Duke University.
Boone, A. L., Floros, I. V. and Johnson, S. A., 2016. Redacting proprietary information at the initial
public offering. Journal of Financial Economics. 120(1). pp.102-123.
Boulton, T. J. and Campbell, T. C., 2016. Managerial confidence and initial public offerings.
Journal of Corporate Finance. 37(2). pp.375-392.
Caution, I., Platt, H.. and Platt, M.2011. Free Cash Flow. SAGE
Cornell, B. and Gokhale, R., 2016. An “Enhanced Multiple” Corporate Valuation Model: Theory
and Empirical Tests. Business Valuation Review. 35(2). pp.52-61.
Esfahanipour, A., Goodarzi, M. and Jahanbin, R., 2016. Analysis and forecasting of IPO
underpricing. Neural Computing and Applications. 27(3). pp.651-658.
Filatotchev, I., Chahine, S. and Bruton, G. D., 2016. Board Interlocks and Initial Public Offering
Performance in the United States and the United Kingdom An Institutional Perspective.
Journal of Management. p.0149206315621145.
Mantell, E. H., 2016. A theory of underwriters’ risk management in a firm-commitment initial
public offering. Review of Quantitative Finance and Accounting. 46(1). pp.179-193.
Moghaddam, B. M. and Talebnia, G., 2016. Review the effect of growth opportunities, return on
equity, volatility of stock price and operational risk on companies’ market value.
International Journal of Humanities and Cultural Studies (IJHCS) ISSN 2356-5926. 14(2).
pp.2072-2087.
Najmi, M., Sarraf, F. and Darabi, R., 2015. Relationship between Capital Structure, Free Cash Flow
and Performance in Companies Listed on Tehran Stock Exchange. European Online Journal
of Natural and Social Sciences: Proceedings. 4(1). pp.1229-1246.
Pinto, J. E. and et.al., 2015. Chapter 6. Free Cash Flow Valuation. CFA Institute Investment Books.
2015(4). pp.295-360.
Pinto, J. E., Robinson, T. R. and Stowe, J. D., 2015. Equity valuation: a survey of professional
practice. Available at SSRN.
Reed, A.V. and Rocholl, J., 2010. The new game in town: Competitive effects of IPOs. The Journal
of Finance, 65(2), pp.495-528.
Online
Four reason for a business language strategy. 2015. [Online]. Available through:
<http://www.rosettastone.com/blog/four-reasons-for-a-business-language-strategy/>.
[Accessed on 21st July 2016].
20

Hall, J., 2015. Rosetta Stone's strategy. [Online]. Available through:
<http://www.fool.com/investing/general/2015/08/05/rosetta-stones-change-in-strategy-
might-just-be-pa.aspx>. [Accessed on 21st July 2016].
Rosetta Stone becomes key partner of Speak to the future. 2014. [Online]. Available through:
<http://www.speaktothefuture.org/rosetta-stone-becomes-key-partner-of-speak-to-the-
future/>. [Accessed on 21st July 2016].
Seave, A., 2014. Rosetta Stone's strategy to change in pivot Away From Competitiors with New
products. [Online]. Available through:
<http://www.forbes.com/sites/avaseave/2014/10/03/its-both-make-and-buy-for-rosetta-
stone/#3152b69947ff>. [Accessed on 21st July 2016].
Sohn, T., 2013. Rosseta Stone Acquires Lexia Learning for $22.5 Million. [Online]. Available
through: <https://thejournal.com/articles/2013/07/25/rosetta-stone-acquires-lexia-learning-
for-22.5-million.aspx?=THE21>. [Accessed on 4th August 2016].
Crook, J., 2013. Rosseta Stone buys up online language learning Community Livemocha. [Online].
Available through: <https://techcrunch.com/2013/04/02/rosetta-stone-buys-up-online-
language-learning-community-livemocha-for-8-3m-in-cash/>. [Accessed on 4th August
2016].
Rosseta Stone expands North American retail presence with the key partners. n.d. [Online].
Available through: <http://investors.rosettastone.com/phoenix.zhtml?c=227935&p=irol-
newsArticle&ID=1306388>. [Accessed on 4th August 2016].
Stross, R., 2012. The Launch Pad: Inside Y Combinator, Silicon Valley's Most Exclusive School for
Startups. Penguin UK.
21

APPENDIX
Appendix 1
Calculation of industry market-multiple
Recent
price
Number
of shares
( in
million)
Market
capitaliza
tion
Debt (in
million)
Enterpri
se value
Long
term
revenue
growth
Price/
EPS
(2008)
Price/
EPS
(2009)
EV/
EBITD
A
(2008)
EV/
EBITDA
(2009)
Apollo Group
Inc. 63.81 160.15
10219.17
15 0
10219.17
15 15.00% 19.2 14.5 9.7 7.2
American
Public
Education Inc. 37.56 18.06 678.3336 0 678.3336 55.00% 42.4 29.3 20.5 13.8
Corinthian
Colleges, Inc. 16.88 86.45 1459.276 31.9 1491.176 16.00% 28.7 18.1 11.6 7.8
Carrer
Education
Corp. 21.05 90.09
1896.394
5 1.7
1898.094
5 -2.00% 19.5 20 6.8 6.8
Capella
Education 50.34 16.69 840.1746 0 840.1746 20.00% 31.5 23.4 13.4 10.3
Strayer
Education 168.01 13.88
2331.978
8 0
2331.978
8 25.00% 33.2 25.8 17.8 14.1
DeVry Inc. 42.47 71.64
3042.550
8 20
3062.550
8 17.00% 23.2 17.5 12.5 9.6
ITT
Educational
Services Inc. 101.6 38.56 3917.696 150 4067.696 17.00% 19 13.6 10.1 7.4
K12 Inc. 15.29 28.86 441.2694 13.7 454.9694 61.00% 18.3 35.4 13.4 8.7
Grand Canyon
Education Inc. 14.72 45.47 669.3184 32.1 701.4184 62.00% N/A 24.3 30.2 11.5
New Oriental
Ed.&Tech.
Group, Inc. 50.33 149.19
7508.732
7 0
7508.732
7 43.00% 32.9 24.5 23.8 17.2
Internet
Activison
Blizzard Inc. 10.03 1359 13630.77 0 13630.77 124.00% 18.5 17.2 6.9 6.9
Amazon.com,
Inc 74.71 429 32050.59 74 32124.59 29.00% 53.8 47.9 27.1 23.6
Dice Holdings
Inc 3.2 62.21 199.072 60.2 259.272 9.00% 12.3 25.7 4.5 6.9
Drugstore.com
, Inc. 1.3 97.36 126.568 2.1 128.668 8.00% 91.1
eBay 14.32 1287.81
18441.43
92 0
18441.43
92 11.00% 12.8 17.1 7 8.1
Google 379.5 315.25
119637.3
75 0
119637.3
75 31.00% 23.6 20.7 13.2 11.3
GSI
commerce 14.93 47.93 715.5949 195.9 911.4949 29.00% 12.2 10.6
22

Tech Target
Inc. 2.38 41.75 99.365 0 99.365 20.00% 8.8 11.3
WebMd
Health Corp. 25.58 57.58
1472.896
4 0
1472.896
4 15.00% 45.8 46 18.1 16.4
Electronics
Arts Inc 19.16 322 6169.52 0 6169.52 15.00% 24.1 11.5
yahoo!Inc! 14.02 1393.35
19534.76
7 0
19534.76
7 3.00% 32.6 37.3 10.2 10.3
Software
Adobe
systems 23.64 524.27
12393.74
28 350
12743.74
28 13.00% 14.9 22.9 8.6 12.6
ArcSight Inc. 14.15 31.5 445.725 0 445.725 34.00% 52.8 39.2 21.8
Intruit 25.35 320.53
8125.435
5 998.1
9123.535
5 15.00% 19.5 16.2 9.2 7.9
Microsoft ft 18.83 8891
167417.5
3 0
167417.5
3 18.00% 10.2 12 5.9 6.8
Omniture 13.54 75.05 1016.177 13.2 1029.377 107.00% 0 0 16.4 9.6
Sales
force.com 37.36 122.43
4573.984
8 0
4573.984
8 44.00% 0 57.7 35 20.7
Sysmantec 16.47 819.92
13504.08
24 1766
15270.08
24 5.00% 9.4 9.5 4.7 4.9
McAfee Inc 34.49 153.72
5301.802
8 0
5301.802
8 22.00% 26.1 24.1 12.3 10.1
Vmware Inc 29.6 389.86
11539.85
6 450
11989.85
6 42.00% 27.1 33.9 21 23.8
Overall
results
Maximum 53.8 57.7 39.2 91.1
Average 22.98
25.410
714285
7
14.8310
344828
14.212903
2258
Median 19.5 23.75 12.3 10.3
Minimum 22.98
25.410
714285
7
14.8310
344828
14.212903
2258
Appendix 2
Calculation of FCF and PV of FCF
2008 2009E 2010E 2011E 2012E 2013E 2014E
2015
E 2016E 2017E 2018E
Revenue 209380
28270
0 381600 496100 620100 762700
92290
0
10890
00
123060
0
13536
00 1421300
Cost of
revenue 28676 39600 53400 74400 99200 129600
16610
0
20690
0 246100
28420
0 312700
Gross profit 180704
24310
0 328200 421700 520900 633100
75680
0
88210
0 984500
10694
00 1108600
Operating
23

expenes
Sales, general
and
administrative
expenditures 132961
17950
0 242300 312500 390700 476700
57680
0
68060
0 769100
84600
0 888300
Research and
development 18387 25400 34300 42200 52700 64800 78400 87100 98400
10830
0 113700
Total operating
expenes 151348
20490
0 276600 354700 443400 541500
65520
0
76770
0 867500
95430
0 1002000
Income from
operations
(EBIT) 29356 38200 51600 67000 77500 91600
10160
0
11440
0 117000
11510
0 106600
Other income
and expenses
Interest income 454
1300.4
2 1755.36 2282.06 2852.46 3508.42
4245.3
4
5009.
4
5660.7
6
6226.5
6 6537.98
Interest
expense -891
-
2923.1
18
-
3945.744 -5129.674
-
6411.83
4
-
7886.31
8
-
9542.7
86
-
11260
.26
-
12724.
404
-
13996.
224
-
14696.24
2
Other income 239
277.04
6 373.968 486.178 607.698 747.446
904.44
2
1067.
22
1205.9
88
1326.5
28 1392.874
Interest and
other income
(expense) net -198
-
1345.6
52
-
1816.416 -2361.436
-
2951.67
6
-
3630.45
2
-
4393.0
04
-
5183.
64
-
5857.6
56
-
6443.1
36 -6765.388
Income before
income taxes 29158
36854.
348
49783.58
4 64638.564
74548.3
24
87969.5
48
97206.
996
10921
6.36
111142
.344
10865
6.864
99834.61
2
Income tax
expense
(benefit) 13435 8481 11448 14883 18603 22881 27687 32670 36918 40608 42639
NOPAT (Net
operating profit
after tax) 15723
28373.
348
38335.58
4 49755.564
55945.3
24
65088.5
48
69519.
996
76546
.36
74224.
344
68048.
864
57195.61
2
Less: CAPEX 7000 5000 8000 9000 9500 10000 11000 11000 9000 8000 5000
Less: Changes
in working
capital 8000 11000 12700 17900 16700 25700 20700 17700 15400 8500
Total 7000 13000 19000 21700 27400 26700 36700 31700 26700 23400 13500
Free cash flow 8723
15373.
348
19335.58
4 28055.564
28545.3
24
38388.5
48
32819.
996
44846
.36
47524.
344
44648.
864
43695.61
2
Year 0 1 2 3 4 5 6 7 8 9 10
PV of 1 dollar
at 7.76% 1 0.9280 0.8612 0.7992 0.7416 0.6882 0.6387
0.592
7 0.5500 0.5104 0.4737
PV OF FCF 8723
14266.
4935
16651.55
75
22421.535
6
21170.4
510
26420.7
780
20961.
9279
26580
.8388
26140.
0490
22790.
2696
20697.87
02
Total PV
226824.7
7
24