Financial Analysis of Rosetta Stone's 2009 IPO: A Case Study

This case study provides a financial analysis of Rosetta Stone's 2009 Initial Public Offering (IPO). It examines the company's business model, core strategies, and the advantages and disadvantages of undertaking an IPO. The report evaluates the use of the market-multiples approach for determining an exit value and calculates a suitable share price, considering relevant factors. It also explores a reasonable rate of return on investment and applies a free cash flow model to arrive at a valuation. The analysis covers the IPO process in the USA, including the costs and legal undertakings involved. The case study concludes with considerations for setting the final offer price for the IPO. Desklib provides access to this and other solved assignments for students.

Financial Entrepreneurial Initiatives
Rosetta Stone: Pricing the 2009 IPO

Table of Contents
INTRODUCTION......................................................................................................................................3
1.......................Key features of Rosetta Stone’s business model and explain its core business strategy
................................................................................................................................................................3
2. Advantages and disadvantages of Rosetta Stone undertaking an IPO...............................................4
2..........Evaluate the use of Market-Multiples approach for Rosetta Stone in determining an exit value
................................................................................................................................................................6
4 Calculation of suitable share price for Rosetta Stone’s IPO using Market-multiples approach and
considerations would need to be made...................................................................................................7
5. Reasonable rate of return on an investment in Rosetta Stone............................................................8
6. Free Cash Flow model to Rosetta Stone to arrive at a valuation.......................................................8
7. Offer price for the IPO.......................................................................................................................9
CONCLUSION........................................................................................................................................10
REFERENCES.........................................................................................................................................10

INTRODUCTION
Financial market are those in which financial securities, commodities and other fungible items
are traded at various costs (Madura, 2014). The securities traded in financial markets includes stocks,
bonds, commodities etc. Initial public offering is the crucial sources of raising funds from the market
through offering equity and preference shares even debentures to public (Chemmanur and Krishnan,
2012). This is an initiative taken by an organization to public its stock however, is a long process to
register a company for IPO.
The report herewith is based on a case scenario of an USA based global education technology
Software Company, “Rosetta Stone” which deals with Language-Learning solutions products. As per
the case, business entity is moved further to the deal of going public in 2009. Therefore, this
investigation represents the advantages and disadvantages of Rosetta Stone to undertake an IPO.
Including this, key features of Rosetta Stone’s business model and its core business strategy are
explained in this report. Furthermore, Market-Multiples approach for Rosetta Stone is used to
determine an exit value along with calculating reasonable rate of return on an investment and free Cash
Flow model is applied to arrive at a valuation.
1 Key features of Rosetta Stone’s business model and explain its core business strategy
Rosetta Stone is an USA based global education technology Software Company deals with
developing language, learning and brain-fitness software. The organization is significantly known for
its innovative Language-Learning solutions products.
Business model of Rosetta stone
From the beginning, organization has started seeking more natural learning methods, therefore,
business model of Rosetta Stone is to use commuter technology to simulate the way people learn their
native languages. Along with this, business entity uses pictures and sounds to impart learning to the
individuals. The core area of business model is that how computer can be used to facilitate language
learning. In 1992, Stoltzfus and Fairfield came with Fairfield language technology, further the
emergence of CD-ROM technology has supported business of the cited company. The business model
of cited Company is specifically designed to distinguish the firm from other language companies and to
create an environment conducive to learning language naturally. The business model of company was
flexible and focused towards innovation. Further, in the year 1999, the organization has released its first
retail language training software product. The organization is continuously using series of CD ROMs
which is emerged as an effective ways to impart new learning to the individuals.
Business strategy of Rosetta Stone

The core business strategy of Rosetta Stone is to combined in language learning software with
test, images, sounds to teach various vocabulary terms and grammatical functions, initially the company
has focused towards school and government sales then it moved towards retail market in 2001. The
mentioned company has announced hiring of Tom Adams, who is a businessman with international
experience, as a CEO, which is found be the core strategy for getting an international exposure. He
played an important role in guiding the company’s expansionary strategy. The core competences of the
business includes Pedagogy, Widgets, Speech, community and live features. The company is creating
new value in the economy through continuous innovations. The name of company was changed in
2006 to Rosetta Stone, Ltd as it converted business from an S to a C corporation. With a unique
business strategy of going public, the company has filed an Initial public offering with the Securities
and Exchange Commission, how, after 2009, the organization is listed New York Stock Exchange. In
2008, Rosetta Stone has won Deloitte's Technology Fast Award and in 2009, it was awarded with 9
Stevie Executive of the Year Award.
An a compirtiotive strategy, the company has expanded n manufactiring and distribution to reach to
success. The organization is commited to minimise costs by achieving efficient in mannufacting. The
sales channle have alos bene aranged to minimise the logistic cost.
2. Advantages and disadvantages of Rosetta Stone undertaking an IPO
Being a private company, Rosetta Stone is evident with limited corporate investment as from
private sources company was raising limited amount of capital. The risk of takeover by other company
with the needed resources, was there on Rosetta Stone. The private investors was also concerned about
recognising the gains achieved through investing in the mentioned company, however, there was a

uncertainty of taking a relatively young company in the market, Adams, a CEO of mentioned company
moved further to the deal of going public in 2009. The impressive financial growth with 53% increase
in revenues has supported decision despite the global economic contraction. The decision for going
public was an opportunity for aforesaid company to establish business creditably as well as it was
going to support corporate entity in building a strong brand image in global marketplace. From the case
study, it has been evident that Rosetta Stone was one among the companies which can have successful
IPO.
Advantages Disadvantage
The major advantage of IPO (initial public stock
offering) for Rosetta is that is can easily access to
large amount of capital from external sources, on
which no interest charge would be charged, but,
dividends are to be paid to investors in terms of
rewards against risk.
The huge costs and time involved in the process
of going public is the biggest Rosetta stone’s IPO
deal. A long process associated with IPO process
which includes prepare registration statements,
consulting with investment bankers, attorneys,
and accountants, is going to affect the company's
management (Reed and Rocholl, 2010).
As an advantage of IPOs, the aforesaid company
can increase public awareness or can create a
brand image which is further supportive in
grabbing new opportunities and increasing
customer base (Chemmanur and He, 2011)
The initial public offering can be extremely
expensive which another disadvantage is for the
cited company. The expenses include the lead
underwriter's commission; spending on legal
services, printing costs, and the personal
marketing etc. The cost of dividend is going to be
an issue associated with initial public offering of
Rosetta stone.
The organization can easily obtain capital for
future needs in terms of offering equity and debt
financing sources in the public which was a
proper solution of limited corporate investment
as from public sources company can raise huge
amount which can be further invested into new
deals.
In addition to that, disadvantages of IPO involve
loss of confidentiality, flexibility, and control
over the business as public company has to
release all operating details to the public along
with sensitive information of business regarding
future plans (Chemmanur and He, 2011).

The market awareness can be further created as
in IPO process, information about the company is
printed in newspapers which is circulated over
the globe, and hence, company can generate
increased attention in media and among existing
and potential customers (Reed and Rocholl,
2010)
Initial public offerings can enhance the
credibility of Rosetta stone with its suppliers,
customers, and lenders, which is going to
improve credit terms. Hence, it could be said that
an initial public offering offers a public valuation
of mentioned organization.
Valuation of IP for Rosetta stone’s
Valuation & offer price
Price Valuation: $38048
Original price projection: $15-$17
Offering price: $26
Issuing share: 6.25million share
However, the cost of IPO in USA is The cost of IPO in USA is approximately $1 million which
includes listing, printing and legal fees etc.
IPO process itself and the legal, financial and other undertakings necessary in “going public”
The IPO process of US is quite typical which was going to be followed by Rosetta stone it its
goes for initial public offerings. The process is completed in almost three months hence, is a long
process, which is going to be a disadvantage for firm (Blum, 2011).
 Prior to initiate for a process, it becomes important to carry out a meeting with qualified
management team or board of directors to discuss about equity-issuance process. Including this,
board of members or responsible persons have to discuss about the IPO deals with various
investment bankers, lawyers and accountants before selecting a lead underwriter for which a

significant cots is to be paid (Plotnicki and Szyszka, 2014). However, some additional meeting
are also to be initiated in mid for discussing on problems and reviews. The guidelines of SEC
prohibited company to carry huge publicity for company’s name, products and geographic
locations, but, a normal advertisement can be created.
 The process further involves preparation for prospects which is prepared to gain specific
attention from parties along with this the company has to provide make a due diligence in which
management shows that nothing in untrue and not a single misleading information about
company is quoted in the registration statements.
 The process of underwriting then stared in which number of investment banks who are agreed to
buy portions, after then SEC review period started, After reviewing the registration process,
letter of comment received from SEC is received. After completing this three months of long
process the organization can trade in equity shares as by getting effective dates and share
offered (Blum, 2011).

Figure 1IPO process in USA
1. Evaluate the use of Market-Multiples approach for Rosetta Stone in determining an exit value
Defining of Market-Multiples approach
The market multiples approach is well known valuation theory which is based on the idea that
similar assets are sold at the same prices. This popular formula for stock valuation assumes that various
ratios have compared value such as operating margins, are found same across similar firms. In other
words, the companies deal with similar business, in same industry and in same macro environment,
might have similar performance (Valuation: Market Multiples Method. 2016). For example, the
companies have same beta, profit margins, growth prospects as well as have similar valuation multiples
(Holthausen and Zmijewski, 2012).
Market multiple valuation for Rosetta Stone
The market multiple valuation is going to be an effective method for Rosetta Stone to determine
stock valuation, therefore, it is important to find out the comparable company of mentioned
organization. Some of the comparable companies for Rosetta Stone are Apollo, American public

education, Corinthian college, Career Education Capella, DeVey, IIT, K12, Grand Canyon, New
Oriental etc. In the process of determining an exit value of firm using market multiple method, first
process is of identifying comparable assets and market values for such assets. After that, the market
values are to be converted into standardized values as comparison among absolute prices cannot be
done accurately, the process is called as valuation multiples (Moore, Filatotchev, and Rasheed, 2012).
This is going to be a simplistic method through which provide useful information about relative value.
In addition, this method is more ‘precise’ than discounted cash flow valuation or EVA and helps users
to avoid the possible misleading precision. The advantage of using such method is that multiple
valuation method considers key statistics that are used by investors hence, is a reliable method for
Rosetta Stone in determining an exit value. However, the limitation of using this method is that it is not
suitable to capture the firm’s valuation in dynamic and ever-changing business scenario and
competition. Furthermore, in case peer group or comparable companies have incorrectly valued their
assets then it can result into misevaluation (Valuation: Market Multiples Method. 2016).
4 Calculation of suitable share price for Rosetta Stone’s IPO using Market-multiples approach and
considerations would need to be made
According to the given case scenario, the organization is going to make an IPO in 2009 hence,
the method of market multiple is used so as to calculate suitable share price for Rosetta stone’s IPO.
Here, is the calculation of suitable share price. The valuation of enterprise is divided by earnings before
interest and taxes and dividend through which average of companies is going to be extracted (Money
and zine, 2016). Here, for calculation most important aspect which is to be considered is of Price-to-
earnings or PE ratio that is specifically used as multiple (Voit, 2013). The companies with lower values
are seen undervalued as compared to peers, on the other hand, other things remain same as they are. In
addition to that, next thing which is to be considered is of Enterprise value, which is denoted as a
market capitalization of an organization which is adjusted by removing the possible effects of financial
assets and obligations (Palea, and Maino, 2013).

Following is the formula to calculate Enterprise value:
EV = Market Capitalization + Debt + Minority Interest – Cash & Cash Equivalents – Investments
(Valuation: Market Multiples Method. 2016)
Using this method, the value of enterprise is divided by the total attributable ounces to each
company in terms of market reserves (Palea, and Maino, 2013). The potential ratio is beneficial in
assessing companies’ valuation as it becomes difficult to measure actual amount of deposits. The
average of EV/ EBITDA is 15.43, this data was for the year 2008, on the other hand value of EV/
EBITDA in 2009 is 10.4 it means value for enterprise is declined in 2009as compared to previous year.
The average of PV ratio for the year 2008 is 26.79, whereas in 2009 it has been declined by 22.4
(Value/EBITDA Multiple. 2016).
5. Reasonable rate of return on an investment in Rosetta Stone
The following section represents the calculation of rate of return on an investment in Rosetta Stone.

For the calculation of risk free rate of return CAPM model is used which is showing the rate
which is earned by an investors against its investors in the company. Following are the assumptions of
discounting factor rates:
 Tax rates: 38%
 Market risk premium: 6.5% (Here, we have chosen to make use of lower MRP)
 Risk Free Rate: 3.26% (30 year treasury -30 year term premium)
The model an above used is based on an assumption that market volatility affects the returns of
a firm. The required rate of return is calculated at 4.46 % which the investors in the cite company will
get returns against the risk of investing money in the company. The beta is identified from financial
time which is 0.37 showing a moderate risk on investors. The market return premium was 6.5% which
is selected lower given in the case study.
6. Free Cash Flow model to Rosetta Stone to arrive at a valuation

The Free cash flow valuation model is used to calculate stock price which are based on
estimating operating free cash flows. The cash flows are further discounted on the basis of appropriate
discount rate. The use of operating free cash flow model is used by Rosetta Stone's to show the cash
generation ability as prior to pay interest as well as other non-cash affecting transactions. As per the
approach of free cash flow, FCF formula is exaplained in the following points.
OFCF = EBIT (1 – T) + depreciation – Capital expenditures – working capital – any other assets
Using this method, weighted average cost of capital (WACC) is computed through using debt
and equity ratios in an organization, through which a capital structure is identified. According to the
given case, WACC for the organization is 2.03% which is further determining the potential values of
projected cash flows. The cost of capital is further calculated on the basis of values such as market
capitalization and Enterprise value (EV). Here formula is include in the following method

The calculations are based on certain assumptions:
 Risk free rate has been assumed to 0.3% because in UK, there is a very low rate of treasury
bills.
 Market return (Rp) =5%
 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.
 Long term revenue growth @ 15%.
The calculated equity value for Rosetta Stone’s is 511,798, however, the intrinsic value is each
equity holding is 3 each.
7. Offer price for the IPO
The overall calculation using DCF model represents that value of price is 3. The market
multiple method has been previous used to calculate price of share for IPO, from the case, it has been
witnessed that the company is willing to put share price between $15 to $17 as the price to EBITDA
is 8 times. Here, the company has to consider the above models used to calculate real value of share.
The investors can be attracted by keeping the shares price, so can see the market growth. The revenue
growth and current value of stock indicators that he prices of share need to be quoted too low. However,
it can be said that the company can go for using DCF model to set offer prices as compared to Market
multiple method.
CONCLUSION
The report above concluded that Rosetta Stone’s decision for going public was an opportunity
to establish business creditably and creating an strong brand image in global marketplace. Market-
Multiples approach for Rosetta Stone and free Cash Flow model is applied to arrive at a valuation
indicated that business has to keep low offer price.

REFERENCES
Books and Journals
Blum, R., 2011. IPO timing determinants. Duke University.
Caution, I., Platt, H.. and Platt, M.2011 Free Cash Flow. SAGE
Chemmanur, T.J. and He, J., 2011. IPO waves, product market competition, and the going public
decision: Theory and evidence. Journal of Financial Economics, 101(2), pp.382-412.
Chemmanur, T.J. and Krishnan, K., 2012. Heterogeneous beliefs, IPO valuation, and the economic role
of the underwriter in IPOs. Financial Management, 41(4), pp.769-811.
Holthausen, R.W. and Zmijewski, M.E., 2012. Valuation with Market Multiples: How to Avoid Pitfalls
When Identifying and Using Comparable Companies1. Journal of Applied Corporate
Finance, 24(3), pp.26-38.
Madura, J., 2014. Financial markets and institutions. Nelson Education.
Moore, C.B., Filatotchev, I. and Rasheed, A.A., 2012. Foreign IPO capital market choice:
Understanding the institutional fit of corporate governance. Strategic Management
Journal, 33(8), pp.914-937.
Palea, V. and Maino, R., 2013. Private equity fair value measurement: a critical perspective on IFRS
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Park, K. and Jang, S.S., 2013. Capital structure, free cash flow, diversification and firm performance: A
holistic analysis. International Journal of Hospitality Management, 33, pp.51-63.
Plotnicki, M. and Szyszka, A., 2014. IPO market timing. The evidence of the disposition effect among
corporate managers. Global Finance Journal, 25(1), pp.48-55.
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.
Voit, J., 2013. The statistical mechanics of financial markets. Springer Science & Business Media.
Online
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Value/EBITDA Multiple. 2016. [Pdf]. Accessed from
<http://people.stern.nyu.edu/adamodar/pdfiles/vebitda.pdf >[Accessed on 21st July 2016].
Valuation: Market Multiples Method. 2016. [Online]. Accessed from <
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