Finding Key Value Drivers in Valuation of Internet Companies using DCF approach

Abstract

The main theme of the article is the search of key value drivers while estimating the fundamental value of the companies that operate in the Internet. The downfall of 2000 left a number of questions among experts and analysts of the stock market without proper answers. Some of the assumptions in valuation models which led to a huge overestimation of Internet companies are still widely discussed among analysts of the stock market. In Russia two biggest Internet portals announced in 2008 their intensions to raise capital through an IPO. The main goal of the article is to describe the companies of this particular type (Internet companies), to introduce a classification of these companies and finally to show clearly that Russian Internet firms even though these companies are privately owned can be valued using the classic DCF approach with the emphasis of key value drivers which are different for each type of the companies in the classification introduced in the article. However, in order to properly use the traditional valuation techniques not only the knowledge of financial management is required. One should understand the business model of the company. Therefore it is crucial to classify the companies that need to be valued on the basis of their mechanisms of generating earnings. According to this classification there are three main types of the companies: Internet shops, Web portals and content providers. Social networks represent a particular business model among content providers and are developing very rapid at the moment. After determining which type of business models is used by the company one should forecast the future earnings of the company using its internal growth drivers. In this case the valuation using traditional DCF techniques is possible and leads to adequate results. The introduction provides with a small piece of history and a brief overview of the previously issued publications on Internet companies valuation. The first paragraph describes key assumptions that were popular on NASDAQ during “The Internet Bubble” period. The second paragraph provides with a classification of the Internet companies as well as differences, advantaged and potential drawbacks of each type of the business model (shops, portals, content providers). The third paragraph gives an example of how these techniques can be applied to a valuation of a privately held Internet company.