SoulCycle
Startup Valuation: IPO
Due on 12/3 before 11:30 AM
Instructions: Your group should upload one electronic copy of your Excel solution on Canvas. You must upload your solution before the start of the lecture on the day in which they are due. Assignments submitted late will not be accepted. Ensure your solution contains your cluster and each group member’s name.
Note: Since this is a long case, you only need to submit answers for the FCF estimation part. If you want more practice, we have included instructions to solve the entire case.
Forecasting in this Case
In this case you are encouraged to forecast some key components of SoulCycle’s future free cash flows. There is no “right” or “wrong” answer for these forecasts. Instead, use the information in the case, and anything you know about the firm and the industry to justify the assumptions you make. Make sure that your forecasting assumptions are made very clear in your assignment. Your submission will be graded based on the logic underlying your forecasts and the way that you apply the valuation methodology that you have learned in class. Where I give you specific instructions on how to forecast a component of free cash flow you should use those instructions. This will limit the complexity of the case and make it easier to compare solutions in class.
To make it easier to check your answers after class make sure you can easily adjust the forecasting assumptions in a version of your spreadsheet to see if you get the same numbers as in the lecture. This will help you check that your valuation methodology is correct.
You should use the information you have about the business and what you know about the firm to try and form. your own estimates for what the future growth and profitability of SoulCycle might look like.
Overview
Related Companies LP along with Elizabeth Cutler and Julie Rice are considering the possibility of IPOing their firm. You have been asked to estimate how much the equity of SoulCycle is worth. Your valuation should take place as of December 31 2014. As a result, your valuation should be based on the projected free cash flows starting in 2015. To do this use the following information.
Note that the excel data file only contains the primary exhibits from the case reading (these are Exhibits 2A, 2B, 2C, 5, and 7B). You may need a few numbers from other Exhibits in the case reading.
Assignment Questions
1. Project SoulCycle’s free cash flows. You should forecast that SoulCycle will follow a two stage growth process. For the next six years it will continue to grow rapidly by adding new studios. After that growth will slow and it will primarily concentrate on operating the studios opened during its expansion period. To forecast the free cash flows this will generate use the following instructions:
Projecting Revenue in Each Year. Revenue growth from Studio Fees at SoulCycle is primarily driven by growth in the number of studios. Accordingly you should forecast revenues from studio fees using the following formula.
Revenue from Studio Fees = (Number of Studios)×(Number of Rides Per Studio)×(Studio Fee Per Ride)
This requires forecasting each of the three components of studio fee revenue. Use the following information to do this:
• Number of studios: You should project the expected number of studios in 2015 and each year after. Based on all of the information in the case make an assumption about the growth rate in the number of studios over the next six years (i.e. starting from its historical value at the end of 2014 and projecting up to and including 2020). Assume a single constant rate and provide 3-5 sentences justifying your assumption based on your analysis of the information that is presented in the case. Make sure that the assumption you make is shown clearly in your assignment. One way to anchor your forecast is to think about how many studios you expect SoulCycle will have at the end of its growth phase (i.e.by the end of 2020). The data provided in Exhibits 2D, 5, 6, 9A and 9B are all good places to look for information to help form and justify your forecast.
Assume that SoulCycle will reach near market saturation by the end of 2020. As a result the number of studios will grow at a constant rate of 0.5% from 2020 to 2021 and each year after that.
Note that the number of studios is changing over the course of the year. For all calculations use the total number of studios at the end of the year to represent the total number of studios in that year (do not bother inferring the average number of studios over the course of year).
• Number of Rides Per Studio: Assume that the number of rides per studio will remain constant at the ratio obtained in 2014 (see Exhibit 2c) for each year into the future.
• Studio Fees Per Ride: To project this, start with the average studio fee per ride in 2014 (Exhibit 2c). In words, this is the average price that a customer pays for one class. Next, make an assumption about how this will grow over the next six years (i.e. through to 2020). Assume a constant growth rate (it can be negative if you think that the average price of rides will fall) and provide 3-5 sentences justifying your assumption based on your analysis of the information that is presented in the case. Think about how the expansion of SoulCycle studios is likely to impact the average price it can charge per ride across all its studios. Make sure that the assumption you make is shown clearly in your assignment.
Assume that studio fees per ride will grow at a constant rate of 1.75% from 2020 to 2021 and each year after that (i.e. to keep up with inflation).
• Revenue from Studio Fees: Multiply the three components of total revenue from studio fees together to obtain your estimate of revenue from studio fees for the entire firm in each year.
• Merchandise Sales: Based on the historical link between merchandise sales and studio fees, forecast that these will be 19% of studio fees for each year going forward. Add this to the total studio fees you forecasted to compute your estimate of “Total Revenue” .
Projecting “Compensation and Related”, “General and Administrative” and “Rent and Occupancy for 2015-2020. Assume that during SoulCycle’s expansion phase, growth in these expenses will be driven primarily by the growth in the number of studios. For each of these expenses, compute its ratio to the number of studios in 2014. Assume this ratio will be constant from 2015 to 2020, and use the ratio along with your forecasts for Number of Studios to project the level of each expense.
Projecting all other expenses items for 2015-2020. All other expenses items (e.g., “retail cost of sales (COGS)” and “depreciation”) are driven by Total Revenue (= Studio Fees + Merchandise Sales). For each item of expense, assume that they will grow at the same rate as Total Revenue starting from 2014 to 2015 and continuing all the way through to and including 2020.
Project earnings before interest and tax (EBIT) for 2021 and each year after that by assuming that SoulCycle’s operating profit margin (EBIT/Total Revenue) stabilizes to a constant level. You should use the information in the case in conjunction with your earlier projections to choose a constant long-run forecast of OPM at SoulCycle from 2021 on. For example, take into account the average OPM that Bally exhibited from 1996-2006 (Exhibit 5) to help guide your forecast. Use this along with your forecasts of Total Revenue to forecast EBIT in 2021 and each year after that. Make sure that the forecast you make is shown clearly in your assignment and provide 3-5 sentences justifying your choice based on the information that is presented in the case.
Taxes. SoulCycle will face a corporate tax rate of 35%. Note that the historical taxes paid by SoulCycle (see Exhibit 2a) have been unrepresentatively low due to income tax loss carryforwards that will not continue into the future.
Projecting Balance Sheet Items in Each Year
There are several items on the balance sheet (including Property Plant and Equipment (net)) that you will need to forecast in order to project free cash flow. For each item you should compute the ratio that was observed relative to Total Revenue in 2014. Use this ratio along with your forecast of Total Revenue to project the level of each item. Part of your job is to decide which balance sheet items you need and how to incorporate them into your free cash flow projections.
The following information defines some of the items on the balance sheet in more detail:
• Deferred Revenue: The balance sheet in Exhibit 2b includes a liability of deferred revenue. This refers to classes that have been bought and paid for in advance but have not been taken yet. As the classes are taken over time, these are then recognized as sales on the income statement.
• Inventories: These primarily refer to inventories of SoulCycle branded merchandise.
• Deferred Rent: The balance sheet in Exhibit 2b includes a liability of deferred rent. SoulCycle has signed many graduated lease schedules that offer discounts early in the life of the lease contract. However, GAAP accounting requires businesses to record lease payments using a straight line accounting method that averages the lease payments over the life of the lease. The deferred rent liability captures the additional rent that is due to be paid in the future relative to what is recorded in the income statement
2. Estimate SoulCycle’s optimal capital structure. To estimate the optimal capital structure for SoulCycle use the following information:
• You will need a starting guess for the enterprise value of SoulCycle despite the fact that it is not currently publicly traded. To do this, choose comparable firm(s) from those provided in Exhibit 7 and use an (Enterprise Value)/EBIT multiple to estimate the EV at SoulCycle. Justify which comparable firm(s) you use to form. your estimate.
• There is very little data to judge how variable SoulCycle’s operating profit margin could be in the future. As part of your free cash flow projections, you forecasted what operating profit margins would be at SoulCycle on average in the long term. Estimate that in a bad year operating profit margins will fall to half this ratio.
• You will need to estimate the yield (rD) that SoulCycle will pay on its debt at the optimal capital structure. To do this, use the following information on debt ratings and yields. Specifically, estimate SoulCycle’s bond rating by computing the actual coverage ratio SoulCycle would have had in 2014 if it had been at its optimal capital structure. Compare this to the information on “Interest Coverage Ratio” to estimate how SoulCycle will be rated in the future.
* Average Interest coverage (EBIT'InterestExpense)for firms at this credit rating. source Moody'S Financial Metrics key Ratios BYRating andIndustry forGlobal Non-Financial
Corporations: December 2013
** Average yield on10year corporate bonds at each rating on Dec31 2014. source: JP
Morgan and us.spindices.com
Justify each of the judgments you make in arriving at your estimate for the optimal capital structure.
3. Estimate the weighted average cost of capital. You should estimate the WACC for SoulCycle at the optimal capital structure. To estimate the asset beta for SoulCycle choose comparable firm(s) from those listed in Exhibit 7. Justify your choice. Assume that cash is the only nonoperating assets at these comparable firms.
4. Estimate SoulCycle’s residual value. You should estimate three different residual values for SoulCycle:
• Growing Perpetuity Assume that the free cash flows grow at a constant rate consistent with your forecasts. To do this you will need to find the year when, according to your forecasts the free cash flows begin to behave like a growing perpetuity (i.e. grow from that year forward at a constant rate).
• Enterprise Value Multiples Estimate the residual value using both a EV/(Total Revenue) multiple and an EV/EBIT multiple based on comparable firm(s) (in Exhibit 7). In both cases, form. an estimate of the residual value at the same point in time as the other two residual value estimates. Hint: when applying this method the data in Exhibit 7 will produce a trailing multiple. You should apply the multiple you get from the comparable firm(s) to SoulCycle’s forecasted Total Revenue (Studio Fees + Merchandise Sales) and EBIT in a consistent way.
5. Valuation and Recommendation. Using each of the three residual values, estimate the value of SoulCycle’s equity at December 31 2014. Which of the estimates do you think is the most reasonable? Justify your choice.