S ogou Inc. Financial Analysis Case Study Solution
Sogou Inc. is a leading player within the Chinese internet industry. In terms of the mobile queries, the Sogou search engine of the company is the second largest search engine in China. If we talk about the shareholder structure, then the principle shareholders of the company are Sohu, Tencent Holdings and Charles Zhang holding 37.8%, 43.7% and 9.2% respectively of the class A and B shares. The company has 392 total outstanding shares at the end of December 2016.
The business profit model of the company has been determined by the group management of Sogou. The company’s profits and revenues are generated through its Sogou search engine. The company generates revenues through advertisements on its search engine and Sogou Input Method software. This is the first cloud based software that is used for the Chinese input language. This software had generated 88 million PC DAU and 283 million mobile DAU in June 2017. The company has also discussed commercial arrangement with Tencent Holdings for product optimization and testing.
The business model is based on key strategies that have been developed these include the continued work to expand the search market share, developing the next generation of the human machine interfaces, unlocking the value of big data and pursuing innovations within the AI technologies. If we analyze the market in which Sogou operates then the market is fast growing online search market and at the end of 2016 it has grown to $ 11.5 billion. The expected CAGR for the industry from 2016 to 2021 is expected to be 21.7% yielding a total value of the market of $ 30.7 billion by the end of 2021.
The market is currently under penetrated as compared to US search markets as the total market of search engine is China is 0.1% of total GDP in 2016. However, the future outlooks of the market are favorable and for this reason, Sogou Inc. also has a bright future. The company would be taking advantage of advertising budgets that are shifted online. Sogou is master in AI technology and online search is its significant application and this would boost the revenues of the company in future years as AI would enable major breakthroughs such as it is key enabler for smart hardware.
Valuation of Sogou Inc.
The valuation for Sogou Inc. has been performed on the basis of the discounted cash flow method and the comparable valuation method. These are discussed below:
Discounted Cash Flow Method
Before forming the DCF model, we need to compute a number of things and first we have forecasted the key elements for the balance sheet and income statement of the company. Since, the company because listed in November 2017, therefore, the previous year financials were not readily available however, we have extracted the past three years’ data from Morning star website source for the years 2014, 2015 and 2016. We have projected the free cash flow for the company by first forecasting the financial statements for the next five-year period from 2017 to 2021 and then computing the free cash flow on the basis of forecasted statements.
Assumptions Used in Forecast
We have computed the sales growth rates for the company for 2015 and 2016 and using the 2016 sales growth rate we have forecasted the financial statements for the next five-year period. All the items in the balance sheet and income statement have been projected using the historical percentages over total sales. We have then used the projected financial statements to compute the free cash flow for the next five-year period which is shown in exhibit 1 in the appendices.
Weighted Average Cost of Capital
We have computed the cost of capital by first computing the cost of equity through capital asset pricing model and then assuming the cost of debt. The following assumptions and justifications are applicable to the computation of the cost of capital shown in exhibit 2 in the appendices.
- The Risk free rate has been taken from Yahoo finance as the rate of return on t bills with maturity of 10 years.
- The market rate of return we used is the sales growth rate for 2016 and we have assumed these rates to be equal.
- The computation for equity beta has been done by using slope function in excel for all the available prices of the company since its IPO in November 2017.
- The income statement and 10-K for the company do not state anything about the cost of debt for the company however, we have used the cost of debt of Baidu for 2016 which is 3.41%.
- The respective debt and equity weights in capital structure have been computed using the 2016 actual figures for Sogou Inc.
- The tax rate has been averaged for the past three years which is approximately 3% only.
- The WACC for the company is 2.79% as shown in exhibit 2 in the appendices.................
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