Raising capital

 I was fortunate enough to have guest speakers in my university seminar, who went through the types and considerations of listing on the capital markets. This is especially interesting and useful if you're keen to enter private equity (PE) or venture capital (VC). Luckily for me, I am interested in these fields.

There are several types of equity markets products - private placements, IPO, SPAC, post-listing and equity-linked convertible note. Private placements include early stage funding for start-ups and Pre-IPO placements are where investors long the equity. SPAC is an interesting one because we have read several news about the boom in special purpose acquisition companies (SPACs), including that of the EV company Lucid-CCIV merger.

IPO is probably one of the most heard-of exit strategies for private equity investments. It basically means the firm will list their stocks onto an exchange for the first time in order to raise large amounts of capital to further expand their business, or pay off debt etc. An IPO takes months to complete, and some of the high-profile IPOs include Bumble at $2.2 billion which made the CEO Whitney Wolfe the youngest self-made female billionaire in the world. This process involves back-and-forth engagements between the firm and analysts and underwriters, and ultimately come up with a deal on the valuation of the company, education on the firm etc.

There are several places where equities can be listed, such as Singapore Exchange (SGX) and New York Stock Exchange (NYSE). Noticeably, HKEX has an extremely large amount of IPO in volumes at $67,711 billion as compared to SGX's $833 billion. Different exchanges also have varying IPO sector breakdowns. For example, the Technology, Media and Telecomm (TMT) sector is 35% on the NYSE/NASDAQ, but only 11% in SGX, which gives us something to think about when deciding on where best to list the firm.

Key valuation methodologies include DCF, DDM, comparables which I have written about in my previous post.

Overall, there are several ways companies can raise capital, either through private placements of IPO listings. In general, firms that have a solid business plan, fundamentals, forecast and lower risk are more attractive and will be valued at a higher price.

Valuation Methods

There are many different ways we can value a company, each with their own benefits and limitations. Which method should we use when valuing a start-up like Nio? Or a mature firm like Coca Cola? Different types of companies require different valuation methods, so this post will be a brief outline of the valuation methods of companies.

To start off, the basic and one of the most important concepts in finance is the time value of money (TVM). $1 today will, in general, be worth more next year, because of inflation. So moving forward in time, we compound the value of money, and moving backward, we discount it. Broadly speaking, the value of a company is the present value of the sum of all future earnings or cash flows of the company. 

1) Dividend Discount Model (DDM) looks at a firm's dividends. What we want to find out is, if the firm pays out a dividend each year forever, what would the sum of all those dividends be worth today? 

2) Discounted Cashflow Method (DCF) looks at a firm's cashflow. There are 2 types of cashflows we can use to estimate the value of the stock - either FCF to Equity (FCFE) or FCF to Firm (FCFF). 

3) Relative valuation method looks at comparing the firm to other firms in the industry. This method uses multiples to estimate the values, such as the Price/Earnings (P/E) ratio and EV/EBITDA.

4) Residual Income method. Residual income is the income that the firm has after deducting the costs from earnings.

There are definitely more ways to value a company, especially once we dive deeper into private equity (PE) or startups (VC space). From there, we will encounter more interesting valuation methods such as triangulation and metrics valuation. One example I've heard of is if you're trying to value a social media start-up, how would you go about it? You could possibly estimate the value per user of the industry and impose that onto the estimated number of users of the start-up to find the value. Modelling and valuation is an extremely versatile tool that one can use to estimate the worth of a company, we just need to know which to use and how to use it according to the type of business model the company has. 

I bought Nio!

After the analysis of the stock, I went ahead to purchase 5 shares of Nio, effectively doubling my stake in the company.

Nio analysis: what happened?

 It has been a week since the release of  Nio's Q4 2020 and FY2020 earnings, but contrary to my analysis as posted before, the stock price fell. I've done some research to find out why.

Nio's stock price was right below US$50 at the start of this week before it dropped to US$46 a share right after earnings release. In a consulting book "Case in Point", I learned that when we analyse a situation, we need to look at the environment. Using the E(P=R-C)M Framework, it shows that your profits = revenue - cost. The E and M on both ends represent economy and market respectively. So, when Nio's stock fell, did the market index fall? DJIA, S&P500, and NASDAQ were all down as of 4th March closing. So it seems that at least some part of the fall in stock price can be attributed to market conditions, and perhaps some to Nio's earnings.

Market conditions

1) bond yields are increasing due to a decrease in demand for bonds and hence a decrease in bond prices. So bond yields are coupons divided by bond prices. With an increase in bond yields, the cost of borrowing and financing increases, as the required rate of return by firms also increases. Thus, investors require a higher return to compensate for the same level of risk, driving the stock prices down. From my university class on International Finance, we looked at DJIA and NASDAQ which prices have dipped recently, with a larger dip for NASDAQ. Perhaps this is because, in times of uncertainties, people may choose to buy value stocks that are more prevalent in DJIA than in NASDAQ. Furthermore, for growth stocks, cashflows and earnings come further in the future, so prices are more sensitive to the rate of return and there is more uncertainty. This overall situation of bonds and stocks going down is perhaps due to (expectations of) rising inflation and could be the transition to a period of uncertainty from a Fed-supported market to an economy-driven one, as mentioned by Chicken Genius Singapore on YouTube.

2) global chip shortage. According to CNBC, there is a "$60 billion global chip shortage for the auto industry". These semiconductor chips are extremely crucial in the manufacturing of vehicles and present a $60 billion loss in revenue in the industry. Because of this, Nio cut its production capacity for Q2 2021 from 10k to 7.5k vehicles per month, which translates to an estimated 90k vehicles delivered for 2021, which is still more than double the 43k in 2020. When the pandemic hit, vehicle sales crashed and automakers reduced their orders for materials including these chips (HBR). There are other reasons for the shortage in chip production, but more than that, transportation of these chips has also been a problem due to shortage of containers among other reasons.

Internally, we look at Nio's earnings. Nio's Q4 2020 loss was larger than Wall Street's expectations at US$0.07 per share compared to the actual loss of US$0.14 per share. On the bright side, total revenues for Q4 2020 have increased to US$1 billion, a 47% increase over Q4 2019. Revenues for 2021 are on track to be an increase over 2020, and the semiconductor industry should recover. According to CNBC, SMIC, China's largest semiconductor manufacturer could fill the gaps in demand. TSMC, the world's largest semiconductor manufacturer, has a larger budget for its capital expenditures for 2021, which will eventually increase chip production.

Overall, the dip seems to be temporary, and it is possible to take advantage of this to lower one's average cost in Nio.

Bottom-up analysis of Nio (NYSE: NIO)

 Bottom-up approach: 

Nio was one of the best performing Chinese companies in the US stock exchange, with stock gains of above 1100% (CNBC), with its deliveries increasing to more than two fold at 43,728 vehicles. Further, Nio is expected to expand globally, first into Europe. 

For more information on number of Nio vehicles sold, kindly refer to https://carsalesbase.com/china-nio/, or https://ir.nio.com/news-events/news-releases/news-release-details/nio-inc-provides-december-fourth-quarter-and-full.

Recently in January, Nio announced that its new sedan, the ET7, would be able to hit the 1,000km (621 miles) range mark using their new 150kWh battery - the first EV to be able to do so. 

Things to note: 

- values were taken from Capital IQ, Ycharts, PRNewswire, Statista and MarketWatch

- Key assumptions were that Nio follows at 2-stage growth, first stage until 2026. 2nd stage growth rate I assumed it to follow the automobile industry now at 4.8%. My professor has given the feedback that I could assume a higher growth rate instead, with Nio's popularity in China

- Certain indicators were taken at face value, such as the 5-year beta. It would perhaps be prudent to average the 5-year beta from multiple sources like Bloomberg and Yahoo! Finance

- The relative valuation method could be another way to value Nio, and sensitivity analysis could be conducted to see what FCF would be like with different growth rates

Overall it was a fun exercise, albeit a rushed one. Looking forward to the post-market earnings release on Monday!

Top-down analysis of Nio (NYSE: NIO)

There are 2 approaches we can use when it comes to analysis - top-down or bottom-up. A top-down approach is analysing the stock from the macro perspective - how the economy affects markets and ultimately share price. A bottom-up, on the other hand, focuses on analysing an individual stock, identify it's fair value and compare it with the market price. Today, most analysts use a hybrid approach of both to give a better grasp of the value of the stock.

I will be analysing the electric vehicle (EV) company "Nio Inc", ticker symbol NIO, from a hybrid approach. The reason I chose Nio is because Nio is expected to release its earnings estimate for full year (FY) 2020 and 4th Quarter 2020 (Q4) on 1st March, just a few days away. I currently hold Nio stocks, but I am bullish on it an am considering adding more to the portfolio, so why not analyse it anyway.

Background information on Nio:

The Tencent-backed company is an up-and-coming EV company today, just like BYD and Tesla. It manufactures autonomous driving EV that comes with advanced tech and even AI (Reuters). Besides EVs, it is also looking at providing "vehicle charging solutions" like its Power Charger and the batteries itself. It was founded in 2014, and went public in 2018. It offers several car models, all of which are Sport Utility Vehicles (SUVs). They have their own sports car, EP9, but only 16 of them were built, and 6 of those were sold to their own investors. More recently, Nio announced its new sedan, which is expected to be released in China early next year.

Top-down approach:

I start off with looking at the PESTEL effects on the economic environment - namely, political, economic, sociological, technological, environmental, legal. The global market size for EVs is expected to increase from US$115b to US$567.2b from 2019 to 2026, with a compound annual growth rate (CAGR) of 15.6% (Statista). According to Statista, EVs are now  increasingly affordable and worth owning, such as due to the further range and lower cost. In China alone, there the number of EVs sold was expected to be 1.7m, which will rise to take over 25-50% of the passenger vehicle market within 4 years from now in the country.

Around the world, governments are subsiding both the supply and demand sides of the EV market. For example, with the EV subsidies in Germany, Renault Zoe has become free to consumers in July 2020, which raised demand. On the supply side, one example is how China's government issues a limited number of new license plates to regular vehicles each year, keeping the rest for EVs. Furthermore, according to Sustainalytics.com, as of end-2019, China has already built at least 500 thousand public charging outlets for EVs, and is riding an up-trend. Overall, the economy seems to be geared towards an EV-dominated market in the future.

Next, I look at the Porter's 5 Forces framework. The EV industry is still in the early stage, with an expected rapid growth over the next decade. This positive-sum competition increases industry profitability and reduces competition. Even with several competitors, it will be interesting to see how established incumbents like Nissan develop their own EV (Nissan Leaf) to compete with EV-focused firms like Nio.

So we now see that EVs taking over the vehicle industry is a "when, not if" situation, given the advanced tech developments, consumer demands and tastes, and governments' push. Furthermore, as investors, it seems that the EV industry is something worth investing in.

Investments in general

 Investments: who are they for?

I believe that everybody should invest (if they are able to). Even as a student, I don't get much money each month and I don't like paying too much for brokerage fees, so I generally save up to buy once every few months. 

There are many things you can invest in. Some of the more common ones are real estate and stocks. Real estate as far as I know in my country, requires a lot of capital. This, coupled with my Bachelors in Finance, is the reason why I delved into the stock market. 

More on the stock market: know what you're investing in, invest safe within your means, and have fun while you're at it!