In this blog post I take a shot at valuing Corsair (NASDAQ:CSRS) using a discounted cash flow valuation method. The calculation suggest an equity value ranging from US$1.62 to US$2.76B.
The Corsair Touch
Corsair Gaming Inc. is an American computer gaming components, peripherals, and systems company founded in 1994 as Corsair Microsystems by Andy Paul, John Beekley, and Don Lieberman. While originally selling processor cache and later system memory modules, soon Corsair started gravitating towards the DIY computer enthusiast market segment.
Over the past two decades Corsair has significantly diversified its product portfolio. Starting with flash memory and power supplies in 2006, Corsair is now a market leader in a wide range of product categories including computer chassis, gaming peripherals, cooling solutions, and streaming gear.
What enables Corsair to become so successful is what I’ll call the “Corsair Touch”. The Corsair Touch describes how Corsair enters a product category and finds a way to become successful. The Corsair Touch consists of a couple of key ingredients.
- Hire or develop experts who are technically proficient and deeply involved with the enthusiast community. The experts have a finger on the pulse when it comes to market trends. Not only can they anticipate new market trends, they also know how to integrate the new trends in future products. Corsair is rarely first to move with a new trend, but more often than not they make the right move.
- Enter any new market with a high-end product to win over the enthusiasts and establish a credible brand reputation. Then expand with more affordable offerings to gain market share. However, always stay clear of the low-end price-sensitive segment.
- Outsource most if not all manufacturing to lower-cost OEMs in Asia and avoid investing in fixed assets.
- Finally, leverage the world-class worldwide distribution and sales engine to push the products to the market
On August 21st, 2020, Corsair Gaming, Inc. filed its IPO prospectus with the SEC aiming to go public on the Nasdaq exchange under the symbol CRSR.
There are four major value drivers to consider:
- Revenue, growth, and duration of growth
- Profitability and efficient use of assets
- Reinvestment in existing and growth assets
We can use the following documents to gather information about Corsair’s value drivers from 2005 to 2020:
- 2015 – 2019: https://sec.report/Document/0001193125-20-227100/
- 2007 – 2011: https://sec.report/Document/0001193125-12-039037/
- 2005 – 2009: https://sec.report/Document/0001193125-10-091920/
For reference I also collected data from publicly listed peers Logitech, Turtle Beach and Razer using the data service provider Finbox.
You can download the excel sheet here: https://hanweiconsulting.com/wp-content/uploads/2020/09/fcffsimpleginzu-corsair-v1.1.xlsx.
As mentioned in the opening paragraphs, Corsair has diversified its product portfolio away from the highly commoditized and volatile DRAM memory market. The company has successfully expanded into a wide range of computer components, accessories, and peripherals. You can see this expansion illustrated in a picture included in the IPO prospectus.
Between 2005 and 2010 Corsair is a nimble growth company focused on driving revenue through expanding the product portfolio and riding the organic growth of the PC DIY market. Between 2010 and 2015, the PC DIY market slows down, and Corsair identifies PC gaming as a market segment with above industry growth potential and more favorable margins.
After an unsuccessful IPO in 2010 and 2012, Corsair turns to Francisco Partners and obtains a $75 million strategic investment in the company. The investment is used to execute the growth strategy outlined in the 2010/2012 IPO prospectus:
- Achieve Leading Market Position in Each Product Family
- Increase Sales of Gaming Peripherals
- Leverage Our Scalable Operating and Business Model
- Build on Our Existing Infrastructure to Address Growing Opportunities in the Asia Pacific Region
- Selectively Pursue Complementary Acquisitions
In 4 years, Corsair doubled its revenue and becomes a $1 billion dollar company. Considering Corsair’s current position, it’s safe to say they absolutely succeeded in each of their strategic goals.
In 2017, Francisco Partners sold its stake in Corsair to EagleTree Capital. From the Press Release we note that the post-acquisition EagleTree aims to “[…] maintain the company’s focus on innovative products, to expand into new markets, and to pursue selective transactions”. This aligns with the growth strategy outlined in the 2020 IPO prospectus:
- Advance as the global leader in high-performance gaming and streaming gear.
- Continue to develop innovative, market-leading gaming and streaming gear.
- Expand into new gear and services that grow our market opportunity.
- Leverage our software platforms to sell more gear to existing customers.
- Strengthen relationships with end-users by increasing direct-to-consumer sales.
- Continue to grow market share globally.
- Selectively pursue complementary acquisitions.
The 7 strategies outlined boil down to 2 standard growth strategies: (1) organic growth through horizontal diversification, and (2) inorganic growth through M&A.
Corsair operates a global, scalable, nimble business model utilizing the “Corsair Touch” to respond quickly to new market trends and demands. The facility in Taiwan assembles, tests, packages, and supplies the DRAM, liquid cooling products and pre-built gaming systems. All other Corsair products are produced at third-party, outsourced, factories located in China, Taiwan, and South-East Asia.
The outsourcing operations strategy allows Corsair to leverage the intense competition between suppliers and choose the best quality and best price. This helps maximize customer willingness to pay (increases price) and helps reduce cost, which combined allows Corsair to capture more value.
The DRAM business is still a significant part of Corsair’s overall business and has a big impact on profitability. DRAM is highly commoditized and operating profits are determined by volatility in market demand and supply, as well as timing of purchase. The gaming peripherals typically have a much higher gross margin in the range of 35-40% or higher.
Since 2007, Corsair has steadily increased gross margin by diversifying into higher-margin product categories. That said, Corsair’s gross margin of 24.2% is still well below industry peers Logitech and Turtle Beach’s 35% and higher gross margin. The same can be said about the operating margin. While positive, unlike its industry rival Razer, the operating margin fluctuates between 2% and 6%. This is also below industry peers Logitech and Turtle Beach. Expressed as a percentage of revenue, both Product Development (RD) and SG&A expenses are below the industry peers.
Looking at the 2018 and 2019 cash flow statements, Corsair has every scent of an early growth company. The cash flow from operations is relatively low compared to the vast amount of cash for investment financed by debt. However, the picture changes if we factor out the recent three acquisitions of Elgato (2018, $46.6 million), Origin PC (2019, $13.8 million) and SCUF Gaming (2019, $136 million). In the 18 months spanning 2019 and the first half of 2020, Corsair spent $126+$10 million in cash on the three aforementioned companies representing 90% of all investment activities. This paints the picture of a company that is primarily looking at acquisitions to fuel future growth rather than reinvesting in existing assets in place.
This can be good or bad news.
It is good news if management believes the current assets in place and operations are well-tuned and ready to provide significant profits as they scale up further. In this case the existing core business becomes the cash cow to fuel the M&A inorganic growth. This offers a well-balanced short-term and long-term perspective for the company.
It is bad news if management believes the current assets in place have no future and the only growth can come from bringing outside products and people to guarantee the future of the company.
I use weighted average cost of capital (“WACC”) calculation to determine the risk. WACC has the following components: equity and debt.
Cost of Equity
To determine the cost of equity we use the following inputs:
- Long-term Riskfree rate: US 10Y bond yield = 0.69% (Sept 10, from tradingeconomics.com)
- Unlevered beta: 1.35 (Sept 10, from Damodaran‘s latest Valuation Spreadsheet)
- Equity risk premium: 6.4275% (Sept 10, calculated using Damodaran‘s latest Valuation Spreadsheet and Corsair’s revenue per region)
Cost of Debt
To determine the cost of debt we use the following inputs:
- Long-term Riskfree rate: US 10Y bond yield = 0.69% (Sept 10, from tradingeconomics.com)
- Interest Coverage Ratio: 2.05, which results in an estimated synthetic rating of B2/B and associated estimated company default spread of 8.25% (Sept 10, from Damodaran‘s latest Valuation Spreadsheet)
- Average maturity: 4 years (90% of debt is due in 2024)
- Tax rate: 25% (United States corporate tax rate)
|(in thousands)||Equity||Debt + Operating Leases||Capital|
|Market Value (*)||$549,610||$481,449||$1,031,060|
|Weight in Cost of Capital||54.32%||46.69%||100%|
|Cost of component||14.95%||6.71%||11.10%|
The cost of capital is relatively high because the high debt-to-equity (increases relevered beta) and low interest coverage rate (lowers synthetic rating). The easiest way to improve the WACC is to use the proceeds of the IPO to lower the debt. This will not only provide additional free cash flow (less interested to be paid) but also increase debt capacity at more favorable interest rates.
The additional debt capacity can then be used as a source of finance for future acquisitions.
Initial Corsair Valuation
Using Damodaran’s model for DCF valuation, an initial Corsair valuation could look like this.
Revenue growth: 15% 2-5Y CAGR. High growth in the coming 5 years driven by continued aggressive expansion of the product portfolio both organically (new product launches in existing categories) and inorganic (acquire market leading companies).
Profitability: 15% EBIT in Year 10: leverage the lean business model to sell more of the same products with minimum overhead, focus on diversifying the portfolio with high-margin computer peripherals, and drive margin with aggressive direct-to-customer business.
Reinvestment: 2.00x Sales-to-Capital in Year 10: continue the focus of reinvestment on growth assets rather than fixed assets, acquire the right companies to be #1 or #2 player in each entered product category or segment, continue the “Corsair Touch”.
Risk: 5.92% WACC in Year 10: similar to that of mature companies (riskfree rate + 4.5%)
Value of Equity ~ US $3.58B
The initial valuation paints a positive picture of Corsair’s future, its projected cash flows and its value. In this section I want to add more personal side notes to this Corsair valuation and hopefully add perspective.
The revenue growth as projected in the Corsair valuation depends on the continued success in the existing product categories and the outstanding success of future product categories and acquisitions. The success essentially depends on the future success of the “Corsair Touch”.
For the “Corsair Touch” to be successful Corsair needs to continue to attract and retain industry experts, and those experts must continue to create value that Corsair customers are willing to pay a premium for. This value not only depends on Corsair but also on the rate of innovation of the OEMs and suppliers who produce the Corsair products. Since Corsair does little own manufacturing it needs a strong and integrated value chain. If the rate of innovation drops significantly and Corsair is no longer able to create products that customers are willing to pay a premium for, it risks being dragged into a price war with lower cost companies.
Additionally, a key strength of the “Corsair Touch” is the global, scalable, nimble business model. For this strength to help fuel growth, Corsair must be able to identify the product categories that have high synergy with the business model. The 2018 Elgato acquisition is a perfect example of this.
Elgato is a market leader in streaming equipment for PC gaming, had a limited high-margin product portfolio of mainstream plug and play equipment, and is operating in a hot and rapidly growing market. The combination “PC”, high-margin”, “plug and play”, “limited portfolio”, and “high growth” is a perfect fit for the “Corsair Touch” model and I have no doubts it will be a success.
Potential targets similar like Elgato could be:
- Thrustmaster, leader in joysticks, game controllers and steering wheels
- Hercules, leader in PC-DJ equipment and software
- Fanatec, leader in sim racing hardware and equipment
SCUF Gaming is a different story as they produce highly customizable game controllers targeted at console gamers. While the high (gross) margin is a plus point, it remains to be seen how the “Corsair Touch” can be levered with these products. After all, Corsair is more known as a “PC Gaming” company and not as a general ‘Gaming” company like their competitor Razor. Also, the “Corsair Touch” does not really cater well to customized products.
Perhaps SCUF Gaming is a way for Corsair to establish itself as more than just a PC Gaming company and expand the product portfolio to all types of gaming. Including PC, console, handheld, mobile, and cloud gaming. That would certainly open up a lot of new avenues for expanding the product portfolio.
The profitability case hinges on two main factors. One, leverage the “Corsair Touch” and charge a premium in high-margin product categories. Two, increase the direct-to-customer sales.
I already discussed the first point at length in the previous sections.
In July 2020 Corsair hired Kenji Gjovig as VP eCommerce. Coming from Albertsons Companies he joined to lead the direct to customer ecommerce business. It will be a tough job. As reported in the 2020 IPO prospectus, sales to Amazon accounted for 26.8% of net revenue for the six months ended June 30, 2020, increasing from 17.7% in 2017.
The big picture challenge for Corsair is that a lot of their business and products are “amazonable”. The online etailers that survive are those who can carve out a niche or offer a product/service that are “unamazonable”. Corsair must find a way how it can attract customers who are used to the ease of simply adding a Corsair product in their one-click Amazon check out. This can be done, but will not be easy and will not be cheap. An easy way out would be to offer lower prices through the online store, but not only does that impact the profitability, it also impacts the brand value. Offering exclusive products or customized products is another option, but that is incompatible with the “Corsair Touch” business model. High expenditure on advertising and marketing to lure people to the ecommerce platform is expensive and will eat into your margin. Offering better or more personal service compared to Amazon may seem easy to on paper but very quickly becomes expensive. Especially for a company selling worldwide.
The reinvestment is targeted mostly at M&A. A key challenge with M&A is that for attractive businesses there are usually multiple bidders and multiple bidders often result in a Winner’s Curse. The Winner’s Curse is a tendency for the winning bid in an auction to exceed the intrinsic value of an item. Similarly, many companies who do M&A end up overpaying for acquisitions.
Overpaying for an acquisition basically means you have overestimated the value (value transfer and value creation) of the acquisition. Reasons for this can be overestimating the synergies (“dreams”), underestimating the cost of capital (minimizing the risk premium), exaggerating the residual growth rate in the calculation of the terminal value, and using multiples of “comparables” which are not really similar or simply inflated.
M&A is really difficult and Corsair will need not only a clear acquisition strategy, a strong negotiation strategy (“BATNA, be able to walk away”), but most importantly key people who can identify potential targets and accurately evaluate the value it can create for the business after acquisition.
It is difficult to judge whether Corsair management is doing things right from outside. However, we can look at the transactions detailed in the 2020 IPO prospectus. Specifically, we can look at the goodwill mentioned. Goodwill is the price paid for future cash flow and is calculated as the acquisition price minus the book value of the assets.
- Elgato (2018): $23.133 million net assets, $23.487 million goodwill
- Origin PC (2019): $1.499 million net assets, $12.270 million goodwill
- SCUF Gaming (2019): $63.670 million net assets, $72.642 million goodwill
The obvious standout here is SCUF Gaming as Corsair paid more in goodwill than net assets. In 2019 SCUF Gaming reported net sales of $68.3 million, gross profit of $26.5 million and operating loss of $2 million.
The terminal value captures the value of a business beyond the forecasted cashflow period. The terminal value often comprises a large portion of the total value of the business. My model uses the perpetuity method which assumes a business will continue to generate cashflows at a constant rate forever.
The obvious caveat is of course that we do not know if Corsair will continue to generate revenues beyond year 10. Perhaps with the rise of cloud gaming or other technologies we soon will not need any of the products Corsair is selling.
My assumption is that Corsair will continue to shift its product portfolio towards new categories and markets and hence I am okay using the perpetuity method in this Corsair valuation.
Corsair Valuation: Sensitivity Analysis
Last step of the Corsair valuation is to do perform a simple sensitivity analysis. In the past I used Crystal Ball to perform my sensitivity analysis but recently I have switched to the ModelRisk excel plugin.
- CAGR 2-5Y: lognormal distribution (mu=10%, sigma=5%)
- Profitability: triangle distribution (min=5%, mode=12.5%, max=20%)
- Sales to Capital ratio: triangle distribution (min=1.5, mode=2.0, max=2.5)
- Mean value of equity ~ $2.29B
- 25% percentile: $1.62B
- 50% percentile: $2.15B
- 75% percentile: $2.76B
Corsair Valuation: Post-IPO Update
On September 23, 2020, Corsair Gaming was listed on the Nasdaq raising $238 million by offering 14 million shares at $17. The share price dropped on opening day by over 16% to $14.24.
I updated my valuation work sheet with the additional data such as outstanding shares and re-ran the simulation. You can find the information below:
Worksheet download: https://hanweiconsulting.com/wp-content/uploads/2020/09/fcffsimpleginzu-corsair-v1.2.xlsx
As of Sept 24, 2020, Corsair sits around the 15% percentile.
Disclaimer: For all intents and purposes, the content and information below is for entertainment purposes only and should not be considered investment advice.