SoulCycle: Valuation for IPO

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.

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.

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.
 Notes for the assignment

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 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 ([Link] 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.1

 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”.

1
Do not worry if the expected number of studios you project is not a round number. Since these are expected values
there is no reason why they need to be round numbers.
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 that ratio, along with your forecast 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.2

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.3 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 item for 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 item for 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
Because you are forecasting EBIT directly in 2021 and each year after using your assumption you do not need to
forecast operating expenses for these years.

3
Do this for as many years past 2020 as needed to estimate the residual values.
 Tasks

1. 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 the best comparable firm 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 of the OPM SoulCycle had seen in the recent past years.

 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.

Interest
Moody's S&P Coverage
Rating Rating Ratio* Yield**

Aaa AAA 28.9 2.74%

Aa AA 16.7 2.98%

A A 9.3 3.16%

Baa BBB 5.5 3.96%

Ba BB 3.3 5.02%

B B 1.7 6.74%

Caa CCC 0.5 11.07%

* Average Interest Coverage (EBIT/Interest Expense) for firms at this credit rating.
Source: Moody's Financial Metrics - Key Ratios By Rating and Industry for Global Non-
Financial Corporations: December 2013

** Average Yield on 10 year corporate bonds at each rating on Dec 31 2014.

Justify each of the judgments you make in arriving at your estimate for the optimal capital structure.
2. 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 non- operating assets at
these comparable firms.

3. Estimate SoulCycle’s residual value. You should estimate four different residual values for
SoulCycle:

 Perpetuity with growth (PVGO>0) 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).

 PVGO = 0 Suppose that industry competition drives the IRR on new investments down the WACC
in the long term. Use the same year that you used in the PVGO>0 scenario to estimate this residual
value.

 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.

4. Valuation and Recommendation. Using each of the four 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.

5. (Optional) An update in 2020. Now we are in March 2020 when covid-19 became a global
pandemic. Please think about how you would change your valuation sheet to reflect the new reality for
the long run valuation.