Valuing A Business By Customers

Valuing A Business By Customers

In the ๐ˆ๐“ ๐ฌ๐ž๐ซ๐ฏ๐ข๐œ๐ž๐ฌ ๐ข๐ง๐๐ฎ๐ฌ๐ญ๐ซ๐ฒ, the majority of the M&A transactions are usually ๐›๐จ๐ฅ๐ญ-๐จ๐ง ๐๐ž๐š๐ฅ๐ฌ ๐ญ๐ก๐š๐ญ ๐Ÿ๐จ๐œ๐ฎ๐ฌ ๐จ๐ง ๐š๐œ๐ช๐ฎ๐ข๐ซ๐ข๐ง๐  ๐ฌ๐ฉ๐ž๐œ๐ข๐Ÿ๐ข๐œ ๐œ๐š๐ฉ๐š๐›๐ข๐ฅ๐ข๐ญ๐ข๐ž๐ฌ ๐š๐ง๐ ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ๐ฌ. Thus, the deal size is smaller than a scale acquisition where the focus is maximising cost synergies.

Thus, when we value such target companies, it is better to value the target firm not as a whole but as the target per customer value.

Over the weekend, i tried to ๐›๐ฎ๐ข๐ฅ๐ ๐š ๐ฆ๐จ๐๐ž๐ฅ ๐Ÿ๐จ๐ซ ๐ฏ๐š๐ฅ๐ฎ๐ข๐ง๐  ๐š ๐ญ๐š๐ซ๐ ๐ž๐ญ ๐œ๐จ๐ฆ๐ฉ๐š๐ง๐ฒ ๐ฉ๐ž๐ซ ๐ž๐ฑ๐ข๐ฌ๐ญ๐ข๐ง๐  /๐ง๐ž๐ฐ ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ and observed some striking results.

For this model, i assumed a small IT service company with substantial F500 companies.

Assumptions
Count of existing customers = 15
Relationship with existing customers = five years
Engagement model = Project-based
WACC of target = 15%
Average Revenue/Customer = $2.5 million
Avg.Directย Costs/Customer excluding bench = $0.83 M
Avg.Contribution Margin/Customer = $1.67 M

๐“๐ก๐ฎ๐ฌ, ๐ญ๐ก๐ž ๐Ÿ๐ข๐ซ๐ฆ’๐ฌ ๐ฉ๐ซ๐ž๐ฌ๐ž๐ง๐ญ ๐ฏ๐š๐ฅ๐ฎ๐ž ๐ฐ๐ข๐ญ๐ก ๐ž๐ฑ๐ข๐ฌ๐ญ๐ข๐ง๐  ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ๐ฌ = $๐Ÿ–๐Ÿ‘.๐Ÿ–๐Ÿ ๐Œ.

1648445989975

Now, the target company growth projections come from acquiring new customers.

Thus, the CAC/new customer = $0.5 M
In the next 10 yrs, i assume the Contribution margin/new customer and CAC/customer will grow at an inflation rate of 3.5%
Currently, New customer additions = 2, and i think that the growth in new customer additions for the next 10 yrs = 10%

Forecasting this model to the next 10 yrs and discounting back at a WACC of 15%, i get the firm’s value from existing and new customers.

๐…๐ž๐ฐ ๐จ๐›๐ฌ๐ž๐ซ๐ฏ๐š๐ญ๐ข๐จ๐ง๐ฌ ๐Ÿ๐ซ๐จ๐ฆ ๐ญ๐ก๐ž ๐š๐ง๐š๐ฅ๐ฒ๐ฌ๐ข๐ฌ
1)When the target has ๐ฅ๐จ๐ง๐ -๐ญ๐ž๐ซ๐ฆ ๐œ๐จ๐ง๐ญ๐ซ๐š๐œ๐ญ๐ฌ ๐ฐ๐ข๐ญ๐ก ๐ข๐ญ๐ฌ ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ๐ฌ, it locks in the customer. Here, the ๐๐ข๐ฌ๐œ๐จ๐ฎ๐ง๐ญ ๐ซ๐š๐ญ๐ž ๐ข๐ฌ ๐ง๐จ๐ญ ๐ญ๐ก๐ž ๐ญ๐š๐ซ๐ ๐ž๐ญ’๐ฌ ๐–๐€๐‚๐‚ ๐›๐ฎ๐ญ ๐ญ๐ก๐ž ๐ซ๐ข๐ฌ๐ค-๐Ÿ๐ซ๐ž๐ž ๐ซ๐š๐ญ๐ž. In my view, the ๐ฆ๐จ๐ซ๐ž ๐ญ๐ก๐ž ๐š๐ง๐ง๐ฎ๐ข๐ญ๐ฒ ๐ซ๐ž๐ฏ๐ž๐ง๐ฎ๐ž๐ฌ, ๐ญ๐ก๐ž ๐ฅ๐จ๐ฐ๐ž๐ซ ๐ญ๐ก๐ž ๐ซ๐ข๐ฌ๐ค ๐š๐ง๐ ๐ก๐ข๐ ๐ก๐ž๐ซ ๐ญ๐ก๐ž ๐ฏ๐š๐ฅ๐ฎ๐ž ๐จ๐Ÿ ๐ญ๐ก๐ž ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ.

2)If the ๐‚๐€๐‚/๐ง๐ž๐ฐ ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ = ๐‚๐จ๐ง๐ญ๐ซ๐ข๐›๐ฎ๐ญ๐ข๐จ๐ง ๐ฆ๐š๐ซ๐ ๐ข๐ง/๐ง๐ž๐ฐ ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ, ๐ญ๐ก๐ž ๐ข๐ง๐œ๐ซ๐ž๐ฆ๐ž๐ง๐ญ๐š๐ฅ ๐ ๐ซ๐จ๐ฐ๐ญ๐ก ๐ข๐ง ๐ฏ๐š๐ฅ๐ฎ๐ž ๐Ÿ๐ซ๐จ๐ฆ ๐š ๐ง๐ž๐ฐ ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ ๐ข๐ฌ ๐ณ๐ž๐ซ๐จ. Thus, firms with a lower CAC/customer, lower cost structure, and higher pricing power will have a higher value.

3)At the ๐ฌ๐ญ๐š๐›๐ฅ๐ž ๐ ๐ซ๐จ๐ฐ๐ญ๐ก, ๐ญ๐ก๐ž ๐ฏ๐š๐ฅ๐ฎ๐ž ๐จ๐Ÿ ๐ญ๐š๐ซ๐ ๐ž๐ญ = ๐ฏ๐š๐ฅ๐ฎ๐ž ๐จ๐Ÿ ๐ž๐ฑ๐ข๐ฌ๐ญ๐ข๐ง๐  ๐œ๐ฎ๐ฌ๐ญ๐จ๐ฆ๐ž๐ซ๐ฌ.

In my view, this model gives me ๐›๐ž๐ญ๐ญ๐ž๐ซ ๐ข๐ง๐ฌ๐ข๐ ๐ก๐ญ๐ฌ ๐ข๐ง๐ญ๐จ ๐ญ๐ก๐ž ๐ญ๐š๐ซ๐ ๐ž๐ญ ๐œ๐จ๐ฆ๐ฉ๐š๐ง๐ฒ ๐›๐ž๐œ๐š๐ฎ๐ฌ๐ž ๐ข๐ญ ๐ฅ๐ข๐ง๐ค๐ฌ ๐ญ๐ก๐ž ๐จ๐ฉ๐ž๐ซ๐š๐ญ๐ข๐ง๐  ๐๐ซ๐ข๐ฏ๐ž๐ซ๐ฌ ๐จ๐Ÿ ๐ญ๐ก๐ž ๐Ÿ๐ข๐ซ๐ฆ rather than looking at financial drivers.

This model is simplistic, but we can tweak the model for the customer churn and degrowth of existing customers.



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