- July 29, 2022
- Posted by: Ramkumar
- Category: Posts

Valuing A Business By Customers
In the ๐๐ ๐ฌ๐๐ซ๐ฏ๐ข๐๐๐ฌ ๐ข๐ง๐๐ฎ๐ฌ๐ญ๐ซ๐ฒ, the majority of the M&A transactions are usually ๐๐จ๐ฅ๐ญ-๐จ๐ง ๐๐๐๐ฅ๐ฌ ๐ญ๐ก๐๐ญ ๐๐จ๐๐ฎ๐ฌ ๐จ๐ง ๐๐๐ช๐ฎ๐ข๐ซ๐ข๐ง๐ ๐ฌ๐ฉ๐๐๐ข๐๐ข๐ ๐๐๐ฉ๐๐๐ข๐ฅ๐ข๐ญ๐ข๐๐ฌ ๐๐ง๐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ๐ฌ. 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 ๐๐ฎ๐ข๐ฅ๐ ๐ ๐ฆ๐จ๐๐๐ฅ ๐๐จ๐ซ ๐ฏ๐๐ฅ๐ฎ๐ข๐ง๐ ๐ ๐ญ๐๐ซ๐ ๐๐ญ ๐๐จ๐ฆ๐ฉ๐๐ง๐ฒ ๐ฉ๐๐ซ ๐๐ฑ๐ข๐ฌ๐ญ๐ข๐ง๐ /๐ง๐๐ฐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ 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
๐๐ก๐ฎ๐ฌ, ๐ญ๐ก๐ ๐๐ข๐ซ๐ฆ’๐ฌ ๐ฉ๐ซ๐๐ฌ๐๐ง๐ญ ๐ฏ๐๐ฅ๐ฎ๐ ๐ฐ๐ข๐ญ๐ก ๐๐ฑ๐ข๐ฌ๐ญ๐ข๐ง๐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ๐ฌ = $๐๐.๐๐ ๐.
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
๐๐ฐ ๐จ๐๐ฌ๐๐ซ๐ฏ๐๐ญ๐ข๐จ๐ง๐ฌ ๐๐ซ๐จ๐ฆ ๐ญ๐ก๐ ๐๐ง๐๐ฅ๐ฒ๐ฌ๐ข๐ฌ
1)When the target has ๐ฅ๐จ๐ง๐ -๐ญ๐๐ซ๐ฆ ๐๐จ๐ง๐ญ๐ซ๐๐๐ญ๐ฌ ๐ฐ๐ข๐ญ๐ก ๐ข๐ญ๐ฌ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ๐ฌ, it locks in the customer. Here, the ๐๐ข๐ฌ๐๐จ๐ฎ๐ง๐ญ ๐ซ๐๐ญ๐ ๐ข๐ฌ ๐ง๐จ๐ญ ๐ญ๐ก๐ ๐ญ๐๐ซ๐ ๐๐ญ’๐ฌ ๐๐๐๐ ๐๐ฎ๐ญ ๐ญ๐ก๐ ๐ซ๐ข๐ฌ๐ค-๐๐ซ๐๐ ๐ซ๐๐ญ๐. In my view, the ๐ฆ๐จ๐ซ๐ ๐ญ๐ก๐ ๐๐ง๐ง๐ฎ๐ข๐ญ๐ฒ ๐ซ๐๐ฏ๐๐ง๐ฎ๐๐ฌ, ๐ญ๐ก๐ ๐ฅ๐จ๐ฐ๐๐ซ ๐ญ๐ก๐ ๐ซ๐ข๐ฌ๐ค ๐๐ง๐ ๐ก๐ข๐ ๐ก๐๐ซ ๐ญ๐ก๐ ๐ฏ๐๐ฅ๐ฎ๐ ๐จ๐ ๐ญ๐ก๐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ.
2)If the ๐๐๐/๐ง๐๐ฐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ = ๐๐จ๐ง๐ญ๐ซ๐ข๐๐ฎ๐ญ๐ข๐จ๐ง ๐ฆ๐๐ซ๐ ๐ข๐ง/๐ง๐๐ฐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ, ๐ญ๐ก๐ ๐ข๐ง๐๐ซ๐๐ฆ๐๐ง๐ญ๐๐ฅ ๐ ๐ซ๐จ๐ฐ๐ญ๐ก ๐ข๐ง ๐ฏ๐๐ฅ๐ฎ๐ ๐๐ซ๐จ๐ฆ ๐ ๐ง๐๐ฐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ ๐ข๐ฌ ๐ณ๐๐ซ๐จ. Thus, firms with a lower CAC/customer, lower cost structure, and higher pricing power will have a higher value.
3)At the ๐ฌ๐ญ๐๐๐ฅ๐ ๐ ๐ซ๐จ๐ฐ๐ญ๐ก, ๐ญ๐ก๐ ๐ฏ๐๐ฅ๐ฎ๐ ๐จ๐ ๐ญ๐๐ซ๐ ๐๐ญ = ๐ฏ๐๐ฅ๐ฎ๐ ๐จ๐ ๐๐ฑ๐ข๐ฌ๐ญ๐ข๐ง๐ ๐๐ฎ๐ฌ๐ญ๐จ๐ฆ๐๐ซ๐ฌ.
In my view, this model gives me ๐๐๐ญ๐ญ๐๐ซ ๐ข๐ง๐ฌ๐ข๐ ๐ก๐ญ๐ฌ ๐ข๐ง๐ญ๐จ ๐ญ๐ก๐ ๐ญ๐๐ซ๐ ๐๐ญ ๐๐จ๐ฆ๐ฉ๐๐ง๐ฒ ๐๐๐๐๐ฎ๐ฌ๐ ๐ข๐ญ ๐ฅ๐ข๐ง๐ค๐ฌ ๐ญ๐ก๐ ๐จ๐ฉ๐๐ซ๐๐ญ๐ข๐ง๐ ๐๐ซ๐ข๐ฏ๐๐ซ๐ฌ ๐จ๐ ๐ญ๐ก๐ ๐๐ข๐ซ๐ฆ 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.