The forecast
The value rests on the cash the business will make. For a seat business, the forecast follows the seats: who stays, who arrives and what each pays.
A seat business, forecast as seats
A phone company sells seats, one per phone line, every month. Each year some customers leave and new ones arrive. The forecast follows exactly that: it carries today’s seats forward, takes away the ones that leave, adds the ones that arrive, and multiplies by the price.
The forecast model for a hosted voice provider is a seat-cohort model. Today’s customers thin by churn every year; each year’s gross additions arrive as a new band and thin by churn after that. Revenue is seats times price, with the price trend applied yearly.
How to read it. The dark bar is the trailing year as measured. Each year after it is the engine’s forecast: seats growing a little faster each year because churn stays at the company’s own low rate.
The seat rule
Gross additions start at the rate implied by the trailing year and fade toward the market’s rate. Churn stays at the company’s own 4.7% a year, against an industry median of 9%. The difference between the two is net seat growth.
Gross additions start from the trailing 7.6% seat growth, blended 60/40 with revenue growth net of the price trend, which gives 8.0% effective growth at today’s churn. They converge on the market’s rate. Because the company keeps its below-median churn, the market’s additions turn into faster net growth than the market’s own: 8.1% in year 1 rising to 9.3% in year 10. The price trend of −1.5% a year runs on top. That growth judgment is listed in the report’s register of things a buyer may not credit; a buyer who doesn’t credit it reads the value down by $157k.
The ten years
| Year | Revenue | Margin | EBITDA | Free cash |
|---|---|---|---|---|
| Now | $2.65M | 20.0% | $530k | — |
| Y1 | $2.82M | 20.7% | $584k | $408k |
| Y2 | $3.01M | 21.2% | $638k | $446k |
| Y3 | $3.21M | 21.5% | $692k | $484k |
| Y4 | $3.43M | 21.8% | $747k | $524k |
| Y5 | $3.67M | 21.9% | $806k | $565k |
| Y6 | $3.93M | 22.1% | $868k | $609k |
| Y7 | $4.22M | 22.1% | $934k | $656k |
| Y8 | $4.53M | 22.2% | $1.01M | $706k |
| Y9 | $4.87M | 22.2% | $1.08M | $761k |
| Y10 | $5.25M | 22.3% | $1.17M | $821k |
Free cash flow to the firm is after tax at 26% on operating profit, capital spending and working capital.
The margin path
The margin starts at today’s normalized 20.0% and drifts toward a long-run 22.3%. That long-run figure is half the company’s own cost structure and half the industry median, so the forecast gives the company credit for what it has shown and no more.
How fast the margin converges
30% a year
Slower convergence: $3.84M.
The policy setting: $3.93M.
Faster convergence: $3.98M.
How far out, and what comes after
The horizon is ten years. The seat book’s half-life at 4.7% churn is about fifteen years, and the method holds the horizon between five and ten. After year ten the value is a terminal value: 60% a perpetuity growing at 1.5% a year and 40% an exit at 7.0× EBITDA, the median precedent multiple. Together they are 37% of enterprise value, inside the 35% to 65% the method expects at an owner-operated discount rate.
seatst = seatst−1 · (1 − churn) + gross additionst
revenuet = seatst × pricet, pricet = pricet−1 · (1 − 1.5%)
- Horizon. ln 2 ÷ churn, held between 5 and 10 years; 10 years here
- Gross additions. implied by trailing net growth at the churn measured over the same twelve months, fading to the market’s gross-add rate
- Free cash flow. operating profit after 26% tax, less capital spending and the change in working capital
- Terminal value. 60% Gordon growth at 1.5%, 40% exit at 7.0× EV/EBITDA; 37% of enterprise value
- Tax shield. the $13k shield on existing debt is valued separately in the bridge, not in the discount rate
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