Corporate Valuation Will Never Be the Same — Nor Should It
In uncertain times, a more rigorous approach to valuing companies is gaining ground
The coronavirus pandemic has played havoc, to say the least, with markets worldwide. Many believe the financial effects will linger well beyond the end of the pandemic itself. In this uncertain environment, how can investors reliably identify sources of value?
This is a watershed moment for the way corporate valuation is traditionally done, says Wharton marketing professor Pete Fader. He believes that, out of necessity, greater caution and scrutiny will reign among investors. “Investors are now assuming a much wider range of possible future outcomes when they evaluate what companies to buy and hold. Because of this uncertainty, investors are much less willing to let go of their hard-earned cash unless they know they’re getting really good value.”
Fader asserts he’s already laid out a path for performing that closer scrutiny. In fact, about two years before the pandemic hit, he and Emory University marketing professor Dan McCarthy introduced a method they call customer-based corporate valuation (CBCV). CBCV involves enhancing the traditional corporate valuation approach by probing data about customer acquisition, retention, and spend. It’s a strategy that Fader says is “more principled, thoughtful, and bottom-up.”
The churn of today’s financial markets makes CBCV an especially valuable tool, according to Fader. McCarthy agrees and talks about what else is behind the new investor caution: Many companies, flush with venture funding from prominent VCs and celebrities, have been underpricing their products and/or splurging on marketing to brag about revenue growth. McCarthy cites a company like Casper Mattress, which sells a product people buy very infrequently but which had nevertheless been growing quickly because of near-omnipresent advertising and a surge in new store openings. All that spending left Casper with a meager profit on newly acquired customers – analysis of their pre-IPO data suggests they spend approximately $320 in marketing costs for each new customer they acquire and earn an incremental profit of less than 40% on that investment, driving adjusted EBITDA losses of more than 17% of their revenues. What’s more, in the run-up to their IPO, even the revenue growth had come back down to earth, with direct sales growth falling to just 13% over the trailing nine months. While the pandemic may buoy online sales in the short-run as their more store-laden competitors are forced to close those stores, the long-run headwinds remain.
Fader echoes that, until recently, investors might well have known they were overpaying for “that digitally native women’s accessories company -- or whatever,” but they assumed they’d be able to sell their stakes for a lot more. Now the party is ending.
The buzz around CBCV began with Fader and McCarthy’s signature assessment of American e-commerce furniture retailer Wayfair in 2017. It’s an analysis that has been referenced frequently in the business press including WSJ, Fortune, and Barron’s.
“At the time, Wayfair was trading for $65 a share. We said they were worth less than $30,” says Fader. “People were laughing at us as the stock went ahead and tripled.” Performing their analysis again in late 2018, the two reached the very same conclusion they did earlier. But after a series of disappointing earnings reports, Wayfair’s stock fell back to earth, going as low as $22 before tripling (again) on buoyant news about greater revenues attributable to the pandemic (due to the closure of virtually all traditional furniture stores). The big question: is this burst of revenue building the kind of loyalty that Wayfair has failed to achieve thus far to date, or is it mostly transient spending that will disappear when those furniture stores open back up again? This is precisely the sort of question that CBCV can help answer, by decomposing the revenue growth into its constituent parts to inform a more diagnostic assessment of the durability of that revenue bump. But, given what Fader and McCarthy have seen thus far, their optimism remains limited.
Fader notes, “When you look at companies through the right lens—through these customer metrics—we can see things that the market as a whole doesn’t necessarily appreciate.” McCarthy adds, “You always want to play good offense, but in a bear market, playing good defense [using CBCV] can be what keeps you in the game.”
Another way in which Fader thinks the pandemic crisis will affect business is in terms of individual firms and how they sell to consumers. Many companies, he says, operate in a way that’s designed to attract every possible customer out there. But he believes instead in the potential of customer centricity: With more limited resources, businesses may increasingly realise “we can’t be everybody’s friend,” and shift their resources primarily to serving and retaining their best customers.
In Fader’s view, CBCV and customer centricity go hand-in-hand and can help forge a new bridge between finance and marketing. He says these approaches will benefit both investors and businesses in the long run—no matter what the markets are doing.