The Corporate Life Cycle
The narratives of the company change as you move forward within the corporate life cycle as discussed in the earlier chapters. Have a look at the following diagram to recall.
Early on in the corporate life cycle, not only is it your story that drives your valuation of a business, but you are also likely to see wide variations across investors in story lines and valuations. As a company ages, the numbers start to play a greater role in determining value, and it is possible that you can attach a value for a company based purely on its numbers, perhaps by extrapolating historical data.
To understand why there are differences in corporate life cycles across firms, the professor looks at three factors:
- Market entry: Some businesses have substantial barriers to entry, either because of regulatory/licensing requirements or due to capital investments that need to be made. In other businesses, entry is much easier, often requiring little or no regulatory approval or intensive capital investment.
- Scaling up: Building on the first point, once you enter a business, the ease with which you can scale up will vary across businesses, some requiring time and substantial capital investments to get bigger, and others not.
- Consumer inertia/stickiness: In some markets, consumers are much more willing to shift from established products to new ones because they have little attachment (emotional or economic) to the products and/or because there are low costs to switching to a new product.
Other things remaining equal, if market entry is easy, scaling up can be done at low cost, and consumer inertia is low, the growth phase of the life cycle will be much more rapid.
A Comparison of Corporate life cycle in tech and non tech companies:
The following image and its description summarizes the chapter well.
Stage 1: Start-Up
- Key questions: Is there a market for the product or service? How big is that market? Will you survive?
- Pricing metrics & measures: Market size, cash on hand, access to capital
- Narrative Vs Numbers: Mostly or all narrative
- Value drivers: Total market size, market share, and target margin
- Dangers: Macro delusions where companies are collectively overpriced, given the market price.
Stage 2: Young growth
- Key questions: Do people use your product or service? How much do they like it?
- Pricing metrics & measures: Number of users, user intensity (EV/Users)
- Narrative Vs Numbers: More narrative than numbers
- Value drivers: Revenue growth & its drivers
- Dangers: Value distractions, with a focus on wrong revenue drivers
Stage 3: High growth
- Key questions: Will people pay for the product or service? Can you scale up, that is, grow as you get bigger?
- Pricing metrics & measures: User engagement with model revenues (EV/sales)
- Narrative Vs Numbers: Mix of narrative and numbers
- Value drivers: Revenue growth and reinvestment
- Dangers: Growth illusions, with failure to factor-in the cost of growth.
Stage 4 & 5: Stable
- Key questions: Can you make money on the product or service and sustain profitability in the face of competition?
- Pricing metrics & measures: Eamings levels and growth (PE, EV/EBIT)
- Narrative Vs Numbers: More numbers than narrative
- Value drivers: Operating margins and return capital
- Dangers: Disruption denial with failure to see threats to sustainable profits.
Stage 6: Decline
- Key questions: What will you get if you sell your assets? How do you plan to return cash flows to your investors?
- Pricing metrics & measures: Cash flows, payout, and debt servicing (PBIV, EV/EBITDA)
- Narrative Vs Numbers: Mostly or all numbers
- Value drivers: Dividends/cash returns and debt ratios
- Dangers: Liquidation leakage with unrealistic assumptions about what others will pay for liquidated assets.