Valuing $MOMT MoneyOnMobile on the 10x revenue club attributes

10x

Valuing a company that is pre profit is hard, but it is a key task that VCs do for a living. One of the top tier VCs, Bill Gurley of Benchmark Capital, wrote a brilliant post on this in 2011 entitled “all revenue is not created equal the keys to the 10x revenue club”.

He defines 10 attributes of ventures that deserve a 10x revenue multiple. (It  was written in 2011, so references to actual valuations are out of date, but the attributes are still totally relevant).

As Bill Gurley puts it:

“What drives true equity value? Those of us with a fondness for finance will argue until we are blue in the face that discounted cash flows (DCF) are the true drivers of value for any financial asset, companies included. The problem is that it is nearly impossible to predict with any accuracy what the long-term cash flows are for a given company; especially a company that is young or that might be using an innovative and new business model. Additionally, knowing what long-term cash flows look like requires knowledge of a vast number of disparate future variables. What is the long-term growth rate? What is the long-term operating margin? How long will this company hold off competition? How much will they be required to reinvest? Therefore, from a purely practical view, the DCF is an unruly valuation tool for young companies. This is not because it is a bad theoretical framework; it is because we don’t have accurate inputs. Garbage in, garbage out.

Because of the difficulty of getting DCF right, investors commonly use a handful of other shortcuts to determine valuations. “Price earnings ratio” and “enterprise value to EBITDA” are common shortcuts, with their own benefits and limitations. I want to argue that for a variety of reasons, the price/revenue multiple is the crudest valuation tool of them all.”

I have applied Gurley’s 10 attributes to a payments company serving the Unbanked/Underbanked in India called MoneyOnMobile.

Disclosure: MoneyOnMobile is a client of Daily Fintech Advisers. I am not a financial adviser, please do your own diligence before investing ($MOMT).

MoneyOnMobile is an unusual company. All their business is in India, but the company is managed by a US listed company. So you can look up the price online. Sometimes, the market gets it wrong. There is a difference between price and value. As Benjamin Graham (the father of value investing who taught Warren Buffet what he needed) famously said:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

What Ben Graham and all all value investors know is that occasionally the Efficient Market thesis is wrong and that some stocks are undervalued and some are overvalued. This valuation inefficiency is a great opportunity. During the last decade, many value investors went to the private markets where the price was only recorded in a press release when there was a funding event. This combination of a flood of capital into private markets and opaqueness led to the public/private inversion, when private companies were valued higher (on paper at least) than public companies; this cannot last and explains a lot of private market down rounds.

The most undervalued in the public markets are often microcap stocks (such as MoneyOnMobile which is traded on the OTC markets under the MOMT ticker symbol) simply because they are too small to get analyst attention.

I have abstracted some key parts from Bill Gurley’s post, but I highly recommend going to the original post if you have a passion for early stage valuation techniques.

1. Competitive Advantage Period

Bill Gurley description:

“By far, the most critical characteristic that separates high multiple companies from low multiple companies is competitive advantage. This concept, well explained in Porter’s book by the same name, basically asks the question, “How easy is it for someone else to provide the same product or service that you provide?”  If your company has “high barriers to entry,” Wall Street will be super excited, as investors will have confidence discounting cash flows many, many years into the future.”

The longest lasting Competitive Advantage Period (CAP) for any company is Coca Cola (which Bill Gulley references and which is Warren Buffet’s favourite stock). CAP times can erode fast if they are based only on technology – think mainframes (IBM) going to PC (Wintel) then PC to Internet and then Search (Google) to Social (Facebook). The years of tech dominance shrink with each generation. Yet Coca Cola, with almost no tech, has outlasted them all.

Coca Cola is often derided as little more than sugared water, but having grown for over a century and valued at over $195 billion, they must be doing something right. What makes Coca Cola special is that they combine a B2B model (their customers are Bottlers) with a Consumer brand. If they just sold sugared water to Bottlers their margins would be razor thin. Coca Cola has massive brand value. If Coca Cola leveraged that brand by owning the whole chain (manufacturing, distribution etc), their fixed overhead costs would make them a lot less valuable.

That same mix of B2B model with a Consumer brand applies to MoneyOnMobile. Their equivalent of the Bottlers are the retailers in India, who buy pre-paid services and sell them to consumers. The MoneyOnMobile consumer brand has been built without any major spend on advertising; the retailers display the MoneyOnMobile logo in order to entice consumers and consumers see the MoneyOnMobile logo on their phone (with geo location they can see nearest retailer).

The Coca Cola brand is fascinating because it works for even the poorest among us. Selling to the bottom of the pyramid is hard but if you can do that you have the on-ramp to the middle class (what Google calls “the next billion”).

As consumers move up the ladder of opportunity from Underbanked to Middle Class, MoneyOnMobile can grow with them because their model is so lightweight. For example:

  • Consumers can keep a feature phone (which is what 55% of Indians use) or upgrade to a smartphone if the price gets low enough. MoneyOnMobile works equally well on both.
  • Consumers can use MoneyOnMobile for the most basic needs (such as topping up pre-paid mobile minutes) and as they move up the ladder of opportunity they can purchase things like insurance and discretionary items (both of which MoneyOnMobile retailers are already selling).

I rate their CAP period as being as long as it takes for 600 million plus people in the Underbanked market in India to emerge into the middle class. That is measured in decades.

2. Network Effects

Bill Gurley description:

“No discussion of competitive advantages and barriers to entry is complete without a nod to perhaps the strongest economic moat of all, network effects. In a system where the value to the incremental customer is a direct function of the customers already in the system, you have a powerful dynamic that tips towards winner take all. Perhaps the definitive piece on this type of advantage is Brian Arthur’s Increasing Returns and Two Worlds of Business published in HBR back in 1996.  This “second world” that Brian refers to is one where the market leader has an unfair advantage that is reinforced by network effects.

There are a few important things to remember about network effects. Some network effect systems are stronger than others. What is key is the decay rate of value of the incremental user to the customer value function. Second, networks effects are discussed way more than they exist. Many things people identify as network effects are merely economies of scale, which are not nearly as powerful. Unfortunately, strong form network effect companies are far and few between. Fortunately, when they do exist, they are typically leading candidates for the 10X+ price/revenue multiple club.  Microsoft, Ebay, Skype, Google Adwords, and Facebook (in their prime) all benefited from network effects.”

In short, Network Effects is the biggie that drives all the other criteria. Network Effects work for MoneyOnMobile at three levels:

  • a retailer sees a neighbouring retailer selling a lot of MoneyOnMobile services. So a new retailer joins the MoneyOnMobile network.
  • a consumer needing cash or other services asks the local retailer they like best why they don’t have MoneyOnMobile services. So a new retailer joins the MoneyOnMobile network.
  • Consumer spending data ells MoneyOnMobile which partnerships are selling well and they can use this data to decide which services to take to their retail network. For example, the stunning success of MOM ATM tells MoneyOnMobile that they should offer this to more of their retailers. The same will be true of any new partnership such as selling insurance. New services drive retailer success which drives new retailers into the network which entices new partnerships which…

To understand how that works, Western readers will have to go back in history to the days of Mom & Pop owned retailers (before the big box retailers arrived in suburban shopping malls) when consumers had personal relationships with the retail store owners.

3. Revenue Visibility

Bill Gurley description:

“It is easy to see why revenue visibility would have a positive impact on a DCF analysis. The more certain you can be of future cash flows, the higher premium you will put on a business, and as a result, you will see a higher price/revenue multiple. One obvious example of this is the predictable nature of SAAS subscription revenue. The opposite of subscription revenue is revenue that is one-time or episodic. “

MoneyOnMobile clearly has no “enterprise lumpiness”. The business is driven by lots of tiny transactions; this is data that can be easily modelled and forecast.

In 2011, when Gurley was writing, subscription revenue was the obvious play. Since then so many ventures have rushed into the subscription revenue business that there is an oversupply problem and consumers who are cost conscious are switching off subscriptions and moving to pay as you go models. These pay as you go (aka “prepaid) models dominate the vast Underbanked markets (not just in the developing world where the Middle Class is growing but also the “people formerly known as Middle Class” in America and Europe).

Getting revenue visibility from a transactional model that honours consumer demand for pay as you go is hard, but MoneyOnMobile has managed that.

4. Customer Lock-in / High Switching Costs

Bill Gurley description:

“If investors value predictability, than retaining customers for long periods of time is obviously a positive. Conversely, if customers are churning away from your company, this is a huge negative. Investors are highly fixated on churn rates, as they should be. Churn has a direct and significant impact on a DCF model. With subscription models, a low-churn customer is quite valuable. In fact, companies with excessively low churn rates (5% annually or less) are very likely to have price/revenue multiples in the top decile. Obviously, high churn rates are really bad for all valuation multiples.

For non-subscription businesses, customer-switching costs also play an important role. If it is relatively easy for your customer to switch back and forth from your products to you competitors, you will likely have a lower price/revenue multiple as your pricing power will be quite limited. On the other hand, if it is quite difficult for a customer to switch away from your product/service, you are likely to have stronger pricing power, and longer customer life, which will inevitably result in better DCF dynamics. Switching costs can take many forms – technical lock-in, data lock-in, high startup costs with a new vendor, and downstream revenue dependencies are just a few.  All things being equal, high switching costs are a positive for price/revenue multiples, and low switching costs are a negative.”

Customer Lock-In tends to imply a subscription model and as discussed earlier there is a growing trend to pay as you go, but what really matters is high switching costs. You can still have high switching costs even when the customer has a choice if a) there are network effects b) the value proposition is strong enough and c) consumers develop habits around the product/service, all of which we see happening with MoneyOnMobile.

5. Gross Margin Levels

Bill Gurley description:

“This may seem super-basic or even tautological but there is a huge difference between companies with high gross margins and those with lower gross margins. Using the DCF framework, you cannot generate much cash from a revenue stream that is saddled with large, variable costs. As a result, lower gross margin companies will trade a highly discounted price/revenue multiples.”

Gross margins for MoneyOnMobile range between about 48% and 60%, with a more normalized range at 50-55%.  This is simply the revenue share to the channel, which the company treats as Cost of Goods Sold (CGS). In this case CGS includes Customer Acquisition Cost (which is then close to zero).

6. Marginal Profitability Calculation

Bill Gurley description:

“Investors love companies with scale. What this means is that investors love companies where, all things being equal, higher revenues create higher profit margins. Microsoft had wonderful scale in this manner for many, many years. Selling more copies of the same piece of software (with zero incremental costs) is a business that scales nicely. Companies that are increasing their profit percentage while they grow are capable of carrying very high valuation multiples, as future periods will have much higher earnings and free cash flow due to the cumulative effect of growth and increased profitability.

In order to measure how a business is scaling, many investors look at marginal incremental profitability. This can be done on a quarter-over-quarter basis, or a year-over-year basis. Simply look at the change in revenue versus the change in costs, and then calculate the incremental operating margin of the two results. If this marginal profitability number is much higher than historical profitability, a company is scaling nicely, and the investor has picture proof of that occurrence. If this number is lower than historic profitability, it raises a red flag for investors, who may be concerned that investments in new growth initiatives are yielding lower cash flow per dollar than previous investments.”

MoneyOnMobile has good operating leverage. Once the company covers infrastructure costs and moves into cash flow positive, revenue growth far outpaces SG&A growth.  For example, in the quarter ending September 30, revenues were up 86% and the SG&A was flat.  The company model shows expenses increasing around $1 for every $5-10 in gross profit once breakeven is achieved, producing very high net margin.

7. Customer Concentration

Bill Gurley description:

“In their S-1, companies are required to highlight all customers that represent over 10% of their overall revenue?  Why do investors care about this?  Once again, all things being equal, you would rather have a highly fragmented customer base versus a highly concentrated one. Customers that represent a large percentage of your revenue have “market power” that is likely to result in pricing, feature, or service demands over time. And because of your dependence on said customer, you are likely to be responsive to those requests, which in the long run will negatively impact discounted cash flows. You also have an obvious issue if your top 2-5 customers can organize against you. This will severely limit pricing power. The ideal situation is tons of very small customers who are essentially “price takers” in the market.  Google’s AdWords program is a great example.”

With 350,000 retailers, MoneyOnMobile clearly scores well on Customer Concentration.

8. Major Partner Dependencies

Bill Gurley description:

“Investors will discount the price/revenue valuation of any company that is heavily dependent on another partner is some way or form. A high profile example of this is Demand Media’s reliance on Google’s SEO traffic. Google isn’t the customer per se, but they can heavily impact the outcomes for Demand.”

Partners in the MoneyOnMobile business are the companies who sell product/services through MoneyOnMobile enabled retailers. One can see the danger of partner dependency in India in the price competition among Telecoms vendors to sell pre paid minutes. Even if you are not reliant on individual Telecoms providers you can still have a more subtle Partner Type Dependency. You can be reliant on Telecoms as a Type and if margins on pre paid minutes erode (as they have done in India) your business suffers. The  MoneyOnMobile enables them to easily add Partners in new markets such as Insurance to meet the demand that they can see from their retail network.

9. Organic Demand vs. Heavy Marketing Spend

Bill Gurley description:

“All things being equal, a heavy reliance on marketing spend will hurt your valuation multiple. Think about this simplistic example. There are two stores in the middle of town. One has a product/service that customers love, and as a result, customers flock to the store day in and day out all on their own. These customers then tell other potential customers, and through this “word of mouth” process, the customer base grows even larger. The second storeowner advertises frequently, and all new customers are a result of this advertisement and promotion (which obviously costs $$). Which business would you prefer to own?  Which one would likely have higher cash flows?  If you have to “buy” or “rent” your customers, you have a non-optimal business model – plain and simple.”

MOM scores well on this. Consumer advertising is done by Retailers. New Retailer acquisition is all organic.

10. Growth

Bill Gurley description:

“We saved the best for last. Nothing contributes to a higher valuation multiple like good ole’ growth. Obviously, the faster you are growing, the larger, and larger future revenues and cash flows will be, which has direct implications for a DCF. High growth also implies that a company has tapped into a powerful new market opportunity, where customer demand is seemingly insatiable. As a result, there is typically a very strong correlation between growth and valuation multiples, including the price/revenue multiple.”

The MOM numbers speak for themselves – 84% year on year and accelerating (September to October was 36% which if annualized would be 432%).

Summary

As Bill Gurley puts it:

“So there are ten business characteristics that can impact a company’s chances of making it into the 10X+ price/revenue multiple club. Clearly, some of these variables are interdependent, and clearly you may find a company or two without every single characteristic, that still make the club. That said, most of the companies that trade at 10X or higher in terms of price/revenue will do extremely well against this scorecard.”

We think MoneyOnMobile scores well on those 10 attributes/characteristics (and has revenue multiple way lower than 10x).

For our earlier coverage of MoneyOnMobile, please see:

MoneyOnMobil is poised to win in the giant india remittances market.

MoneyOnMobile is an open alternative to mPesa for the unbanked and underbanked

First the Rest then the West – the MoneyOnMobile leapfrog story in India.

Image Source.

Bernard Lunn is a Fintech deal-maker, author, adviser and thought-leader.

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