Tren Griffin+ Your Authors @trengriffin I work for Microsoft. Previously I was a partner at Eagle River, a private equity firm established by Craig McCaw. I am on the board of directors of Kymeta. Oct. 19, 2019 3 min read + Your Authors

1/ I promised to write more on what I learned from John Malone and Craig McCaw. This letter was sent by McCaw Cellular in July 1994 to inform employees about the first accounting profit in its six year history. The business was sold to to AT&T for $11.5 billion two months later.

2/ McCaw Cellular's result was achieved by focusing on growing the value of the business (which is driven by discounted value of cash flows over the long term) instead of trying to maximize short-term GAAP profit. Cable television was grown in the same way by Malone and McCaw.

3/ If McCaw Cellular purchased equipment that asset's cost was recognized throughout its useful life. But when McCaw invested cash to acquire customers that expense was incurred immediately. Investors who knew that customer lifetime value was being created financed the business.

4/ Of course, not all businesses that lack accounting profits over the short term are creating value. The best tool to sort this out is unit economics, which is a valuation process conducted from the bottom up to determine the value of current and future customers of a business.

5/ Like any tool that is a model, the proper use of a customer lifetime value analysis is fully dependent on its assumptions. The model can be used to discover value or to hide problems. A margin of safety is always wise, especially with a model like this. 

6/ The value of all of the customers determined on a bottoms-up basis can be added up to value the entire business. While this unit economics process isn't precise, no valuation process is ever precise. An investor's goal is to be approximately right rather than precisely wrong.

7/ John Malone: "The first thing you do is make sure you have enough juice [cash] to survive and you don’t have credit issues that are going to bite you in the near term."

Raising the necessary cash to grow a business based on CLV isn't easy, but it is easier than it once was.

8/ "A perfect business in terms of the simplicity of valuation would be an annuity; an annuity generates an annual stream of cash that either remains constant or grows at a steady rate every year. Real businesses, even the best ones, are unfortunately not annuities.” Seth Klarman

9/ Why can't I use an earnings multiple and avoid uncertainty?

"With DCF models, the value is sensitive to the inputs. But the assumptions underlying the inputs are explicit. You can compare them to base rates and debate them. With multiples, those assumptions are buried...."

10/ "The assigned multiple becomes a point of persuasion rather than a thoughtful case based on the economic drivers of value." Mauboussin 
"Multiples have inherent limitations. You must earn your right to use a multiple."

11/ "Unit economics analysis is a bottoms-up exercise designed to express the value of a business on a per unit basis. The right unit could, be a customer or a store. But the "unit” used should be capable of being summed up to establish the value of the entire business.

12/ "We create revenue forecasts for the firm by decomposing revenues into 'How many customers I am going to acquire. How long are they going to stay with me? How many orders are they going to place, and how much are they going to spend?'" 

If you want to learn more about "unit economics" approaches to valuation read Fader and McCarthy. For example: 

A unit economics analysis is also applicable to businesses that are not subscription-based: 

You can follow @trengriffin.


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