ROIC and NOPAT margins seem unreasonably high
After completing a DCF for a target company I calculate a few metrics for an executive summary.
This is a SaaS growth equity investment and the target goes from unprofitable to profitable through the holding period. In the last historical year the NOPAT margin and ROIC are 4.3% and 8.5%, respectively. These 2 metrics have been growing the last three years by about 10% each year. In the last historical year, the company repaid their outstanding notes and are debtless now. The company generates so much cash that they were able to pay 1 bill of notes in 3 years.
Due to not having debt and me assuming there will be no debt issuances in the future (because I cannot predict that), my ROIC stays above 100% between pro-forma year 3 and year 6. The ROIC is about 50% at the end of projected year 10. The NOPAT margin stays in the mid 30s% throughout the forecast period, finishing year 10 at 28%. This looks very unreasonable.
I calculate NOPAT as EBIT adjusted for non-recurring items * (1- tax rate)/average invested capital. The company does not have significant non-recurring items that I add to EBIT and project afterwards. Average invested capital is average equity (this year and last year) + average long term debt (I exclude operating lease obligations and there are no finance leases).
My assumptions for revenue growth and expenses follow management guidelines and I reduce growth assumptions (as well as stabilizing expenses) further into the projections. The result of my DCF puts the implied share price closer to the low of wall street's estimates.
1) What can I be possibly doing wrong or are such ratios a common occurrance with projections of high growth companies?
2) Are such metrics (if true) a good argument for investing in the company, even though it may be trading close to its implied share price from the DCF?
Thanks!
Hm, anyone want to chime in?
I don't think many SaaS investors are looking at ROIC metrics. You want to frame this in terms of LTV/CAC, gross margin and payback periods. Ideally you build a model that stacks the customer vintages on top of each other and then you can tease out the relationship between growth and profitability.
Thank you for the idea!
If the target focuses on R&D rather than sales teams, would the LTV/CAC carry as much weight? Or you would focus on a different set of metrics such as productivity of engineers and R&D cost as a % of revenue?
Actually if anyone is interested in learning more about SaaS metrics, you should really check out the posts by David Skok.
Besides sitting on the board of Apollo, he collaborates with senior tech people (from hubspot, netsuite etc) to write about SaaS (among other things).
https://www.forentrepreneurs.com/saas-metrics-2/
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