Terminal growth rate for tech companies
Currently valuing a tech company that provides ERP, CRM software. Recently moved to providing SaaS (say last year). I know the 5-year projections for the company and it’s YOY growth rates are around 30% rn.
What would be a good terminal growth rate I can use? I know normally we use 2% but since it’s a software company and is experiencing huge growth right now, I think 2% will be a bit too understated. What do you guys think?
gonna need more info than that houston
Currently in a tech group and run into this a lot. Typically we will run the DCF over a much longer period, say 10 years as opposed to 5 to allow the company to arrive at more of a “steady state” growth rate. (I.e linear decrease in growth YoY until the terminal year in which we would use 2-4%)
Hopefully that helps.
What if client has only provided us 5 Year projections?
Basically forecast based on historicals (averages or hard codes). Essentially hold operating margin constant or use the average of the projection period. Once you have your "EBIT" basically you should be fine by using the effective tax rate.
For the balance sheet items we would typically use a modest growth in CapEx and D&A given the tech focus they won't have a ton of PP&E but instead will have larger amortization. To calculate change in working capital usually we would use the line items as % of revenue for the purposes of a DCF if projections aren't given. You obviously could use DSO, DPO etc..
Long story short you don't really have to project that many things to get to a functional DCF model over 10-Years.
Out of curiosity: how do you account for probability of distress in a high growth company over a 10-yr projection?
Make scenarios and apply a probability to them.
To calculate an expected value?
Not going to speak for Rover, but essentially you "risk" their estimates the further they get out. If they have EBITDA of $250 million ten years our you could risk it each year by roughly 5%..
Example:
Year 5: EBITDA of $50 million (risked 10%) -> New EBITDA of $45 million Year 6 XX% Year 7 XX% Year 8 XX% Year 9 XX% Year 10: EBITDA $250 million (risked 30%) -> $175 million
This isn't for a DCF, but more of a "Risked Based Present Value" calc. Take into account the probability of them actually hitting their targets. Allows you to create a bear, base, bull case pretty easily with plugs.
What I have frequently been told, if you don’t feel comfortable projecting full financials for 10-15 years, is to use Multi-Stage Terminal values. Plenty of articles on this out there
You can use H model for stabilising the terminal growth
Out of curiosity, is this tech company actually profitable / CF+? (Lots of them aren't, as I'm sure you know).
Use EMM. Assume SoftBank buys you for 30x NTM revenue. Done.
Multi-stage terminal value calculation and/or the H model (modified GGM).
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