The multi-period excess earnings method is commonly used to estimate the fair value of customer-related assets in general, and subscriber relationships in particular.
The key principle of this methodology is that subscriber relationships do not generate cash flows in a vacuum. Rather, they are supported by several other assets, such as fixed assets, working capital and intangible assets.
The operating profit generated by customers is attributed to a set of assets. Excess earnings aims to estimate the value strictly attributable to subscribers over their remaining useful life (e.g., taking churn rates into account), by subtracting from the operating profit a contributory asset charge, which represents the theoretical rent that would have to be paid for the use of these assets were they not owned.
The difference between the operating profit and this charge is called "excess earning" and is fully attributable to the subscribers. Discounting these excess earnings over the remaining useful life of the subscribers then leads to an appropriate fair value.
To value subscriber relationships, the acquirer needs a process to remove duplication, such as multiple SIM customers, non-active cards and machine-to-machine SIMs.
Examining the multi-period excess earnings method
The application of the multi-period excess earnings method is not easy in the telecommunications industry for the following reasons:
- The nature of the subscriber varies (private/corporate, pre-paid/post-paid, geographic area/country), as each can differ in terms of growth trends, margin levels, useful lives and churn rates. Consequently, even if the valuation methodology is the same for each category, there may be a need to split the subscribers into different categories and value them separately to take these differences into account.
- The nature of services proposed should also be taken into consideration, to deal with the specifics of mono-service providers (mobile, fixed, internet and TV) or those of operators providing bundled offers (triple play, or quadruple play).
- The churn rate significantly impacts valuations, with annual attrition rates varying from 10% to 35%, depending on the subscriber category. In addition, attrition risks based on the potential transfer of technologies or trade names are to be taken into account.
- The useful life is determined in a way that is consistent with the subscribers' cash flow patterns. A common rule is to retain a useful life that can capture 90% or 95% of the total value of subscriber relationships.