“Subscribers Are the New, New Thing in Business” declared The Economist (April 11, 2018). The magazine says that “Subscription models are seen by many investors and executives as the holy grail, because they promise a recurring stream of revenue…. The attractions of subscription businesses are obvious. Firms can predict the future better and build deeper relationships with customers who have less incentives to shop around.”
Telecom companies, Internet service providers, media and entertainment firms, as well as insurance companies are the traditional, subscription-based enterprises, but the subscription model is fast expanding. Many software producers offer subscription services to customers, and even Procter and Gamble sells detergents to subscribers. Gillette markets razors on the basis of monthly fees, and Rolls-Royce, General Electric and Pratt & Whitney offer “power by the hour subscriptions.” And, as The Economist notes: “Several star firms floating their share this year have subscription models. Dropbox, a cloud-storage firm, listed on NASDAQ on March 23rd and is worth $13bn. It boasts 500m registered users…. Spotify, has 159m users but derives its $27bn valuation from 71m “premium subscribers” who pay to listen without adverts.” “The subscription boom will doubtless continue.” concludes The Economist. I concur.
Subscription-based companies offer investors and managers the rare opportunity to value their most important asset: the customer franchise. Investors can track the development of this asset over time, and compare the market multiple―price-per-customer―across peer companies. This is a much more powerful investment tool than the traditional valuation based on reported earnings (see my blog post “The Unbearable Lightness of Earnings,” April 15, 2018).
Valuating customer franchise: The life-time value of a firm’s customers (subscribers) can be estimated as:
- Gross margin per subscriber, equal: monthly average revenue per user (ARPU), minus: average monthly operating costs per user (accounting expenses minus intangible investments, like R&D and product design)
- Average subscriber duration, equal: 1/Monthly churn (% deactivations)
- Ending number of subscribers
Life-time subscriber value
Real-life case, SiriusXM:
SiriusXM is the major provider in North America of music and entertainment content to cars via satellite radio. More than 20% of all cars in the U.S. carry Sirius’s services. I base my subscriber value calculation on Sirius’s Fourth quarter 2017 report.
SiriusXM: Subscribers life-time value
- Subscriber gross margin =
ARPU ($1.147B/3/27.5m) = $13.90
Minus: Operating costs per subscriber:
($865M/3/27.5M) = $10.50
- Subscriber duration = 1/Monthly churn =
1/0.018 = 55.6 months
- End of quarter number of subscribers:
Equal: Subscriber value of $5.7 Billion
The estimated subscriber value of $5.7B is conservative, since it doesn’t factor in growth of the subscriber base and/or rate increases. But even this conservative value is by far the largest asset owned by Sirius, yet not presented on its balance sheet, courtesy accounting rule-makers.
Given Sirius’s market capitalization of $28B on May 1, 2018, its customer franchise multiple is 4.9. Considering all the deficiencies of reported accounting earnings, the customer franchise multiple is a much more meaningful valuation metric than the widely used P/E ratio. Both the customer value and its multiple can be examined over time and across peer companies to assess share over/under valuation for investment purposes.
For comparison purposes, Spotify’s customer franchise value as of end of 2017 was: $2.37 billion (gross margin = €1.44; church rate = 5.1%; number of premium subscribers = 71 million). Spotify’s market cap in May 2018 is $28 billion, so its price-to-customer value is: 11.8, more than twice Sirius’s multiple.
Finally, in case the company doesn’t provide its churn rate―non-required information by GAAP―there are ways of approximating it. See for example,
Now you have the full picture of subscription companies’ assets that matter.
 $1.147B is quarterly subscriber revenue, divided by 3 to convert to monthly revenue, divided by number of paying subscribers.
 $865M are quarterly operating costs minus: programming and content, cost of equipment, and engineering and design costs.
 Paying subscribers + half of paid promotional subscribers.
 I converted the franchise value in Euros to U.S. dollars.