Customer Lifetime Value Analytics as a Critical Strategic Asset in Private Equity

As the private equity sector navigates its recovery from the downturn that began in late 2022, investors are increasingly focusing on strategies that can give them a competitive edge. With clearer macroeconomic conditions and more robust financing markets, the first half of 2024 has shown promising signs of recovery. Q2, in particular, marked the most active period for deal-making in the past two years, according to a recent EY report. In this competitive environment, traditional due diligence methods alone may not suffice to secure the best investments. Firms must look beyond conventional approaches and leverage advanced tools that provide deeper, differentiated insights. This is where the Customer Lifetime Value (CLV) lens becomes critical, offering a forward-looking perspective that can significantly improve investment decisions. We will dive into why, and how we can help uncover the often otherwise hidden insights, including through our new game-changing model, CLV Ultra.

Customer Value Lens as a Critical Competitive Edge for Investors

Today, investors are using a wide range of tools to gain an edge over their competitors. In addition to traditional market research, financial, legal, and operational due diligence, they are increasingly utilizing alternative data and employing advanced data analytics to gain insight into company performance and find targets that can deliver hefty multiples on their investment (or avoid lemons that may look good according to more traditional benchmarks!).

However, the most sophisticated investors understand that traditional tools, while important, often miss a critical aspect of a successful investment: a forward-looking view of the company’s most valuable asset – its customer base and how much it is worth. An objective, well-executed  customer value analysis, such as that provided by Theta and powered by our new CLV Ultra model, enhances the due diligence process by offering deeper insights into a company’s long-term revenue and profit potential, focusing on customer dynamics. Unlike traditional analyses that focus on past performance and broad market trends, a customer value lens provides insight into the sustainability of revenue streams by assessing customer acquisition cost, retention, repeat purchasing behavior, spending and contribution profit patterns, and overall customer lifetime value – all at the individual customer level. This helps private equity firms not just see how much revenue a company generates, but understand how that revenue is generated – through repeat purchases from a loyal and highly-tenured customer base, or through one-off transactions from newly-acquired customers who subsequently churn. Over the course of the hundreds of analyses that we have performed, we have found that both scenarios come up with surprising frequency. However, we have also found that regardless of how good or bad the quality of the customer base may be overall, there are some customer segments that are healthier than others within that base, so this analysis can also determine which segments to double down on and which to deprioritize. This forward-looking perspective enables firms to better assess a company’s true health, spot hidden risks that might not yet be reflected in the financials, and make more informed investment decisions that drive long-term value creation.

CLV Ultra: Next-Level Investment Due Diligence

Over the last several years at Theta, we have helped numerous private equity firms evaluate more than a hundred potential targets and portfolio companies, as well as demonstrate their full value to prospective buyers using the customer value lens. Here are just a few questions our CLV model helped shed light on that are critical to the ultimate success or failure of a prospective investment:

1. Business Model Sustainability and Economics

• Is the company’s business model sustainable from the unit economic perspective – does the company make more after it acquires customers than it spends to acquire them, and if so, how healthy is the spread between the two?
• How much operating leverage will the company generate as it grows?
• How do the company’s CLV, CAC, and marketing ROI stack up versus competitors? For example, the CLV to CAC ratio is a commonly used indicator of a company’s sustainability and its potential for profitable investment in customer acquisition. In our experience, we’ve seen CLV to CAC ratios ranging from less than 1x to over 60x. To assess how good this ratio is, it must be compared to industry peers.

2. Customer Value and Segmentation

• How valuable are the customers that the company is acquiring today, versus customers acquired two years ago?
• What are the most valuable customer segments? How can we acquire more customers from such segments?
• What are the opportunities to improve company valuation by acquiring more valuable customers and retaining and developing the existing customer base?

3. Monetization and Financial Projections

• How well do customers monetize over the short-term, medium-term, and long-term?
• What will revenue and EBITDA be over the next few years? How might revenue and EBITDA vary under different scenarios for total marketing spend (and mix), and what are the biggest risk factors to achieving those projections?

Our previous CLV model provided unparalleled advantages to our private equity clients in due diligence, portfolio company operations, and exit stages of the investment cycle. But our latest and greatest model, CLV Ultra, takes it to the next level. Not only does it offer technical improvements – it also provides strategic advantages. It offers faster turnaround times, which means quicker investment decisions. It also provides much higher accuracy and diagnostic insight, which reduces the risk of costly errors, especially for more recently acquired customers. All told, a Theta analysis powered by CLV Ultra ensures that your investments are based on the most reliable financial projections available. 

Quicker turnaround time. Even before CLV Ultra, our team was able to deliver deep customer value insights within three weeks or less. But a key aspect of CLV Ultra is its ability to automatically identify various drivers of customer behavior, which allows us to significantly automate the entire modeling process, further shortening the time to insights – critically important for a fast-paced diligence environment!

Higher model accuracy. Accurately forecasting customer metrics such as CLV is essential in the due diligence process because the stakes are high, and the cost of a mistake can be significant. With CLV Ultra, we solved a number of problems that allowed us to achieve 95%+ accuracy for most cohorts:

• Valuing newly acquired customers. An age-old problem is how to calculate the CLV of a customer with very limited transaction history. This is especially relevant in PE contexts, because those recently-acquired cohorts are more of a bellwether for future cohorts than the ones you acquired five years ago. The problem of valuing “young” customers is made worse by the fact that growing companies usually have many more of them vs the “old” customers; therefore, accurately valuing them is even more important than it would be for more mature firms. CLV Ultra implements a cross-cohort modeling approach that takes into account the behavior of “older” cohorts and automatically identifies highly flexible trends, allowing it to predict how newly acquired customers will behave in the future with a high degree of accuracy.
• Adapting to changing customer behaviors. The world is dynamic, and customer behavior constantly changes, impacted by both internal and external factors, such as seasonality, inflation, new product introductions, new competitors, demand shocks, and more. Ignoring these behavioral shifts leads to subpar accuracy in CLV predictions, revenue forecasts, and overall company valuation. Our CLV models have always been designed to handle these factors, but CLV Ultra identifies these shifts automatically and more systematically, ensuring that every change is captured quickly and accurately, maximizing the value of the customer lens for investment decisions. Incorporating various assumptions (e.g., how long will the pandemic last? How quickly will inflation subside?) enables investors to model different scenarios of the company’s revenues and valuation, providing an indispensable tool in due diligence.

The same insights from the CLV Ultra model that investors rely on when evaluating a potential investment can be used when selling a portfolio company. By applying such CLV Ultra analysis, investors can effectively demonstrate to potential buyers the quality of the company’s revenue streams, the health of its customer base, and the overall long-term value of the business, often not observed using traditional valuation methods. This comprehensive understanding not only highlights the company’s strengths but also positions it more attractively in the market, enabling investors to negotiate a higher sale price and achieve a more successful exit.

As the private equity industry continues to recover, firms that leverage a customer value lens stand to gain a significant edge. By integrating CLV analysis into their investment process, these firms can achieve and communicate a more comprehensive understanding of a company’s true long-term potential. The ability to accurately forecast customer behavior, adapt to changing market conditions, and enhance portfolio company performance through targeted customer insights will be critical for driving superior returns. In today’s increasingly competitive market, where traditional due diligence methods have become table stakes, the customer value lens powered by the CLV Ultra model offers a powerful tool to identify, invest in, grow, and sell businesses that are well-positioned for long-term success.