Revenue is generally the most important driver of company performance.

Each industry typically has its own approach to modeling Revenue: A real-estate company might make assumptions about vacancy and rental rates in each city it owns properties. A casino operator might estimate win-% for slot machines and individual hotel rates at each casino.

Projecting Revenue then is industry-specific and often requires elaborate separate schedules.

However, in most models Revenue can be summarized into two components: 1) Organic Revenue and 2) External Revenue.

Organic Revenue is the Revenue that is generated from a company’s existing assets & operations excluding Revenue from growth capital expenditure (CAPEX) & acquisitions but including Revenue from maintenance CAPEX.

Growth CAPEX is expenditure made to develop new capacity or enhance the Revenue potential of existing assets and should not be included in the Organic Revenue estimate. It is instead a part of the External Revenue.

By contrast, Maintenance CAPEX – spent to keep assets in the current condition, not to enhance them – should be included in the Organic Revenue estimate.

In the case of Alstria, we make the simplifying assumption that all CAPEX is maintenance CAPEX, used to refurbish rather than enhance properties (although management would probably disagree).

When we estimate an Organic Growth Rate for Rental Income, we are implicitly assuming some level of CAPEX is necessary to achieve that growth. We think about how much rental space can be leased out and how the vacancy situation will evolve. So without spending the maintenance CAPEX, some rental space would become unfit for re-leasing. Some tenants may vacate their premises or be unwilling to pay the same rent they have paid so far. So the Organic Rental Growth would fall out lower, say at 1.5% without the maintenance CAPEX, than the 2.0% we are estimating including maintenance CAPEX. Importantly though, we don’t separately add Rental Income for the maintenance CAPEX (as it is included in the Organic Growth already).

In the absence of a separate Revenue Model (as described above), Organic Revenue is often modeled as a simple growth function: Last year’s Revenue x (1 + Growth Rate). The Organic Growth Rate would encapsulate next-year’s expected industry trends, management’s marketing efforts, maintenance CAPEX and numerous other factors that might impact growth of existing Revenues.

External Revenue is the Revenue generated from Acquisitions or growth CAPEX invested in the existing asset base. The analyst has to estimate how much incremental Revenue will be generated for a given expenditure.

In real estate, the question would be: “How much yield will the new acquisition, development, or other investment generate?”

The gross yield of that new investment would then be:

(New Rent) / (CAPEX or Acquisition Cost of New Asset)

External Revenue is calculated on separate schedules (discussed more fully in the video), then linked back up to the P&L.

Whether CAPEX is growth or maintenance is often within a grey zone.

It is often not clear (or even possible to determine) whether an asset was enhanced or only maintained. In the end, the analyst must decide “is it worth breaking out this amount separately?” and “Have I accounted for the growth impact of this expenditure either in the Organic or in the External Rental Growth estimate?”

Wherever the CAPEX is allocated, the important thing is to neither double-count nor to ignore the growth impact of that CAPEX.

Organic Revenue is a function of last year’s actual rental income multiplied by next year’s assumed growth rate (we’re using best-guess placeholders for now). Basic formula:

Rental Income (last year) * (1 + Placeholder Growth Rate %) = Projected Organic Revenue

Placeholder values are temporary guesses for future growth rates or other values. These are to be replaced by more thoughtful estimates later, after we’ve had a chance to review published disclosure, management’s commentary about the business and other industry data that can help us gain accuracy.

Mid-Year Convention is the assumption that all buy & sell transactions occur in the middle of the year (i.e. June 30 not Jan 1).

Consequently, only half of the rent from the purchase of a new asset is included in the year it is bought: the rents from July through December. The following year, a full year of rent is then included in the projections.

The same principle applies for sale of assets and the related loss of income: Income from January to June is still included, but income from July to December is no longer counted.