With the Twitter IPO stealing headlines, it’s easy to miss the steady climb of software as a service (SaaS) corporate valuations on public and private markets.
SaaS is gaining ground on the traditional software licence and maintenance model as enterprise customers become more comfortable accessing their software in the cloud and appreciate the monthly subscription compared with a large upfront licence fee. They receive timely, automatic upgrades rather than waiting for the next version to roll out, and they can access the information anywhere, at the office or away. Investors like the model, too, as demonstrated by the rise in share prices for SaaS companies.
The Software Equity Group, a boutique investment bank based in San Diego, tracks valuations and transactions of companies using a traditional software model and those offering SaaS. The companies selling software the old way have an average enterprise value of three times revenue and an EBITDA multiple of 13 times. Most verticals within this category have revenue multiples between two and three times. Other industries would be overjoyed to receive that high a value, until you look at the SaaS numbers: these companies trade at a whopping six and a half times revenue and EBITDA multiples of 40 times.
Within traditional software companies, growth in revenue has been slowing and is now down to 10%. These companies are losing market share to SaaS companies and are being constrained by tight IT budgets. The higher SaaS multiples are due to a higher percentage of recurring revenue. Recurring revenue is highly prized by investors because it is more certain, which lowers the risk of distress and increases the chances of long-term dividend payments. Gross margins are high due to the inherent scalability of software: it doesn’t cost much to add another customer.
I like lending to SaaS companies because of the predictability of the recurring revenue. Customers tend to be sticky because once they start using the operating software it’s very difficult to switch to another provider. With relatively stable revenue, management has flexibility in accelerating or dialing back growth expenditures and as a result can access lower-cost debt financing.
Furthermore, over the years, many mature software licence vendors have lost customers as they opt out of maintenance and support contracts despite continuing to use the product. These lost customers can be enticed back to the fold with a SaaS model if there are compelling upgrades or if they benefit from multiple access points.
Some software companies are looking to convert their models to SaaS or acquire SaaS businesses. Adobe is a great example. As the company converts to a SaaS model, its revenue growth rate has rapidly decelerated, yet its revenue multiple has grown to 5.8 times from 2.9 times over the last three years due to a growing percentage of recurring revenue.
What about smaller companies, the kind we generally have in Vancouver? For software companies with less than $100 million in market capitalization in the sample population, the average revenue is $69 million, the average revenue multiple is 1.2 times and the average EBITDA multiple is eight times. The SaaS companies, however, had average revenue only slightly higher at $70 million, but a much higher average revenue multiple of 10 times (the median was eight times).
With regard to mergers and acquisitions, average revenue multiples for software companies have recently climbed to 2.3 times revenue. However, public buyers are paying more at 2.4 times versus private buyers at 1.2 times median. Again, SaaS is climbing faster in deal volume, and transaction multiples are up to 4.6 times revenue from 3.9 times a year earlier.
The message for companies considering their next platform is clear: the market is rewarding companies that invest the time and money to convert to software as a service.
