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SaaS Company Valuation Trends

How does the market value SaaS companies in comparison to other software companies?  Out of 25 different categories of software companies, pure play SaaS companies are the third most valuable category.  Not surprisingly, SaaS companies are faring well on exits as well.  In this post we will take a look at SaaS valuation and exit trends as well as some interesting trends that potentially foretell a significant slowdown in SaaS company revenue growth and valuations.

Before we get too far into this analysis I’d like to plug the team at Software Equity Group and their monthly, quarterly, and annual Software Industry Equity Reports.  SEG is an investment bank and M&A advisory serving the software and technology sectors.  They publish the some of the industry’s most comprehensive analyses of software technology company valuations and M&A transaction forensics.  I’ve liberally used information from their latest 3Q09 Software Equity Industry Report which you can access here.

Before jumping into the details of SaaS company valuations, it is important to set some overall context.  The following table describes the relative valuation performance of 24 different software categories.  The categories are sorted based upon Q3 2009 Enterprise Value/Revenue multiples which appears to be the best metric these days for assessing the value of software companies.  If you need to brush up on your understanding of Enterprise Value and EV/Revenue multiples check out this quick post.

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This table shows the changes in EV/Revenue and EV/EBITDA multiples for each of the 24 categories between Q3 2008 and Q3 2009.  As the data indicates, Security and eCommerce, Software have the highest EV/Revenue multiples.  The next tier are companies that have >2.0x EV/Revenue multiples – Healthcare, Financial Services, HR & Workforce Management, Enterprise Application Integration, Storage & Storage Systems Management, etc.  On an overall basis the enterprise value of software companies has declined about 12% on a year over year basis.  Surprisingly, 8 categories have shown valuation growth – those are the ones highlighted in italics.  One of the more surprising pieces of information is that some categories have seen significant declines in EV/EBITDA multiples, but not much decline in the EV/Revenue multiple or valuation.  In other words, even though profits were down, valuations did not decline in lockstep.  This leads one to believe, for now, that revenue multiples are a better way of valuing these categories than EBITDA multiples.  Another potential takeaway is that increasing profits during recessions does not necessarily lead to improvements in valuations.  It is almost a Biblical fact that tech companies will cut costs and increase profits during recessions to build shareholder value.  These numbers potentially indicate that profit growth at the expense of revenue growth may not be a solid strategy in today’s market.  I’m sure we’ll explore this concept in another post some time.

Now we’ve set an overall context on software company valuations, let’s take a look at SaaS valuations.  The Software Equity Group maintains a SaaS Index that is composed of 15 companies.  The following table shows the relative valuation trends for these companies.  The companies are sorted from the highest to lowest Enterprise Value.

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As this table shows, the median 3Q09 EV/Revenue Multiple for these SaaS companies is 2.6x, which in comparison to all other software categories would be #3 behind Security and eCommerce.  Median EV/Revenue for SaaS companies declined 14% YoY, slightly more than the median software category.  SaaS companies that have achieved revenue scale (>$100 million) enjoy a significant valuation advantage over other software categories averaging a 3.6x vs 1.7x EV/Revenue multiple.

When it comes to exit valuations, SaaS companies are performing significantly better than their software peers.  As this chart indicates, software company EV/Revenue exit multiples have been slowly increasing over the past 4 quarters for traditional software companies:

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SaaS companies are performing at almost twice the level of their software peers:

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While these numbers are definitely trending down, they help to demonstrate the ongoing maturity of the SaaS space.  Of the 15 companies in the SEG SaaS Index, 10 have more than $100 million in revenue.  It is inevitable that as software companies grow past $100 million, their revenue growth rates will decline.  Valuation metrics will eventually revert to the mean of other software companies.

Another sign that SaaS companies may have hit a bump along the road to continuous growth is the apparent significant decline in a key metric:.  Max Bleyleben, a VC with London-based Kennet Partners recently did entitled “Why SaaS sales productivity is collapsing.”  Max analyzes a post from Bessemer Venture Partners Philippe Botteri.  Here’s an excerpt from Max’s post:

Philippe Botteri has put together an interesting analysis of his 13-member index of public SaaS companies (see here for the full spreadsheet).  Essentially he has applied the same sales productivity metrics we use to evaluate private SaaS companies to public companies and charted their evolution over time. 

The resulting graph provides a stark picture of the recession’s impact on these companies: an 85% decline in the productivity ratio (incremental gross profit / sales & marketing cost), which is now running at 0.10 vs a target of 1.00.  These companies are struggling to add new customer revenue and are surviving primarily on their existing recurring revenue base.

The rate and scale of the productivity decline are telling, but the absolute ratios should be taken with a grain of salt.

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