Tech Industry Analysis

SaaS vs Enterprise Software Valuations - What Price is Right

Having survived the Great Recession, the Software-as-a-Service (SaaS) business model is entering the realm of mainstream IT buyers. SaaS has become the model of choice for most new software ventures. As we predicted in late 2007, valuation multiples of public SaaS companies declined to near parity with valuation multiples of traditional enterprise software (on-premise) firms during the economic crisis of 2008 and early 2009. In the past 18 months this convergence was broken as equities of SaaS companies rocketed forward with an average appreciation of over 44% during the past 52 weeks and some firms showing triple digit percentage gains. Several SaaS firms now sport Ev/Sales multiples of 11X revenue and greater. Taking a checkpoint on the SaaS scenario for the next 52 weeks and beyond, we believe there are several key questions worth examining: 

• Are the current SaaS valuation multiples sustainable? Are SaaS companies overvalued? If so, which ones? Are any SaaS companies undervalued?
• What is the right valuation methodology for a SaaS company?
• Are enterprise software companies closing the valuation gap or are they destined to permanently trail behind?
• Will SaaS companies close the profitability gap relative to enterprise software, or is the SaaS business model inherently less efficient?
• What drives valuation of software companies (SaaS and enterprise software alike) today?

In a recent research report: "SaaS Valuation: What Price is Right?" we analyzed valuation and operating performance parameters of 103 publicly listed software companies, of which 19 can be classified as SaaS companies (and a few more would lay claim to being SaaS). We tallied the performance, operating efficiency and valuation drivers, and found some surprising results.

SaaS companies continue to hold a valuation premium to enterprise software companies. This gap has been driven by SaaS growth characteristics. However, enterprise software companies are presently closing the short-term growth gap. One could attribute this to a post-recessionary bounce or anything else, but the short term growth of enterprise software companies is now within striking distance of many SaaS firms. Despite narrowing the gap in growth, the valuation gap remains as wide as the Amazon during the rainy season. As of March 9, 2011, the average SaaS company commanded a Price/Sales multiple of 5.45, up from 3.15X in mid 2009.  In comparison, the average Price/Sales multiple for enterprise software firms rose from 2.84X to 3.97X. SaaS revenue multiples rose by 73% from mid-2009, while enterprise software multiples rose by about 43% during the same period.

The single biggest driver of valuation multiples for SaaS companies appears to be revenue growth. Company size continues to matter for SaaS companies as larger cap SaaS names outperformed their smaller rivals. Profitability, efficiency and cash flow are mostly ignored by SaaS investors, at least for now. Given the SaaS growth profile, this may be fine, - as long as markets continue looking the other way and interest rates are low. Yet, lack of efficiency is typically something that stays with companies and is often part of the corporate DNA.  To put it mildly, it will be pretty tough to change it if the economic environment sours or investor scrutiny sharpens.

Operating profitability of SaaS companies continues to lag. Given the impressive growth of SaaS firms, investor concerns, if they do exist, are seemingly taking a back seat to the argument for investing in growth and taking market share. Given the nascent nature and low adoption rates of SaaS, this idea still has legs. One could argue that SaaS companies do not become a meaningful business until they reach $500Mil in revenue and are till then, for all intents and purposes, publicly trading venture stage companies. Theory aside, history of the software industry shows time and again that delivering profitable growth is a management discipline learned at a young age. Businesses that eschew profits for maximum growth are often unable to deliver consistent profitability. Whether it is a management discipline problem or a business model flaw is difficult to determine, and beside the point for shareholders. There is no real reason why a $200 million software company cannot grow the top line 30% or more and also deliver a modest level of profitability.

In assessing all the data, it appears that relative to historical performance norms, valuation multiples for all software equities are stretched and look vulnerable in the short to mid-term, especially if Q1 2011 numbers and/or guidance come in light.  Some of the higher multiple, low MGI-score SaaS equities like SuccessFactors and others, could be particularly effected by an investor pullback.  At present, there appears to be little room for error in managing these high-growth, high multiple companies. We estimate that barring any exogenous negative events, SaaS companies have about nine to twelve months to get their act together with regard to profitabilty. In twelve months or less, we will likely see a fresh crop of social media companies with explosive growth coming public - companies like Groupon, Facebook, and Twitter. When they do, the high multiple torch and attendant investor interest will pass from SaaS names to the new investor favorites. 

For content of the full research report on SaaS Valuation, visit our website. 

 

 

Breakthrough Analysis of SaaS and Enterprise Software Valuations Released

Are SaaS Valuations Sustainable? MGI Research Announces Breakthrough SaaS Valuation Report

March 22nd, 2011 - San Francisco, CA - Today MGI Research LLC announced the latest update to its widely popular "SaaS Valuation - What Price is Right?" research report. With data on more than 100 SaaS and Enterprise Software companies, this in-depth analysis addresses many of the questions facing technology executives, investors, and entrepreneurs. 

"The question is - are we at the peak of inflated expectations for SaaS or are we in in the very early stages of what can be potentially a $50Bil+ market?" said Igor Stenmark, Managing Director of MGI Research. "Software-as-a-Service (SaaS) has become the dominant deployment architecture and business model for software, and valuation multiples of SaaS companies are near all-time highs. Yet, our field research shows that production adoption of SaaS solutions amongst large organizations still represents only a small fraction of their application portfolio." he continued.

The new MGI Research report provides an in-depth analysis of what drives valuation multiples and market performance for SaaS companies and provides a simple formula for estiamting valuation of SaaS companies. The report examines the following key questions:

• How do SaaS and Enterprise Software firms compare in terms of valuation and performance?
• What is the valuation outlook for SaaS companies?
• Should SaaS companies be focused on growth or profitability?
• Does size matter for SaaS valuation?
• Are current SaaS valuation multiples sustainable?
• Which companies and segments of the SaaS sector are under/over valued, and why?

The report contains data on  software firms such as Salesforce, SuccessFactors, Taleo, Concur, Intuit, and many others.

This research report is available immediately to MGI Research subscribers. Individual copies may be purchased in the MGI Research Store. For additional information, visit www.mgiresearch.com

About MGI Research LLC

MGI Research specializes in quantitative research and benchmark data and provides clients with confidential, partner-only strategic advisory services. Founded in 2008, MGI Research counts some of the largest and smallest tech companies, institutional investors, and Fortune 500 CIOs among its clientele. 

Contact: 

Andrew Dailey, Managing Director, MGI Research, LLC

O +1 415 381-1042 
M +1 415 419-6253 
adailey@mgiresearch.com

This research report contains data on the following companies:

ACI WORLDWIDE, INC. ADOBE SYSTEMS INCORPORATED AUTODESK, INC. ADVENT SOFTWARE, INC., ANSYS, INC., Ariba, Inc., Asiainfo-Linkage, Inc., ATHENAHEALTH, INC., ASPEN TECHNOLOGY, INC., BLACKBOARD INC., ACTUATE CORPORATION, BLACKBAUD, INC., BMC SOFTWARE, INC., BSQUARE CORPORATION, BROADVISION, INC., CA, INC., CALLIDUS SOFTWARE INC., CADENCE DESIGN SYSTEMS, INC., CERNER CORPORATION, CLICKSOFTWARE TECHNOLOGIES LTD., CONCUR TECHNOLOGIES, INC., CONVIO, INC., COMPUWARE CORPORATION, SALESFORCE.COM, INC., CSG SYSTEMS INTERNATIONAL, INC., Constellation Software Inc., CONSTANT CONTACT, INC., CITRIX SYSTEMS, INC., COMMVAULT SYSTEMS, INC., DEMANDTEC, INC., DIGIMARC CORPORATION, Amdocs Limited, BOTTOMLINE TECHNOLOGIES (DE), INC., EPICOR SOFTWARE CORPORATION, SOURCEFIRE, INC. FORTINET, INC., GUIDANCE SOFTWARE, INC., HEALTHSTREAM, INC., INTRALINKS HOLDINGS, INC., INFORMATICA CORPORATION, INTERACTIVE INTELLIGENCE, INC., INTUIT INC., JDA SOFTWARE GROUP, INC., KENEXA CORPORATION, MAGMA DESIGN AUTOMATION, INC., LIVEPERSON, INC., LAWSON SOFTWARE, INC., MANHATTAN ASSOCIATES, INC., MEDASSETS, INC., MEDIWARE INFORMATION SYSTEMS, INC., MENTOR GRAPHICS CORPORATION, Merge Healthcare Incorporated, MICROSOFT CORPORATION, MICROSTRATEGY INCORPORATED, NETSUITE INC., NOVELL, INC., NETSCOUT SYSTEMS, INC., NUANCE COMMUNICATIONS, INC., OPNET TECHNOLOGIES, INC., OPENWAVE SYSTEMS INC., ORACLE CORPORATION, OPEN TEXT CORPORATION, PDF SOLUTIONS, INC., PARAMETRIC TECHNOLOGY CORPORATION, PROGRESS SOFTWARE CORPORATION, PROS HOLDINGS, INC., DELTEK, INC., PERVASIVE SOFTWARE INC., QLIK TECHNOLOGIES INC., QUEST SOFTWARE, INC., QUALITY SYSTEMS, INC., RADIANT SYSTEMS, INC., RED HAT, INC., RENAISSANCE LEARNING, INC., RIGHTNOW TECHNOLOGIES, INC., RADISYS CORPORATION, SABA SOFTWARE, INC., SAP AG, SCIENTIFIC LEARNING CORPORATION, SOUNDBITE COMMUNICATIONS, INC., SUCCESSFACTORS, INC., SMITH MICRO SOFTWARE, INC., SYNCHRONOSS TECHNOLOGIES, INC., SYNOPSYS, INC., SUPPORT.COM, INC., SPS COMMERCE, INC., SciQuest, Inc., SRS LABS, INC., SS&C TECHNOLOGIES HOLDINGS, INC., SOLARWINDS, INC., SXC Health Solutions Corp., SYMANTEC CORPORATION, TALEO CORPORATION, TELENAV, INC., DEALERTRACK HOLDINGS, INC., MONOTYPE IMAGING HOLDINGS INC., THE ULTIMATE SOFTWARE GROUP, INC., VASCO DATA SECURITY INTERNATIONAL, INC., VMWARE, INC., VOCUS, INC., Vital Images, Inc., XATA Corporation, ZIX CORPORATION

 

MGI Research, MGI Index, MGI-X, and MGI-Change Vector are trademarks of MGI Research LLC. All other company and product names may be trademarks of the respective companies with which they are associated. This is not an offer to buy or sell securities. All information is provided on a strictly AS-IS basis.

MGI Research latest research report: "SaaS Valuation: What Price is Right?" - http://bit.ly/i54j4V - Analysis of #SaaS valuation benchmarks and factors that separate most highly valued firms from the average. The report also reviews a simple formula for valuing SaaS companies.

Research Flash: #Cloud#Computing: "Current adoption rates for cloud computing are still in single digits when measured in terms of a percentage of the application portfolio" http://bit.ly/gTha6B

New Research Report - "Cloud Computing: A Definition" http://bit.ly/gTha6B
Separate cloud computing facts from fiction. Get insight into new opportunities in the emerging cloud computing landscape.

Salesforce Launches Chatter - Dreamforce 2009 Highlights

November 19, 2009                                                                                       © 2009 MGI RESEARCH, LLC

Playing to a record crowd, Salesforce.com CEO and uber-salesman Marc Benioff, kicked off Dreamforce 2009 yesterday morning at Moscone Convention center in San Francisco, CA.  The new products (some shipping now, some to arrive in 2010) will do more to shore up its installed base and core markets (sales and support) than create massive new revenue opportunities for the company.  The headline product – Chatter – is a validation of social applications (think Facebook and Twitter) in the enterprise.  Salesforce’s announcements highlight the unique strengths and limitations of the on-demand SaaS (“Cloud”) software delivery model.    

Salesforce is the most successful Cloud/SaaS software company with a healthy MGI-X score of 1,301.  MGI scores are strong measures of management's effectiveness and the strength of the operating model. While Salesforce's MGI-X score is much improved over the past 18 months, it lags software industry leaders like Oracle considerably, and is below the best-in-class threshold score of 2,000.

Competitively, Salesforce has now signaled its strategic intent and capabilities – Oracle can rest easy, SAP slightly less so, Microsoft’s Sharepoint is clearly in CRM’s cross-hairs, and we believe Facebook and Twitter could be surprise winners from the launch of Chatter. Given that it is still not clear what the business models are for Facebook and Twitter, it is difficult to see how Chatter will drive revenues directly.  Although Chatter could further entrench Salesforce within its existing market, and as such is arguably more of a defensive than an offensive move (which would also explain the pre-announcement of the product well before a firm ship date is set). More fundamentally, one cannot help but question the size of the market Salesforce has chosen to address, and its R&D motivation and capacity to capture marketshare.

In a marathon keynote presentation so long that people were streaming out well before the finish, CEO Benioff gave three major product announcements. One of them, Sales Cloud 2, drew the loudest applause and was clearly targeted at the Salesforce.com installed base of sales reps and sales operations management.  Key highlights include quote generation functionality, tighter integration with Microsoft Outlook (“an incredible breakthrough for our R&D team”), Cloud Scheduler (a slick internet scheduling tool), and hosted content accessible on mobile devices. No functional or technical breakthroughs, but it was interesting to see Salesforce use internet and consumer products as the inspiration for their own developments (e.g., Evite as the model for Cloud Scheduler)  – something corporate users are clamoring for, and a relative rarity amongst enterprise applications providers, even in 2009.  Benioff also gave a demo of the forthcoming upgrade of the Salesforce GUI.  It’s an improvement similar to what SAP’s mySAP was in the 1990s – good enough to placate the critics, but not a sea change in the user experience.

The Service Cloud 2 highlights center around the integration of the net, and social networking tools like Facebook and Twitter to help service center personnel connect with where customers really are – i.e., on the internet. The product incorporates concepts like crowd sourcing, and enabling direct messages to customers via Facebook and Twitter.  Again, nothing earth shattering, but a welcome departure from traditional software applications, and an bright indication of where app functionality is going.

The big announcement, Chatter, is notable in several ways. First, it’s a clear statement that Salesforce is not going to attack the core territory of SAP and Oracle. Instead of going into more complex, transaction heavy functionality that is essential to an enterprise (e.g., financials, manufacturing, order management), Salesforce is signaling that it will go after lightweight, horizontal application functionality “at the edge”, with the hope that corporate buyers will increasingly view the heavyweight functionality offered by SAP and Oracle as commodity.  Second, by coupling the Chatter functionality with content, groups, and APIs, Chatter is targeted at the huge installed base of Microsoft Sharepoint users.  Legacy knowledge management and workgroup apps like Lotus Notes and Groupwise, among many others, will struggle to compete against the appeal of Chatter.  Third, Chatter validates the enterprise use of social applications like Facebook and Twitter, and it puts a price tag on the functionality. Fourth, Chatter arms the Salesforce.com sales team with a product that can be sold to every user in the enterprise – not just sales, marketing, and support users.   This opens a massive sales opportunity, and raises some key issues. Will users actually pay for this type of functionality? Is there any ROI or TCO advantages to this type of product – or is it merely a “nice to have”, or even a “curious to have”.  Informal polling data what individuals would pay for Facebook or Twitter indicates that a paid license model for either of them would be a risky bet. 

Competitively, here are the conclusions from Day One of Dreamforce. 

SAP is not at risk of losing key ground to Salesforce. Certainly Salesforce will continue to make inroads vs SAP in sales and marketing driven deals.  In fact it’s hard to see SAP win a sales CRM deal anywhere outside of its hardcore installed base. There is little to no risk of CRM going after SAP’s core enterprise business. SAP would do its users a great service by emulating Salesforce’s consumer internet-oriented inputs to R&D. 

Oracle -- the lack of any breakthrough product or entry into a new market is neutral news for Oracle.  Salesforce and Oracle will continue to battle in CRM deals, with Salesforce winning more in the midmarket, where Oracle is much less competitive, and the two going head to head in the large accounts. Salesforce solidified its position, but is far from delivering a knock-out blow to Oracle in CRM, marketing, and service automation. Microsoft will face increased competition from Salesforce in the Sharepoint market – this is a space that Microsoft has produced considerable success in the past five years, and in which MSFT has become the de facto corporate standard.  While one could assume that Chatter will block Facebook, Twitter, and Linked-In from the enterprise, the more likely outcome is that Chatter could slow the corporate use of those products until Salesforce actually delivers Chatter sometime in 2H 2010.  The MGI take is that FB and Twitter will benefit from Salesforce’s endorsement of the space, and the real losers are the myriad start-ups in Silicon Valley attempting to deliver “enterprise ready” social collaboration tools like FB and Twitter.

Looking ahead to the 2010 and beyond for Salesforce, it’s not clear that they have: a) the R&D firepower to extend much beyond where they are; b) enough product to sell that is a “must-have” vs “nice to have”, especially next year when budgets may continue to be tight; and c) that they are targeting markets that can help them double their revenues over the next five years.  Knowledge management, collaboration, and social applications are hot and sexy today, but currently and historically have proven to be relatively meager markets.  With improvements to its core sales application, Salesforce may reduce the churn in its subscriber base, though there will always be some churn. The services and support market is largely untapped, and Salesforce should be competitive against the entrenched legacy players.  Will Chatter evolve into the most profitable talk of the town, or simply be a sweet nothing on the Salesforce income statement? Our bet would be the latter.