We’ve always found the subject of valuation for technology companies a curious topic, one that we could probably bore too many people with during cocktail hour conversations. There are plenty of good authorities when it comes to tech valuation (some of the best research we’ve seen over the years comes from Pacific Crest) and nearly every sell-side analyst worth their salt has a theory or two on the topic. But ultimately, tech valuation is more art than science (remember the crazy theories during the last dot-com rush when eyeballs somehow served in place of real operating metrics?).
Last fall we wrote about the topic of valuation in the Spend Matters PRO brief Procurement Vendor Valuation, M&A, and IPOs: Recent Deals and 2014 Forecast, touching on many of the elements in valuation play right now – so far, the summary observations and takeaways have largely played out. But this analysis says little for the fact that we appear to have a market at the current time that is bifurcated between certain vendors (e.g., Fieldglass) worth eight to 12 times topline revenue (or higher in the case of certain private investment rounds) and those like Intesource and Iasta, which are going for less than two times their topline. This Spend Matters PRO research brief offers up a perspective on what elements appear to be driving valuation and multiples in this market beyond the basics of SaaS and related valuation metrics.
It would be easy to dismiss the difference in valuation among providers as having to do with services of non-SaaS revenue. But it’s not that simple. If we take Rosslyn Analytics, which recently listed on the London AIM exchange (typically small cap listings), the firm still has a healthy valuation number (close to 10 times topline trailing year revenue – five to six times, by our estimates, forward revenue) for a company despite also delivering spend classification services as a component of its capabilities. Or take Tungsten (formerly OB10 with some new trade financing and analytics capabilities), which is also trading at the higher end of our valuation range on the AIM and utilizes material services for supplier on-boarding and enablement (and supplier sales, for that matter) and will at some point need to add services as a component to its new analytics offering (including data acquisition/ETL and initial classification). Clearly, we can “knock out” services contribution to revenue, in isolation, as a key contributor to valuation today.
There must be other, more subtle elements at work when it comes to valuation in procurement and supply chain these days. Let’s consider Intesource and Iasta for a moment (which were both sold for traditional non-tech, non-bubble multiples). These two providers:
- Bring material capabilities in what some describe as “upstream” procurement spanning spend analysis, sourcing, supplier management, etc.
- Offer services-driven elements to their model, though Intesource, with a focus on full services sourcing event management, was far more labor-intensive than Iasta.
- Were growing at flat-to-moderate clips on a 2-3 year trending basis (depending on provider) but not realizing “SaaS” scale growth like some vendors in the sector.
- Had nothing fundamentally wrong with their underlying business models or unsatisfied customers
Now contrast this with vendors getting a higher multiple in private capital raises (e.g., Coupa, Tradeshift), those that trade (or traded, like Ariba) with premium valuations, and those that were recently acquired (e.g., Fieldglass):
- In terms of SaaS/cloud revenue, all of these providers have recurring SaaS revenue streams growing in excess of 30 percent a year and made a concerted effort to get rid of – or never need to deliver – lower value services revenue
- These providers (and others like them including Tungsten) target the broader lifecycle of procurement enablement and/or connectivity with suppliers instead of a single area
- Many base their revenue models (indirectly or directly) on transaction value (note: Coupa is an exception in this regard)
- They have generally succeeded in building services or platform-as-a-service ecosystems around their solutions and do not rely entirely on direct sales
- The market perceives them as having a single platform/data model rather than having multiple loosely or tightly coupled stacks (note, perception here is important, as Ariba was about as far from a Workday-like single data model as a fellow true SaaS vendor can get)
So where does this leave us in terms of underlying factors that appear to drive valuation multiples today? Here are a few key takeaways as we see it (included but not entirely based on the contributing elements, above). Providers looking to maximize topline valuation in funding rounds, with public investors and in M&A situations should:
- Get in on transactional revenue streams (percentage of dollar value, flat fee per transaction, etc.) where possible to align growth with actual usage. This is perhaps the most important recommendation on this list.
- Target SaaS growth multiples in excess of 25 percent per year (ideally 50-100 percent if below $10-15 million in revenue). At least half of SaaS valuation comes down to growth rates, plain and simple.
- Focus on profit. Madison Dearborn initially bought Fieldglass (we were told) on a valuation higher than what Ariba (and others) would pay based on earnings growth. A few years later, they realized a 4-5X return on their original investment.
- Think like Workday (and Coupa). Pursue a single architecture/data model/stack strategy and stick with it (if acquisitions are a part of the mix, do not have them disrupt this approach – i.e., loosely couple them and/or re-platform them).
- Deliver solutions that are more closely tied to transactions than decision support and purchasing/supplier management activities alone (though high topline and margin growth rates can make up for a focus that is otherwise not as attractive).
- Make a targeted (and public) effort to do fewer and fewer services in house (and be able to point to a provider ecosystem of services providers that is helping scale the business). It is not simply enough “not to focus on services.” or show a declining services line (as with Iasta) to maximize valuation.
- Create a perception (and hopefully a reality) of a broader partner/channel or platform-as-a-service ecosystem. In all the companies we’ve looked at as part of our analysis with higher valuation multiples, the partner and/or PaaS ecosystem element appears to be present.
- Sell products in which procurement does not have to be the only customer – this is an odd observation, but it seems to holds true across the providers and valuations we’ve considered. For example, if finance, HR, IT, or other stakeholders are a customer or influencer (or perceived influencer), the typical valuation multiple is likely to be higher than the norm.
- Have a message that is easy for potential investors to understand and talks about the end business value that is generated (the complexity of what certain tech providers such as E2open enable is far more complicated to understand than providers supporting more targeted use cases and scenarios).
- Let private investors have a chance at buying your stock earlier rather than later (as the recent AIM listings show, public company multiples may be higher than private company multiples).
As a final related topical note, we have spent much of our careers working on multiple sides of transactions and are often asked this question: how do advisors ensure maximum valuation for the parties they represent?
From a seller’s perspective (the focus of this research brief), the old rule of thumb of accentuating the strengths of the asset while minimizing (some would say masking) the weaknesses still holds true as there’s no such thing as a perfect asset. But this is where the deal canvas part comes in.
Our recommendations in this regard include:
- Understanding the industry segment included how it started and where it’s going – having a point of view of as an integrated unit (management team + advisor). A good transactions advisor will have insight or opinion into evolution of the segment.
- Develop a hypothesis on the drivers of the valuation. Is it financial, processes-based, or customers? If financial, is it top-line, gross margin, EBITDA, OIBA, etc.? Highlight those that are most beneficial while taking attention away from those that matter less.
- Keep in mind that while there are countless industry-accepted valuation methods, 99 percent of transactions come down to the clear identification of cash flow, future growth potential, and inherent risks associated with a deal. Don’t get too far from the basics!
And always, as the saying goes, keep in mind that price is what someone pays, while value is what they actually get. Given the intangibles that Fair Market Value takes into consideration, a management team and their advisor will need to juggle market perception with the investment value of the asset and really hit the high note on potential suitor’s intrinsic value for what it needs at this time in order to make its portfolio complete.
And that is more art than science.