Financial Literacy

I had to chuckle the other day when I read a post entitled “Why Twitter is underhyped and is probably worth five to 10 billion dollars” by the infamous Robert Scoble.  I am somewhat of a student of technology company valuations.  While Twitter may someday be worth $5 billion, it’s not going to be any time soon.  If Mr. Scoble thinks they are worth $5 billion then perhaps he might need to take a drug test since there is no way that Twitter is worth $5 billion today or even next year.

The best way to gauge the value of a company is to look at what how the markets value a company’s stock.  For private, venture backed companies like Twitter there is no daily market for their stock, but we can look at publicly traded technology companies to get a feel for how the real world values them.  Later in this post we’ll take a look at how the market values technology companies and see how Twitter stacks up.  First, let’s take a look at Mr. Scoble’s ideas about why Twitter is worth $5 to $10 billion.

 “The experiences I'm having with business owners in every city makes me understand some things:

1. Twitter has taken over the business world and this should be very worrying for other companies like Google, Yelp, Facebook, Microsoft, Yahoo and others.

2. Twitter is underhyped. I'm now convinced that Twitter has locked up a whole raft of businesses and that Twitter is actually worth five to 10 billion dollars.

Preliminary numbers are in for 2009 private equity backed bankruptcies and not surprisingly the numbers are up significantly from 2008.  As reported by peHUB in 2008 there were 46 Chapter 11 filings for PE-backed firms, through November 30, 2009 there were 83.  This was a sharp increase in comparison to the two PE backed firms who went bankrupt in 2008.

My first exposure to private equity was in 2003 when I became an operating executive for a portfolio company of Golden Gate Capital and Cerberus Capital Management.  This was at the beginning of the private equity boom that lasted through 2008.  At that point in time it was inconceivable that a serious private equity backed firm would ever go bust.  It was also inconceivable that a portfolio company’s debt would ever trade at a discount.  Such events would be considered professional suicide – a bankruptcy or downgrade would seriously impinge a firm’s ability to raise debt or equity in the future.  In 2010 the world has changed and the stigma of bankruptcy simply is not what it once was.

As shown in the following table the pace of PE backed bankruptcies in 2009 significantly accelerated in the first half of 2009 and then tailed off dramatically:

The types of firms filing for Chapter 11 protection should be no surprise:

Morgan Stanley’s Mary Meeker, the “Queen of the Net”, is famous for her in-depth analyses of technology markets.  In 2009 Mary and her team have been heavily promoting Mobile Internet as the next big wave in the technology market.  Several copies of her 68 slide October “Economy & Internet Trends” presentation from the Web 2.0 Summit have circulated around the web.  Recently Morgan Stanley released the 671 slide presentation, the Mobile Internet Key Themes Report, that underlies Mary and her team’s research.  If you were ever looking for the definitive research primer on why Mobile Internet will be the most dominant theme of the technology market for the next 5 years look no further.  You can download the entire presentation via this link.  You can also view it below.

In the past few weeks there have been several exits for private equity investors in the supply chain management space.  Using some baseball analogies, one could be categorized as a single, two would be considered doubles, and three are potential home runs, but no grand slams.  The companies that have achieved some type of exit in the past few weeks include Advant-e Corporation, GXS & Inovis, JDA & i2, Descartes, SPS Commerce, and RedPrairie. 

While most people consider supply chain management to be a mature and somewhat boring marketplace, the diversity of the types of exits that have occurred recently show how investors can obtain significant returns even in these tough times.  Generally, supply chain management companies are not considered to be too valuable in comparison to other software markets.  Take a look at the following table from the Software Equity Group’s 3Q 2009 Software Industry Equity Report.  Out of the 24 markets that SEG tracks, supply chain management is the 19^th most valuable market in terms of Enterprise Value/Revenue and EV/EBITDA multiples:

Advant-e $2 Million Dividend

Advant-e (Nasdaq:ADVC

Earlier this year, ZL Technologies sued Gartner for over $1.6 billion in damages over Gartner’s placement of ZL Technologies in the email archiving Magic Quadrant.  Recently, the Federal Court for the Northern District of California dismissed the case and handed Gartner a nice little victory.  The Court did not slam the door totally in ZL Technology’s face since they left them a slight bit of room to amend their complaint.  You can read the Court’s entire Order here.

The details and an assessment of the initial lawsuit were covered in an earlier post entitled “Suing Gartner Won’t Solve Your Magic Quadrant Problems.”  Basically, ZL Technologies got fed up of being binned in the ‘Niche’ quadrant year after year.  ZL Technologies has been in business for 10 years and included in the MQ since 2005.  After being pigeon-holed in the ‘Niche’ quadrant for the fifth year in a row, ZL Technologies decided that Gartner and their analyst Carolyn DiCenzo were so biased against them that their only recourse was to sue Gartner.  ZL made seven claims against Gartner in their original lawsuit.  These included defamation of character, false statements about Gartner’s products/services, and false statements about Symantec under the Lanham Act

It continues to be a tough market to sell technology products and services.  Recent Q3 earnings announcements help to reinforce that the recession is still impacting the top lines of technology companies.  Consider the following:

• IBM total Q3 revenues declined 6.9%
• SAP’s new license revenue declined 31% and total Q3 revenues declined 9%
• Oracle’s new license revenue was down 17%, and total revenues were down 5%
• Microsoft’s revenues declined 14%

If these tech heavy weights are having a hard time growing revenues it would not be too surprising if your company was struggling as well.  One of the most common complaints cited by sales teams and sales management is that prospects simply cannot appreciate the value a company’s offerings bring to the table and the significant economic benefits they could achieve if they simply implemented your solutions.  Often, the root cause of these problems is that product managers and product marketeers lack the financial literacy skills needed to express compelling value equations for their products and services.

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.