In the past six months, software industry giants IBM, Oracle, and SAP have all acquired software as a service, or SaaS, companies. Each paid more than 7 times trailing 12-month revenue for their latest additions.
SAP paid more than 12 times trailing 12-month revenue for the human capital management solutions provider SuccessFactors. The San Mateo, Calif.,-based company had revenue of $291 million in the 12 months prior to its purchase where SAP shelled out $3.5 billion for the business.
To put the prices being paid for SaaS companies in perspective, over the same timeframe, companies sold in the information technology services and business process outsourcing space went for 0.5 times to a little more than 2 times trailing 12-month revenue.
The large valuations we’re seeing in the SaaS market beg the question: Is SaaS driving another bubble like the Internet drove in 1999? We didn’t know it at the time, but by March 2000, it was “party over.”
The answer is definitely not. Here’s why.
Unlike the dotcom companies of the late 1990s – when IPOs were fueled by too much venture capital, which was being poured into too many companies that failed to turn a profit, SaaS companies are the real deal. They have real customers, real sales, real profits, and real enterprise value – because they provide real returns to their customers.
As a result, I’m confident that these super-high valuations for SaaS will continue for at least the next 12 to 24 months based on accelerated growth. After that, values may come down as growth slows, but the SaaS market should remain healthy and strong.
So no, this is not a bubble. Instead we’re witnessing a strategic land grab among traditional software companies for a position in the lucrative SaaS market. Their actions certainly put pressure on the de facto SaaS market front-runner, Salesforce.com. They also lend credence to my view that SaaS is an industry that is at the end of its beginning. or early phase, and is now positioned for further growth through specialization and segmentation.
But here’s a note of caution – especially to M&A advisors. Just because leading SaaS companies will see high valuations during the next couple of years does not mean that all of these acquisitions will be successful.
Companies like IBM, Oracle and SAP are all smart about acquisitions. They’re good at identifying companies that are a strategic fit for their businesses and they’re good at executing business strategies after the deals are done.
One example is IBM’s purchase of Tivoli Systems in 1996 for $743 million, which was about 10 times trailing 12-month revenue. At the time, many analysts opined that IBM had grossly overpaid for the asset. But within a year, IBM was able to leverage Tivoli into almost a billion dollars in revenue. So in the end, did IBM pay 10 times or less than 1 time 12-month trailing revenue for Tivoli?
IBM made the price it paid for Tivoli look like a deep discount. What IBM proved is that Tivoli had more value to IBM than Tivoli had to itself at the time.
But not all buyers are as sophisticated and capable as IBM. And not all sellers have as much to work with as Tivoli.
So even though SaaS buyers and sellers will have a window of opportunity over the next 12-24 months, M&A advisors will need to work closely with clients to ensure that they aren’t blinded by the light. Advisors need to help find the deals that will pay off for them over the long run based on their ability to build enterprise value.
And in getting the right deals done, the responsibility is on the buyers – not the sellers – because the burden to make acquisitions successful is on the buyer.
The first thing advisors must do is cast as wide a net as they can to find possible buyers for a company. Then, advisors need to sit with potential buyers to understand what they can do with the asset.
How will they grow it? Will they keep the present management? Will they keep the company as an independent unit or fold it into the mother ship?
The buyers that can dig deep into the details and plans of how they will build value after buying a company are the most deserving of the asset.
And chances are buyers who know how to realize the most value are probably the ones willing to pay above current market prices. That’s because like IBM with the Tivoli deal, they are buying future value.