Software Industry Valuations Rise, Driven by Demand for Software-as-a-Service

8/19/11Follow @bvbigelow

Global spending on information and communications technologies is fueling higher valuations for public software companies, according to a quarterly report released by the San Diego-based Software Equity Group. Much of that increased spending, however, reflects an intensifying demand for cloud computing and software as a service (SaaS), as big-company CIOs increasingly accept the notion of outsourcing many programs that were previously installed on corporate networks.

As a result, valuations of public SaaS companies have continued to climb, and more SaaS companies got acquired during the second quarter that ended in June.

For all sectors of the software industry, the Software Equity Group counted 397 buyouts and mergers with a cumulative value of more than $21.3 billion during the second quarter. That was down from a revised tally of 423 mergers and acquisitions during the previous quarter, although the latest quarter’s $21.3 billion worth of deals was almost twice the $11.1 billion total in the previous quarter.

However, that $21.3 billion was skewed by a single mega-deal—Microsoft’s May 10 acquisition of Skype for $8.5 billion. During the same quarter of 2010, the firm counted 378 mergers and acquisitions valued at a total of $17.2 billion.

The firm also counted nine software IPOs, which collectively raised more than $3 billion, at an average of $344 million. That was up sharply from the four software IPOs with an average valuation of $120 million during the previous quarter. The nine companies listed on major U.S. exchanges (including three foreign software companies) during the quarter are: Pandora Media (NYSE: P), LinkedIn (NYSE: LNKD), Renren (NYSE: RENN), Yandex (NASDAQ: YNDX), Ellie Mae (NYSE AMEX: ELLI), Jiayuan.com (NASDAQ: DATE), FriendFinder Network (NASDAQ: [[ticker:FFN ]]), The Active Network (NYSE: ACTV), and HomeAway (NASDAQ: AWAY).

The Software Equity Group’s quarterly software industry equity report is widely viewed as a key economic barometer. The firm, which operates as an investment bank and M&A advisory firm, tracks both public market valuations and mergers and acquisitions deals. The firm’s median valuations for public companies, which are calculated as a multiple of trailing 12-month revenue, are widely used to benchmark the value of companies in the software, SaaS, and Internet sectors. The firm’s complete quarterly reports can be downloaded here.

Some other highlights of the firm’s M&A analysis:

—M&A deal volume has been close to its historically healthy level of 400 transactions a quarter for five of the past six quarters.

—The 5.2x median valuation (enterprise value divided by trailing 12 month revenue) is the highest median since the first quarter of 2008. Forty-five SaaS companies were acquired during the second quarter, an increase from the 39 SaaS deals during the previous quarter, and 26 during the fourth quarter of 2010. In its report, the firm says the growing number of SaaS buyouts indicate that SaaS providers have “finally become an important target for acquirers, as well as an array of recent IT spending surveys showing SaaS was gaining increased acceptance among enterprise CIOs.

—Chinese-based Internet companies are gaining significant attention among investors. Fourteen of the 81 public companies in the firm’s Internet index are based in China, and are trading at a median 7.5x EV/TTM revenue. That’s in sharp contrast to the other 67 public Internet companies in the index, which are trading at a median 2.4x EV / TTM revenue.

Enterprise Value (EV) is defined as a company’s capitalization minus cash and short-term investments, plus total debt, preferred equity, and total minority interest. TTM is trailing twelve-month revenue. EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization.

Bruce V. Bigelow is the editor of Xconomy San Diego. You can e-mail him at bbigelow@xconomy.com or call (619) 669-8788 Follow @bvbigelow

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