San Diego’s Software Equity Group Sees Software M&A Deals Ramping Up in 2011

The way some people talk, the annual report from the Software Equity Group is the software industry’s equivalent to “The Baseball Abstract,” the wildly popular report on hitting, pitching, and fielding statistics that Bill James began publishing in Kansas 34 years ago.

“Nobody else comes close to capturing the trends and transactions in the software industry that they have,” says Jeb Spencer, a co-founder and managing partner at TVC Capital, a small private equity firm in San Diego that invests only in software companies. It’s also surprising to many, Spencer says, that the best and most thorough analysis of the software industry’s transaction activity is put together by a boutique investment banking firm in San Diego.

But it’s certainly being read carefully at the higher levels of software companies, buyout firms, and elsewhere. The 2010 Software Industry Equity Report provides data, insights, analysis, and other information about software mergers & acquisitions, public software developers’ financial and stock market performance, software industry market trends, initial public offerings, and venture capital investments. It also includes the Software Equity Group’s 2011 “Buyer Survey,” which offers insights into the acquisition strategies at the largest software companies in the world.

JMI Equity managing partner Paul Barber tells me the report is an excellent resource to benchmark a software company’s performance against their peer group. And Mission Ventures managing partner Leo Spiegel says the annual report fills a gap in terms of providing in-depth industry research that is no longer available from many major financial institutions, which have cut back on equity analysts who make “buy” and “sell” recommendations on certain companies as a service to investment clients.

They are hardly alone. The Software Equity Group says it has sent copies of its 2010 Software Industry Equity Report to 20,000 subscribers in 64 countries. Customers, who are willing to pay $595 a copy, include software industry executives, venture capitalists, private equity investors, and other investment banks.

The latest report predicts that software mergers and acquisitions will ramp up significantly this year, after M&A deals increased almost 20 percent last year in comparison to 2009, according to Ken Bender, who founded the Software Equity Group in 1992. The firm has represented both sides in M&A deals, but the firm works mostly for the software companies getting acquired.

The software business in general is recovering from the contractions that occurred during the Great Recession, and software company valuations are expected to increase by 10 to 15 percent in 2011. “It should be a good year if you’re a seller in certain categories,” Bender says.

Ken Bender

“What’s really changed is the mindset among buyers, which has resulted from the fact that 65 percent of software M&As were written off or written down within three years,” Bender says. These days, buyouts are far less likely to be a CEO-driven decision at public software companies. “Dozens and dozens of companies like IBM and Autodesk have shifted from CEO-driven, top-down acquisitions to a consensus-driven process that includes finance, production management, R&D, and all the other major departments. So deals are taking twice as long. It’s not that they’re not closing, but they are taking twice as long and requiring more due diligence.”

The longer process also means more deals are washing out, with a deal “mortality rate” that Bender estimates is two to three times higher than it was before the recession began in 2008.

“The buyers are extraordinarily focused on what plays to their core business,” Bender says. The priority for about 40 percent of the buyers is to enhance their current product lines, and about 30 percent—especially the bigger companies—are focused on extending their reach into adjacent product categories or territories like the Far East.

Bender and Brad Weekes, an associate at the Software Equity Group, also provided some highlights from the 2010 Software Industry Equity Report:

—The report includes several indexes that track public software companies, Internet companies and software-as-a-service (SaaS). In 2001, the software index was comprised of 332 public companies doing one or more deals a year. In 2010, the same index consists of 161 public companies. The annual median valuation of these companies is 2.3 times trailing 12-months revenue—the highest valuation level since 2007.

—The annual median valuation of 21 companies in the SaaS index is 3.6 times their trailing 12-month revenue figures. “After 11 consecutive quarters of declining revenue,” Weekes says, “the trailing twelve-month revenue growth rates for SaaS rose in the third quarter of 2010, and gained more in the fourth quarter.”

—Thirty percent of buyers in the firm’s 2011 survey believe that it is “very important” that a target be all or substantially SaaS/subscription based, more than double the 13 percent in the 2010 survey. Only 17 percent said that SaaS was “unimportant” in 2011, a sharp decline from the 47 who expressed such disinterest in 2010. Nevertheless, Bender says the big question is how far big companies like Procter & Gamble and Coke are willing to go in terms of adopting a SaaS-based model in their businesses, as they have no intention of using SaaS for corporate financial management and other confidential and sensitive data.

—Big software companies were hit by the recession, and have tightened their operating expenses, Bender says. Median revenue growth for the software industry has historically hovered around 15 percent. But it fell to 5 percent in 2009 and was 4.5 percent last year. Revenue growth has been recovering, but it’s still unclear whether the median growth rate will return to the industry’s historic norm.

—The annual median valuation for the 56 companies in the Internet index is 1.6 times trailing 12-month revenue.

The Software Equity Group also put together an abbreviated chart that highlights some key data from the report:

Enterprise Value (EV) is defined as a company’s capitalization minus cash & 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 or call (619) 669-8788 Follow @bvbigelow

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