Tech M&A Monthly: 10 Keys to a Valuable Valuation

Introduction

Bruce Milne

Good day to you wherever you are in the world. Welcome to Tech M&A Monthly. Our special presentation this month: Ten keys to a Valuable Valuation. I'm Bruce Milne, CEO of the Corum Group, your host. We have a lot to cover, so now I'm going to hand things over to Timothy Goddard, our moderator.  

Timothy Goddard

Thank you, Bruce. Looking forward to today, we have a packed agenda, so let's just jump right into it. We are going to start with a report on an AI webcast we had recently, a look at a couple of other events coming up, then into our final research report of the year, followed by our Ten Keys special presentation, and then we'll close with a special report on Quality of Revenue, which is an important factor in the valuation question, and as we have time we'll do Q&A, so feel free to ask us questions and we'll address those during the webinar or contact you personally afterward.  

Special Event Reports  

First, I'm going to turn you over to Ivan Ruzic out of New York to tell us about the AI spotlight webcast.  

Ivan Ruzic

This past month, the World Financial Symposium and Corum collaborated on a webcast where we focused on the M&A markets for AI and AI-enabled technology. Since 2012, over 250 companies in the AI domain have been acquired. We explored AI adoption across the four areas of the value chain where AI can have a significant and disruptive impact, together with some benchmark M&A deals.  

The AI spotlight also featured a panel discussion involving three executives with a rich history in AI. Two of those panelists were Tim Casio from Samsung and Jiren Parikh from Ghost Robotics. The third was our own Elon Gasper, EVP here at Corum.  

The panel explored whether we were in an AI bubble or at the start of a stable, longer-term trend, as well as discussing machine learning and the important distinction between AI-enabled and AI-enabling technology.  

By the way, the spotlight aired on the same day that Samsung announced it had just acquired a deep learning powered chatbot startup Fluenty.  

We also saw that use cases suggest that AI is delivering real value to serious adopters and can be a powerful force for disruption, but that adoption outside of tech is still at a very early stage.  

For potential sellers, the research data validated that this is the best market we've seen in which to secure high strategic valuations or that any advantage still maintained by AI innovators is likely to be fleeting.  

To learn more, you can go to wfs.com and listen to an archive of the AI spotlight.  

Timothy Goddard

Thank you, Ivan. We have a couple of other spotlights coming up, one just next week, in fact. One is looking at marketing technology M&A, which I will be taking part in, and then another one on data security. We are very proud to be partnering with World Financial Symposiums, so look for a lot more of them in the year to come.  

Also, with WFS, Growth and Exit Strategies for Software and IT Companies, that conference is coming up in San Francisco on February 22. We certainly hope you can join us for that, it's going to be an excellent event. 

Research Report: Bull Market Rages On  

Now, I'd like to move to our research report and turn things over to his team, Yasmin Khodamoradi, Becky Hill, and Patrick Cunningham.  

Elon Gasper

Thanks, Tim. We begin with the Public Markets, where major averages hit new highs again in early November before some retreat, still netting monthly gains behind strong corporate earnings, the Dow up almost 4 percent, tech seeing sharper swings but the NASDAQ still closing at another record. Asian issues enjoyed modest gains, Europe’s struggling a bit to keep pace last month, and a new Dow high again today, and all still up mightily for the year, as the great bull rages on toward its March birthday without even a 10% correction in nearly 2 years, twice the average time – what an animal! The prize is his if he continues uphill through next summer.  

Our Corum Index showed overall volume matching last year as the supply side slowdown may be abating, though the more volatile megadeal volume declined. On the other hand, PE buying overall continued to increase, while continuing disintermediation of VCs kept them boxed in with lack of inventory on the sell side.  

The 2017 megadeals wall continues to grow, Infrastructure notably adding over $7 billion in deal value last month.  

One transaction in those Infrastructure waters saw Barracuda, a big fish with cloud-enabled security solutions, hooked by top-tier PE buyer Thoma Bravo for $1.6B at 4x revenues, as the M&A tide driven by private equity continues.  

November’s largest catch was landed from the semiconductor consolidation wave, as Marvell shelled out $6B for rival Cavium to level up in its competition with Intel and Broadcom.  

No megadeals in the Internet market last month, how is it doing, Yasmin?  

Internet Software Valuation Metrics  

Yasmin Khodamoradi

Sales multiples in the Internet sector retreated slightly to Q1 levels with EBITDA metrics keeping momentum. The travel subsector in particular saw a series of deals out of Europe.  

In the UK, AirBnB bought disability-focused listing site Accomable to offer more accessible rentals. Swiss accommodation search engine Hotelscan was acquired by Lastminute to diversify its metasearch portfolio.  

Atcore, which develops travel reservation systems for tour operators such as Tui and Thomas Cook, was picked up by Inflexion Private Equity, possibly setting the stage for further acquisitions in Asia and South America.  

And Greek online travel agency e-Travel was bolted on to Swedish booking site eTRAVELi following their acquisition by CVC Partners.  

Stateside, travel discovery app Trip.com was bought by Chinese travel giant CTrip, to initiate their North American expansion, echoing their entry into the European market with last year’s acquisition of Skyscanner.  

CTrip also went through Skyscanner to purchase Twizoo, an AI startup which helps brands automate the aggregation of relevant consumer discussion on Twitter.  

In the social networking space, video sharing platform Musical.ly was bought for $800M by Chinese media giant Toutiao, to expand into the American mobile video market and gain relationships with Hearst and Viacom.  

And coworking unicorn WeWork put their four billion dollar investment from SoftBank to use, acquiring in-person networking site Meetup.com for a reported $200M.  

How did IT Services do, Becky?  

IT Services Software Valuation Metrics  

Becky Hill

IT Services valuations held steady and may have found their highest point, as we suggested in our last quarterly. Focused services continue to be the primary driver of M&A in the sector.  

Starting with a recent megadeal, IoT-focused systems integrator Aricent was bought for $2B and nearly 3x sales by French tech consultancy Altran. This surprisingly high multiple reflects the convergence of focused IT services and IoT software.  

Blending the focused IT services and data security trends, Optiv Security fortified its integration capabilities with two purchases: Maryland-based big data and orchestration services firm Decision Lab and Canadian security integration provider Conexsys.  

Temenos integration specialist Syncordis, out of Luxembourg, was picked up for over $33M by Indian consulting company Larsen & Toubro Infotech, boosting it in the European banking market.  

In the ERP system integration space, Virginia-based Deltek services company NeoSystems was bought for over $22M by Novume Solutions to extend its professional services portfolio.  

And in London, supply chain and ERP solutions provider Anisa was pocketed for over $17M by Sanderson Group to complement its enterprise division.  

In the digital marketing space, Moku Collective was acquired by digital agency DEG to deepen its Salesforce Commerce Cloud focus.  

Ad agency Dentsu Aegis continued its shopping spree with Dutch omni-channel and loyalty specialist Oxyma Group as a tuck in to Dentsu’s portfolio agency, Merkle, which it acquired in a mega deal last year.  

UK online marketing agency Atom42 was picked up by Korea-based Samsung Group company Cheil Worldwide. And creative shop Obscura was picked up by Madison Square Garden Company for its immersive large-scale interactive projections.  

How’s the consumer sector, Patrick?  

Consumer Software Valuation Metrics  

Patrick Cunningham

Volatile sales metrics in the consumer sector returned to summer levels, though through differing paths.  

Slot machine maker Aristocrat made another big move into social gaming after its Plarium purchase by netting social casino player Big Fish for nearly $1B, which should expand Aristocrat’s digital arm alongside its gambling expertise, and marks the first consumer mega deal of the year.  

In Sweden, Experiment 101, which developed role-playing game Biomutant, was nabbed for about $9M by game publisher THQ Nordic, following THQ’s recent acquisition of Black Forest Games.  

French racing video games developer Eden Games was bought for $12M by Millennial Esports Corporation, an interesting turn with an esports company buying a game studio.  

In core gaming, Respawn Entertainment, the creator of the blockbuster first-person shooter franchise, Titanfall, was snapped up for $315M by Electronic Arts, which will allow Respawn to realize its ambitions in working on a Star Wars project and a yet-to-be named virtual reality game. EA reportedly outbid Japanese gaming giant Nexon, which picked up Pixelberry, a developer of narrative mobile titles like High School Story and Choices, in Nexon’s first gaming deal of the year.  

And Zynga put out $100M for the card game assets of Turkish studio Peak Games to strengthen its casual card game portfolio with its first major deal in two years.  

Elon Gasper

And, Shazam! The company, I mean, bought by Apple this week for a reported $400M to freshen up its music service and maybe spin up some magic from Shazam’s AR platform and “Visual Shazam” object recognition capability, which could surface in Siri and iOS. Will Spotify or Google respond to this move? We’ll see and comment in another webinar -- back to you, Tim.  

Timothy Goddard

Thanks, Elon. The big news today is the Disney-Fox deal. Are there any tech aspects to that deal?  

Elon Gasper

Elon: Well, the tech “hidden gem” of the deal gives Disney majority control of Hulu, along with streaming platform BAMtech, which Disney bought in August, you can see the outlines of a major shift in consumer content distribution infrastructure. Expect opportunities for tuck-in acquisitions.  

Timothy Goddard

Depending on what happens with the other big news today, the net neutrality regulations, it could be an interesting few months in this space.  

Ten Keys to a Valuable Valuation

Now, speaking of interesting, let’s go to the meat of our webcast here, Ten Keys to a Valuable Valuation, and I'm happy to turn things back over to Bruce Milne.  

Why Courm?

Bruce Milne

The Corum Group is recognized as the leading expert on valuations for software, IT, and related technology companies. Since 1999, Corum has authored the software valuation section for Wiley, the world’s premiere publisher of higher education materials.  

Corum was chosen because we have valued and sold more such companies than anyone in history, and have the world’s largest proprietary database of software related companies - over 200,000. Data on those companies is regularly updated by our three research centers around the world, information curated through over 200 events per year that these firms are invited to. To put this level of outreach into perspective, this is more online and live educational conferences than is produced by all other tech investment banks combined. As you can imagine, one of the key topics at these events is valuation, which we'll be talking about today.  

Let’s hear from the experts on valuation, some of them dialing in from the far corners of the globe. Remember, this will only be an overview, as our time is short.  

We will start off here at HQ with Libby Chick.  

Understanding Tech vs Traditional Firms

Libby Chick

To make the discussion of valuation more relevant, you first have to understand why software companies are so different than traditional firms. Just take a look at this chart of traditional firms versus software companies.  

As you can see from this list, software companies and traditional firms do not match up well on basic characteristics. Further, their economics are completely different. As this graph shows, fixed versus variable costs are completely different. At the increment, unlike traditional businesses, the next product you sell in software is all profit. Thus, software companies are valued much higher than traditional firms.  

Bruce Milne

Yes, that's why some of the greatest wealth in history is among founders and investors in software-related companies.  

Now to the topic of type of valuation, we'll turn to Evelyn Chen who comes to us from China.  

The Purpose of the Valuation

Evelyn Chen

First off you need to understand the purpose for your valuation. People speak about valuations as if they are all the same. Not true. There are valuations for a divorce, or settlement of your estate. What’s acceptable for the courts involved in such proceedings is much different. If you’re raising financing that’s a different kind of valuation. If you’re setting up ESOP, buy-sell agreements, then different metrics will apply.  

Thus, you can’t just go to some accounting firm and ask for a valuation from their consulting group. You’ll be sorely disappointed. What you want is a valuation for a knowledgeable strategic or financial buyer – one who has the strategic imperative to pay a premium. Those valuations look carefully at the underlying value, which is often intangible, and future potential, which is critical to the buyer. Those are much higher valuations.  

Bruce Milne

How much higher? The average tech company versus the average standard company with the same revenue size, the tech company is worth 6x more on average.  

Now we'll go to the ten valuation methods to apply and hear from the head of our research team, Yasmin.  

10 Valuation Methods To Apply for Strategic Sale Under Auction 

Yasmin Khodamoradi

The valuation methods that we’re going to be talking about today are for strategic sale to a buyer that will be bidding in an auction environment. In that case, the actual process plays a critical role in determining the final value.  

There are basically ten ways to value a company (don’t mention in detail):  

1. Sales multiples from public companies
2. Earnings multiples from public companies
3. Comparable M&A transactions
4. Discounted Cash Flow (DCF)
5. Replacement cost
6. Dollars per RND developer
7. Internal Rate of Return (IRR)
8. Liquidation value
9. Book value
10. Internal transaction price  

We’re only going to be talking about the first five, for as mentioned earlier, software companies are very different than traditional firms, where hard asset valuation methods traditionally apply.  

Multiples of sales and EBITDA are the most commonly used methods, in addition to the Comparable Transactions, and Discounted Cash Flow analysis. In very few cases, you may also look at Replacement Value. It should always be remembered that none of these methods provides an exact valuation and a weighting of them should be used to offer a range of values for discussion.  

Bruce Milne

Thank you, Yasmin.  

Now before we go to specific methods, let’s talk about what is in the valuation presentation?  

Contents of The Valuation Presentation

Elizabeth Gotski

In presenting your valuation, before turning to the numbers, introduce your company in the valuation report; its market and value proposition, the opportunity it presents.  

You should include a summary of the business, its history and technology, its strengths and weaknesses – business risks, along with its unique position in the market. Also, identify other markets where your product or services can apply.  

This information is based on a few sources: the original executive summary you prepared, the competitive research, plus feedback you've received in dialogue with potential buyers. They will confirm why you're valuable to them, what elements of the company they want or need the most, which will help improve value.  

Along with an accurate view of your market, there should be an explicit definition of your business and revenue model, with some reference to other similar companies that might make logical comparables, especially companies that went on to be successful in related markets.  

Bruce Milne

Yes. Remember this is a sales document. This is a document explaining your company, why you are valuable to a buyer, what the opportunity is that you present. So it's important that this document be able to work its way through the buying organization right up to the board and outside advisors, so it has to be one of the best documents you've ever produced.   Now let's go to the numbers, the financials required, and we'll hear from Jeff Brown in Texas.

Financials Required

Jeff Brown

The financials required include three years of past financial statements. They may need to be recast per GAAP standards or to take out one-time charges or expenses that wouldn’t be part of ongoing operations.  

Even more important are three years of pro-forma earnings statement in a standard accepted financial model with detailed assumptions on strategy, growth and profits. If not included, the foundation of your entire valuation is undermined.  

Pro-forma earnings do not have to be computed using standard GAAP and usually leave out one-time expenses that are not part of normal operations. A pro-forma financial statement can exclude anything a company believes obscures the accuracy of its financial outlook.  

One note on preparing these financials is to be cautious and supportable, especially in year one, as the buyer may tie part of the transaction value to an earnout based on your projected revenues and profits.  

Bruce Milne

Thanks, Jeff. One of the questions we get sometimes from the companies that call us daily is, “I'm not profitable yet.” or “I don't have much net worth.” It doesn't matter. Remember, the buyers are buying the future, that's why these projections have to be well thought through, otherwise, the entire valuation falls apart.  

We mentioned public company multiples. Let's hear from Amanda Tallman on that. 

1. Public Company Multiples

Amanda Tallman

When it comes to establishing a range of valuations for a transaction, one of the first places that almost everyone starts is with an analysis of public company financials. This is because public data is readily available and also serves as an objective, public measure of value.  

The analysis involves a comparison of two primary operating metrics, enterprise value to sales, and enterprise value to EBITDA for your peer group. This peer group is a company most like yours, though sometimes you may be in multiple markets that are a hybrid. Size, growth, and business focus all come into play when establishing a peer group.  

Remember that any valuation based on public companies is no more than just a guide. It doesn’t reflect a potential buyer's premium for strategic value or change of control, nor does it reflect any appropriate discounts. After all, public companies are usually more highly valued than private ones. This is one of the places where experience really counts, and a seasoned analyst can be invaluable.  

Bruce Milne

Thank you very much, good presentation.  

Now let's go back to Patrick here at HQ on comparable transactions.

2. Comparable Transactions

Patrick Cunningham

One important approach used in determining the valuation of a subject company is analyzing comparable transactions. Most of us know how residential real estate values are driven by comps, and the same principles apply to tech companies. Key criteria for finding good comps include acquisitions of companies that have like business models, ones that are in the same industry, companies that have similar profiles for growth and profitability, or companies of similar size. Comparative analysis is somewhat perishable. The preference is always for more recent transactions over older ones. Since many M&A deals are private, finding the right set of comps can be challenging and is one reason why you want to work with a firm that has extensive research capabilities.  

Bruce Milne

Some of the biggest arguments we have with buyers is, “which comps did you use?” You have to make them fresh and they have to be relevant. If you're part of a disruptive trend, it's going to be a different discussion. Obviously, it's going to be helping you get your valuation up, and you want the high ground in these negotiations, that's why your research has to be impeccable.  

Now the most popular method, DCF, discounted cash flow, and Becky Hill.  

3. Discounted Cash Flow

Becky Hill

The DCF, or Discounted Cash Flow valuation method is the most universally used method by all forms of buyers, tech, and otherwise. The reason is that DCF attempts to capture the present value of your cash flow going into the future, critical to whether the acquisition will be accretive for the buyer, and useful to young selling companies that may not have enough track record to use the other valuation methods.  

The three years of projections are discounted to the present as is the terminal value, which represents all subsequent years’ cash flow. The terminal value is usually a sales multiple of year three revenues. These two calculated values – terminal value and three years discounted represents the present value of the company.  

The discount rate is critical – it is highly technical and must be supported - for growing technology companies it usually ends up being 15%-20% or more.  

Bruce Milne

The reason this is so important, to both tech and non-tech companies, is that they are public or want to go public, so it is important they have these numbers to see whether or not the acquisition will be accretive and drive their stock up.  

Now to a method that is very important, although we don't use it that often, replacement value and Bruce Lazenby in Ottawa.

4. Replacement Value

Bruce Lazenby

The classic build versus buy analysis is the foundation of a replacement cost valuation method. The fully burdened cost per person or contractor, the number of full-time employees and contractors required, and the number of years in development will go into building this analysis.  

Not to be overlooked, prior legacy work done has to be factored in, and the time-to-market factor, which will be defined with underlying assumptions. With this information, an acquirer will calculate their ability to build it themselves.  

This method may be useful for a seller where other valuation methods don’t fairly value the investment put into a company, such as raw startups and legacy companies that don’t get high multiples but often have an extraordinary investment in technology, domain expertise, and/or user bases.  

Bruce Milne

Thanks, Bruce. Some of this logic is going into our negotiations recently for acqui-hires, there's a lot of it going on for smaller firms.  

Now how do we put this all together? Weighted averaging and we'll hear from Jaber Tannay.  

5. Weighted Averaging

Jaber Tannay

A weighted valuation provides a good way to balance the three main approaches we’ve just discussed: Public Company Multiples, Comparable Transactions, and Discounted Cash Flow. 

The valuation methods can be weighted evenly, or you can move the weighting to support your strategy or the dynamics of your market. For example, if you are a SaaS software company and your focus is on customer acquisition and top-line growth and not on generating high EBITDA multiples, you may want to raise your weightings on comparable transactions and reduce weightings on the DCF method. The main thing about adjusting your weighting is that it provides you with different scenarios to study and build your case before presenting a valuation model to an interested buyer.   

Bruce Milne

Thank you very much. Now let's go to Joel Espelien, who is also in Europe right now. When do you present your valuation?  

When To Present Your Valuation

Joel Espelien

As a seller, when should you present your valuation to buyers? The answer: as late as possible. In today’s market, your business should be growing, multiples are staying strong and along the way, you will learn why you are important to particular buyers. The marketplace will determine your most valuable attributes.  

During a properly managed M&A process, buyers will frequently disclose their preferred valuation methods, market comparables, deal structures, and the points about your business they find most valuable. All of this you can use to craft your valuation.  

In addition, time will help to create an auction environment that will increase the value of your company with multiple buyers bidding. Ultimately, deal value is determined by what qualified, interested buyers are willing to pay, and a broad market engagement ensures that you’re leveraging the right candidates.  

Too many software company owners sell themselves short, leave money on the table because they never let an auction process develop. Our experience has been that properly executed, the process will generate, on average, 48% greater deal value for your company.  

Bruce Milne

Yes indeed. 48% increase in liquidity. You can do a great job on the comps and the DCF, your numbers, your research, etc., but you have to have the process in place, create that auction environment, in order to get maximum value.  

Thank you to all the presenters. Tim, I'll turn it back over to you.  

Timothy Goddard

Thank you, Bruce. We will be sending those materials out if you would like a copy, but if you're really interested, and we're getting a lot of responses here, we recommend you attend the Selling Up Selling Out conference, that's our bootcamp that covers not just valuations, but structure, proper negotiation, how you do these transactions. It's been going on every week since September of 1990. It is the gold standard in the industry, with both buyers and sellers attending.  

In addition to conferences held around the world, we also have quarterly seminars at our Corum University facilities here in Seattle, where you can personally meet and get in-depth answers from the experts who have presented today.  

Now on to that bonus segment I promised on quality of revenue from Dan Bernstein.  

Quality of Revenue

Daniel Bernstein

Similar to how diamonds are valued differently by different grade designations, the quality of your revenue will determine the way that buyers value you as they look at your financials. While a lot of companies think that having a high topline revenue number is important, that’s only scratching the surface. Most companies will do a very thorough analysis of your revenue and where it’s coming from. Pure recurring, software SAAS revenue is valued the highest. On-premise recurring software or maintenance revenue is valued at the next designation. Perpetual or one-time software license revenue is not valued highly, while one-time and non-recurring service revenue is valued the least.  

If you have a subscription or recurring revenue, keep an eye out on your churn. Churn should be constrained to less than 10% per annum from a revenue standpoint for a buyer to feel that your business will continue to generate cash from your customers on an ongoing basis and that there is nothing significantly wrong with your business that causes it to lose customers.

As a great number of strategic buyers are backed by private equity firms, this rigorous analysis of your quality of revenue will be a step undertaken by most buyers. Understanding where your revenue is coming from and how you retain your customer base is an important component of getting the highest value for your company.  

We will be releasing a white paper in the coming weeks that goes into this topic in more detail. Stay tuned!  

Timothy Goddard

Thanks, Dan, we're looking forward to that.  

Also, to look forward to, next month is our annual report, so be sure to tune in; this is the largest tech M&A event of the year. We have panelists from Salesforce, IBM and others joining us. We will be doing valuation metrics on all six sectors and 30 subsectors. It's going to be fantastic.  

Q&A

We do have just a couple of minutes for questions, and we have had some come in, so let me toss this one to you, Bruce. With valuations as high as they are right now, how much dry powder is on corporate and public equity balance sheets to do deals?

Market Cash Available

Bruce Milne

Dry powder. That's the key question. We did a conference ten years ago and we said the total amount of cash available, both in PE and strategic buyers, it was around $200B globally. It is now well over $4T. Part of the problem, which you have read about, is they are hungry for deals, everyone wants that company that is growing, that might be the next unicorn. What we see is that a lot of the acquisitions are going to go down into the smaller companies, particularly being bought through the portfolio companies of the PE buyers. We had a special report on that. They are voracious. I think it is the best time in history for the smaller companies to sell. There's almost no limit to the cash, almost all the deals we're doing are cash for cash. Some are multiple offers. We are closing a deal next month where we had 22 bidders on that. We haven't seen that since the dot-com days. So don't worry about dry powder. What I do worry about is valuations going down. We have been bumping along at a top line here. If something happens, the stock market adjusts, whatever, we could see these valuations drop, so people will have missed the window. 

How To Get Private M&A Comparables

Timothy Goddard

Another question, and I'll take this one. "How do you get private M&A comparables?" The best way, if you ask me, will be to tune into that webcast we mentioned. We will go into a number of comparable transactions for many different companies. That's a focus in all the monthlies we do, but particularly in our annual report.  

There are other resources out there, the 451 Group, there are a lot of public data, especially for the larger companies, more and more folks are trying to do this, like CB Insights and Pitchbook. There are lots of different databases and resources, but frankly, the easiest, especially if you have a specific question, is we are happy to discuss these sorts of things. We're watching it every day here at Corum and we're happy to share the insights that we glean if you have specific questions.  

And that brings us to our closing. If we didn't get to your question, we will follow up with you by email. Thanks for attending, and we'll see you next time.