The deceleration in revenue growth was not entirely unexpected, given the forecast cutbacks in enterprise IT spending and the macroeconomic headwinds most public software companies have been facing.
This excerpt is from our complimentary Q3 2012 Software Industry Financial Report which can be downloaded here: http://www.softwareequity.com/research_reports.aspx
The 146 public companies comprising the SEG Software Index grew revenue by only a median 13.2% in 3Q12, after posting median growth rates of 14.9% for Q1 and 15.5% for Q2 (Figure 4). The deceleration in revenue growth was not entirely unexpected, given the forecast cutbacks in enterprise IT spending and the macroeconomic headwinds most public software companies have been facing. Indeed, given that growth in enterprise IT spending for all of 2012 is unlikely to exceed 4% or 5%, public software companies have done well to achieve the revenue growth they’ve reported for the first three quarters.
Despite the overall slowdown in TTM revenue growth rates, a number of public software companies read the tea leaves well and pushed their top line well above the median. Of the ten software companies posting the highest TTM revenue growth in Q3, six derived all or a substantial part of their revenue from mobile software solutions. The list includes Unwired Planet (274.5% TTM revenue growth), Qihoo (169.9%), Gree (146.6%), NQ Mobile (113.4%), Velti (66.0%) and Zynga (43.1%).
However, mobile continues to be a double-edged sword. Five of the ten software companies with the lowest TTM revenue growth were also mobile solution providers: Smith Micro Software (-57% TTM revenue growth), Myriad Group (-35%), Access (-28%), RealNetworks (-16%) and Trunkbow (-9%). Unlike their top performing peers, these mobile companies are struggling to adapt legacy business models to a rapidly evolving market.
Two of the top ten companies achieving the best TTM revenue growth were security software providers Palo Alto Networks (115%) and Sourcefire (38%). Rounding out the top ten software overachievers were Sapiens International (72%) and Allot Communications (39%).
The third quarter’s growth rate helped drive median TTM revenue of the SEG Software Index above $389 million (Figure 4). Indeed, Q3’s median TTM revenue was more than twice the median TTM revenue of the SEG Software Index in 3Q08. Over this same time period, the number of public software companies has declined from 201 to 146 – further evidence that consolidation in the software sector is resulting in not only fewer, but considerably larger, publicly traded software companies (Figure 5).
Despite the marked decline in TTM revenue growth, public software companies proved especially adept at maintaining their healthy EBITDA margins in the third quarter. The median EBITDA margin of the on-premise public software companies comprising our Software Index was 19.1% in Q3, a modest improvement over 2Q12’s 18.5% (Figure 4).
Many of the most profitable on-premise software companies are industry behemoths that have the size and market leverage to drive high margins, including Oracle (43.5% EBITDA margin), Microsoft (41.7%) and SAP (36.1%). But an array of smaller, mid-cap public software companies also had a keen eye on the bottom line in 3Q12, led by CheckPoint Software (56.6% EBITDA margin), Gree (53.4%), ANSYS (47.3%), MSCI (45.0%) and NeuStar (42.0%).
The smallest player among our top ten most profitable software companies was SolarWinds, with TTM revenue of $233 million. Benefitting from a highly unique and cost effective revenue and sales strategy, SolarWinds drove its Q3 EBITDA margins to 46.5%.
Public software companies continued to maintain historically high levels of cash and equivalents on their balance sheets, undoubtedly a reflection of their elevated EBITDA margins. In 3Q08, the median cash and equivalents of the SEG Software Index was $72.9 million and the median EBITDA margin was only 12.8%. In 3Q12, median cash and equivalents had grown 117% to $158.5 million, and the median EBITDA margin had increased 49% over the four year period (Figure 6). The significant cash reserves and strong balance sheets of most public software companies, particularly the industry’s largest players, bode well for many small and mid-cap software company M&A targets.