SEG Publishes Q2 2015 Software Industry Financial Report

Pages from Software_Industry_Financial_Report_2Q15

Software Equity Group’s complimentary 2Q15 Software Industry Financial Report is available for download. Our 2Q15 Report provides the facts, data and insight you need to keep your finger on the software industry’s pulse.  We’ve assessed how public software, Internet and SaaS companies performed in Q2; how they’ve performed amid the current macro environment and technological disruptions driven by mobile and cloud computing and how their stock prices and market valuations have responded.  Our 2Q15 Report also measures M&A deal volume and exit valuations overall and by software product category.  Our goal is to provide timely information and insight about the financial health, market performance, and acquisition activity of the software industry’s key players and product sectors.

Software Equity Group’s Quarterly and Monthly Reports are widely recognized as the best way to keep your finger on the financial pulse of the software industry.  As testament, our reports are now read and relied upon by more than 70K+ software industry executives, entrepreneurs, venture capitalists, private equity investors and professional advisors in 70+ countries around the globe. Shouldn’t you know what they know?

To obtain your complimentary copy, please click here.

U.S. Economy: Software Industry Macroeconomics

The following article is from Software Equity Group’s 2011 Q3 Software Equity Industry Report.  A complimentary copy of the quarterly report can be downloaded here: http://www.softwareequity.com/research_reports.aspx

We begin with a brief synopsis of U.S. Gross Domestic Product (GDP) performance in 3Q11 based upon the latest data available at this time. GDP is best defined as the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports.

In a Wall Street Journal survey of fifty six leading economists in September 2011, the average 3Q 2011 GDP growth rate was estimated to be 2.0%, a modest but encouraging improvement over Q2’s 1.3% growth and Q1’s barely discernable uptick of 0.4%.  While 2011’s anemic growth rates and recession predictions are worrisome, growth in Q3 GDP would mark the ninth consecutive quarter of economic expansion (Figure 1).  However, the prospect of actually achieving that 2% forecast is increasingly unlikely because of the pall hanging over the world’s financial markets from the European debt crisis, head-spinning stock market volatility, and other macro uncertainty. One in three economists surveyed by the Wall Street Journal now predict the U.S. economy will slip into recession during the next twelve months.

The Conference Board’s index of U.S. Leading Economic Indicators (LEI) rose only 0.3% in August, following a 0.6% increase in July and a 0.3% increase in June.  Those predicting an impending recession need only point to the dearth of negative economic trends. Only four of the Board’s ten LEI indicators were positive: Real money supply, interest rate spread, building permits and the index of supplier deliveries.  The negative contributors, beginning with the largest negative contributor, were stock prices, the index of consumer expectations, average weekly manufacturing hours, average weekly initial claims for unemployment insurance (inverted), manufacturers’ new orders for consumer goods and materials, and manufacturers’ new orders for nondefense capital goods.

The recent employment report, released by the U.S. Bureau of Labor Statistics, provided some reason for guarded optimism.  The U.S. economy added 103,000 workers in September, sharply  beating a Bloomberg News’ survey of economists which projected only 60,000 new workers. The U.S. unemployment rate refused to budge, holding steady at 9.1%.  Information services and healthcare accounted for most of Q3’s new jobs.  One economists surveyed by Bloomberg probably sums it up best when he said, “The economy isn’t doing well, but it didn’t lose the momentum that the markets feared.”

IT Spending

The following article is from Software Equity Group’s 2011 Q3 Software Equity Industry Report.  A complimentary copy of the quarterly report can be downloaded here: http://www.softwareequity.com/research_reports.aspx

For those who may be new to our reports, SEG carefully monitors IT spending each quarter as a means of forecasting downstream public software company financial performance and M&A activity.  Several of the IT spending analysts we track modified their earlier projections of 5% – 7% growth in global IT spending, but they did not always agree.  Example: In early September, Goldman Sachs cut its 2011 IT spending forecast to 5% from 6%, citing lower IT spending in developed markets as a key driver.  In late September, Gartner increased its 2011 IT spending forecast to 7.6% from 7.1%, citing currency impacts, rather than any true underlying strength in the global IT spending.

Domestically, Goldman and Gartner are forecasting 3% and 5% IT growth, respectively, for all of 2011.  The projected domestic slowdown is largely driven by sluggish U.S. GDP growth, which Goldman determined has a 62% correlation with IT spending growth. Another basis for the spending slowdown: projections of lower S&P 500 operating profits. After operating profit growth of over 20% in 2010, Goldman is projecting S&P 500 operating profits will improve a modest 14% in 2011, and only 6% in 2012.

While 3% – 5% growth in IT spending may conform to what Goldman Sachs characterizes as “normal levels,” the wealth is not being spread evenly among IT providers.  A more granular analysis reveals the growth is driven mostly by a relatively few product categories, including cloud computing and mobility, that are receiving a rapidly increasing share of the IT budget.  Gartner is forecasting tablet spending will grow at a 52% CAGR from 2010 to 2015, boosted by 206% YoY growth from 2010 to 2011.  Goldman Sachs estimates the mobile sector, including tablets, will grow at a CAGR of 75% from 2010 to 2014.

Investments in public cloud computing and SaaS also continue to rapidly outgrow the broader IT market.  Gartner forecasts that spending on public cloud computing and SaaS will grow at a five year CAGR of 19.1% and 14.9%, respectively, from 2010 to 2015, while Goldman Sachs forecasts SaaS spending will see a 20.9% CAGR from 2010 to 2014, driving the percent of SaaS applications in the enterprise to 15% by 2014.

The shift in mindset by enterprise CIOs, from rejection to growing acceptance of SaaS deployed solutions, has been clearly noted by large public software companies.  Our 2011 buyer survey (published in our 2010 Annual Report and available on our blog) documented a 131% increase in buyers – most larger, public software and IT companies – who declared that in 2011, SaaS deployed solutions were a “very important” requisite for acquisition targets. We’ll poll buyers again in early January, but we expect the trend to continue.

Underscoring the shifting attitude of enterprise CIOs toward SaaS solutions, a recent Forrester study on enterprise spending found 44% of surveyed companies are currently implementing or planning to implement SaaS solutions.  Moreover, the scope of SaaS deployed enterprise solutions is widening.  A recent Gartner report highlighted eight distinct SaaS product categories with notable and growing enterprise penetration.  Collaboration and CRM were the most popular enterprise deployments of SaaS, at 46% and 32% respectively.  SaaS deployed ERP applications, which have struggled to gain an enterprise foothold due to their mission critical nature and significant back office application integration requirements, reached 7% market penetration.

Public Software/SaaS/Internet Company Stock Performance

The following article is from Software Equity Group’s 2011 Q3 Software Equity Industry Report.  A complimentary copy of the quarterly report can be downloaded here: http://www.softwareequity.com/research_reports.aspx

The major U.S. exchanges and the median stock price performance of public companies comprising our Software, SaaS and Internet Indices all finished lower at the close of Q3 2011.  A U.S. credit rating downgrade and European debt fears proved too much for investors, who eventually opted for capital preservation over upside potential. It was a jolting ride. In August and September, the Dow industrials changed by more than 1% on 29 days, and more than 2% on 15 days.  The volatility was reminiscent of the market’s extreme volatility in Q4 2008.

By the close of the third quarter, the Dow, S&P 500 and NASDAQ were down 5.7%, 10.0% and 9.0%, respectively, from the first trading day of 2011 (Figure 2).  During the same period, the SEG Software, SEG SaaS and SEG Internet indices were down 9.5%, 17.9% and 20.5% respectively.  The dramatic decline of public Software, SaaS and Internet company stock prices reflects an investor selloff of relatively risky technology stocks and a flight to Treasurys.  Across all three SEG tracking indices, 197 (71%) of the 278 public companies comprising our indices reported lower year-to-date (YTD) stock prices, far greater than the 99 companies (35.6%) that saw their stock prices decline by the close of 2Q11.  Still, ten outstanding software companies managed to achieve YTD stock market returns on September 30 that exceeded the first trading day 2011 closing price by more than 45% (Figure 3).  Included in the group is Internet high flyer, LinkedIn, which posted a 74% YTD return over its first day closing price in May of this year.

Public Software/SaaS/Internet Company Market Valuations

The following article is from Software Equity Group’s 2011 Q3 Software Equity Industry Report.  A complimentary copy of the quarterly report can be downloaded here: http://www.softwareequity.com/research_reports.aspx

The median market valuations of public companies comprising the SEG Software, SaaS and Internet indices, measured as a multiple of EV/Revenue, were 2.1x, 4.8x and 2.6x, respectively, at the close of the third quarter (Figure 4).  Although these Q3 median EV/Revenue multiples declined across the board from Q2, they were still markedly higher than from a year ago.

Bucking the lower market valuation trend were ten public software, SaaS and Internet companies that closed 3Q11 with stellar EV/Revenue multiples of 12.2x or higher, primarily because investors clearly resonated with their stellar median revenue growth rate of 67% (Figure 5).

Baidu, known as “China’s Google”, once again led the pack with a median 3Q11 market valuation of 29.9x EV/Revenue.  Baidu reported year-over-year revenue growth of 83.7% (which is extraordinary, considering revenue exceeds $1B), and a remarkable EBITDA margin of 56.9%.  Baidu narrowly beat out Qihoo, a Chinese provider of online security that went public in 2011, for top market valuation honors.  All told, five of the ten EV/Revenue high flyers are headquartered in China, demonstrating continued investor enthusiasm for the mammoth Chinese domestic market, despite lingering concerns about inflation and slowed growth

Public Software Company Financial Performance

The following article is from Software Equity Group’s 2011 Q3 Software Equity Industry Report.  A complimentary copy of the quarterly report can be downloaded here: http://www.softwareequity.com/research_reports.aspx

The median TTM revenue of the 144 public companies comprising the SEG Software Index grew 14.7% in 3Q11, compared to 14.1% the prior quarter (Figure 6).  The 14.7% median TTM growth rate was the highest of any quarter since 2Q07 (16%), and pushed the median TTM revenue of the SEG Software Index above $300 million for the first time ever.  The $300 million milestone was achieved less than three years after the median TTM revenue of the SEG Software Index surpassed $200 million in 1Q09 – further evidence that consolidation in the software sector is resulting in not only fewer, but considerably larger, publicly traded software companies.

The Street strategy of many public software companies in 2011 has been to forecast conservative revenue growth in case of a sharp economic downturn, then beat their guidance if it didn’t materialize.  According to our random sample of 28 public software companies with recent earnings calls, 23 (82.1%) exceeded their forecast revenue projections (Figure 8).  With only one quarter left for CIOs to spend previously approved IT budget money, look for further improvement in the 4Q11 SEG Software Index median TTM revenue growth rate.

Unsurprisingly, public software companies that are focused on the hottest IT spending categories and vertical markets, including mobility, cloud infrastructure and healthcare, grew their 3Q11 TTM revenue far more aggressively than the 14.7% median.  Among the most noteworthy: mobility players Trunkbow International Holdings (104.4%), Gree (82.2%) and Opera (32.9%); healthcare players Merge Healthcare (134.4%) and eResearchTechnology (80.3%); and cloud infrastructure and optimization players F5 networks (36.0%) and VMWare (37.8%).

Throughout the Great Recession, as growth rates plummeted, public software companies shifted attention to the bottom line and grew their EBITDA margins from a median 11.2% in 4Q07 to a high of 19.4% in 3Q10.  The median EBITDA margins of SEG Software Index companies was 18.4% at the close 3Q11, slightly below the peak. In unpredictable times, achieving forecasted profitability is no easy feat. Of the 28 public software companies in our random sample, only six (21.4%) beat their EPS forecast to the Street (Figure 8).  Among the industry’s largest players, Microsoft was the only $500+ million revenue company in our random sample to exceed its earnings target.

Public software balance sheets remained healthy in 3Q11.  Median cash and equivalents were $117.4 million, up 10.7% year-over-year and current ratios remained at a healthy level of 2.0 (Figure 6).  The steady increase in the cash reserves of most public software companies over the past few years has undoubtedly been a by-product of their much improved EBITDA margins. Consider that in 3Q07 when the median EBITDA margin was only 11.2%, the median cash and equivalents of the SEG Software Index was $70.5 million.  In 3Q11 the median EBITDA margin was 18.4% and median cash and equivalents had grown to  $117.4 million, a 60% increase from four years ago (Figure 9).  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 targets.