Bruce Stuart: Calculating the business valuation of the cloud

What do we know about the impact of entering the SaaS business on the potential value of your business?  After all isn’t that what it is all about…increasing the value of your business.  We are beginning to learn a great deal.  The focus and purpose of this installment is to help you understand the potential for increasing the value of your business by investing in a recurring revenue future.

The experience-the multiples

In the software business it currently appears that full line /mature software companies are being valued differently then their cloud/SaaS counterparts.   Price earnings ratios of a portfolio of publically traded cloud and SaaS centric software companies are trading at approximately two to three times the price earnings ratios of a portfolio of more established on premise focused companies.  We also know from recent merger and acquisition activity that some very strong earnings multiples are being paid for cloud and SaaS centric organizations.

In the partner business we know that values of cloud/SaaS and even managed print services partners are anywhere from two to four times that of partners of the same size (in revenue terms) not employing an annuity model.

The value acceleration

What is it about the cloud, SaaS or MPS business that suggests that it will provide a dramatic acceleration to the growth of the value of your business?  There are in fact a number of drivers that would support the expectation of valuation acceleration:

  • Cloud/SaaS/MPS contracts are annuities
  • EBIT
  • ROIC
  • Demand growth

When one of your salespeople sells a recurring revenue contract of three years in duration, the net present value of every dollar of monthly revenue is worth approximately $2.50(assuming a 10 per cent discount rate, no up sell and no client loss).

The various cloud/SaaS businesses as they currently structured and modeled looks like it can comfortably generate a sustainable EBITA in the range of 25-30 per cent within 24 to 36 months of startup.

The business, after the first two or three years, appears to have no problem generating rates of return on invested capital far in excess of the cost of the invested capital.  Every percentage point of ROIC in excess of the cost of capital goes straight to the growth of company value.

Growth in the recurring revenue (cloud/SaaS/MPS) business happens in three ways.  We know that over time the average contract size sold by a cloud or SaaS partner increases.  We also know that a certain percentage of clients are “up sold” during the course of a contract, meaning the monthly contract amount goes up.  We also know that the market for cloud and SaaS solutions is forecast to be growing at 25-35 per cent per year with no reason to expect that most reputable cloud/SaaS solutions will not attract new clients at that rate or higher.

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Adding recurring revenue to the transactional revenue of your organization will have a multiplied impact on your business.  We estimate that for every percentage point of recurring revenue that you add to the transaction driven revenue blend of your business you will increase the value of your business by 2-3%.  Think about it!

Contemplation points

What would we like you to be thinking about as a result of what you just read?

There is mounting evidence that cloud and SaaS centric businesses are worth more per revenue dollar then their transaction driven, on premise counterparts, even if the on premise counterparts are more established.  The multiple is material and appears to be in the range of 2-4X, depending on the specific circumstances.

There are a number of key business drivers that would support the expectation in the growth of the value of your business with the addition of a recurring revenue driven business or cloud practice.

Properly executed, your recurring revenue business can add up to 2-3 per cent to the value of your business for every percentage point increase in the revenue blend of your business.  For example, taking your business to a 10 per cent recurring revenue blend (from zero percent) could increase its value by 20-30 per cent.

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About Channelcorp

Margaret and Bruce Stuart founded Channelcorp in 1989.  The firm is a global leader in the assistance of reseller, distributor and vendor clients. Channelcorp specializes in the business model transformation that is required in the face of the structural changes to recurring revenue driven business models in the worldwide IT business (www.channelcorp.com/services.php).  Channelcorp publishes and sells four industry- leading books and 12 white papers (www.channelcorp.com/publications.php).  

 

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