By Ken Bender, Managing Director, Software Equity Group, L.L.C.
Software M&A deal volume has declined sharply and median exit valuations
have plunged. For many private software companies, it’s a buyer’s market, and
today is undeniably the wrong time to sell. But a good number of others could
exit today at a superb valuation, and we have the data to prove it. Problem is,
these highly opportune prospective sellers, beaten down by the relentless flood
of economic bad news and lower median software valuations, refuse to leave the
storm shelter and come to the table!
The decline in M&A activity and valuations, detailed below, should come as no
surprise. It happens in every recession. GDP drops; IT capital spending declines
and public software company revenue growth slows. As a result, some large public
software companies feel much less pressure to acquire, and software M&A activity
and valuations decelerate. In addition, a good number of VC-backed companies are
deemed undeserving of additional funding and disposed of by fire sale. This
recession is proving no exception. The median exit multiple of U.S. software M&A
transactions was 1.1x TTM revenue in 1Q09, compared to 2.1x TTM revenue in 2007.
While there were a notable number of transactions in the 1.5x – 2.0x TTM revenue
range, it’s reasonable for many ISVs to bide their time until lifted by a rising
M&A tide. That could be months, or years, from now.
What’s surprising, and what makes this recession very different from any we’ve
experienced in our 17 year history of software industry investment banking, is
the number of private software companies that could fetch a premium exit price
today but refuse to believe it. Buyers have the cash, mindset, motivation and
mandate to acquire software companies they deem highly strategic, but ISVs seem
disbelieving or oblivious.
In support, we offer hard data, buyer survey results, and a substantial amount
of anecdotal evidence.
In January 2009, Software Equity Group surveyed the VP’s of Corporate
Development, CFOs, and CEOs of 203 of the largest software companies in North
America, both public and private. Collectively, these companies are the most
active acquirers of software companies and their acquisition activity heavily
influences M&A trends in the software industry. We received an excellent
68% of respondents to our survey indicated they plan to acquire at the same or
greater rate than the past few years, with the majority indicating an expected
increase in acquisition activity. Indeed, the survey responses seemed to portend
greater software industry deal volume in 2009 than in 2008. 96% of respondents
expect to acquire at least one software company in 2009, compared to 68% who
actually acquired at least one software company in 2008. The percentage of
respondents that plan to acquire three or more software companies in 2009
almost doubled from the percentage of those that did acquire three or more
software companies in 2008 (28%).
Our survey data is further borne out by our ongoing, frank and revealing
conversations with the corp dev heads, CFOs and CEOs of some 125 public software
companies over the past three months. They are frustrated and perplexed by
smaller software companies that are seemingly uninterested in being acquired.
These public software companies have the appetite, the Board mandate and balance
sheet cash, but sellers – those with best of breed suites and point solutions,
solid revenue and good profitability – are not to be found.
What makes a software company today a highly desirable strategic acquisition
target worthy of a hefty multiple? The buyer must perceive the seller to be
vital to customer acquisition and retention, competitive differentiation and/or
incremental revenue. Our respondents unequivocally confirmed the leading M&A
drivers in 2009 are products and technology, with 44% of respondents indicating
they’ll acquire in order to fill product gaps and extend the functionality of
Simply being highly strategic, however, may not be enough to garner a 3x, 4x or
higher multiple in the current market. It also helps to be profitable. The
responses to our survey also confirmed the expected shift in buyer preference
from targets with aggressive compounded annual revenue growth (usually to the
detriment of the bottom line) to companies with a strong EBITDA margin. During
an economic downturn, when larger software companies themselves focus
obsessively on profitability as a way of ameliorating Street concern about
little or no top line growth, there’s a very strong bias in favor of accretive
Further proof that for some software companies their ship has not sailed: While
52% of respondents to our survey indicated they’d expect to pay a median 31%
less in 1H09 than they paid in 1H08 for the same companies, our in-depth
analysis of each of those 1H08 transactions revealed these buyers paid a median
5.9x TTM revenue purchase price. Applying a 40% discount lowers the anticipated
revenue multiple to 3.5x, not too shabby an exit valuation in today’s market, or
Has it held true? Have buyers actually demonstrated a willingness to dig deep,
even in the current market, for acquisition candidates they deemed strategically
vital? The table below includes a wide array of software M&A transactions in the
past six months with exit multiples considerably in excess of the 2.1x TTM
revenue median valuation of pre-recession 2007.
So what’s wrong with waiting, even if you’re highly strategic and could attract
a really healthy exit valuation today? Perhaps nothing, or perhaps everything.
First, prior success may not portend future success, and for the private
software company, there are ongoing execution risks. Any event that adversely
impacts revenue, profitability or market share may well have a materially
negative impact on exit value.
Second, buyers today have cash and a mindset to buy. A privately held $5
million, $15 million or $50 million software company that’s perceived to be
highly strategic will garner their full and undistracted attention today. When
the economy recovers it will be much, much harder to get and keep the attention
of these public software companies as they focus on considerably bigger ticket
opportunities that will consume their resources and relegate smaller companies
to much lower on the shopping list.
Third, and perhaps of greatest concern, although most of the justifiably proud
ISVs we know would argue their solutions are best of breed with high barriers to
entry and several years lead time, in truth many are at considerable risk of
being marginalized and imperiled in three years or so when M&A volumes and
valuations recover. Today’s motivated buyer will almost certainly develop a
competing, good enough solution internally or acquire and invest heavily in a
less viable competitor. We’ve seen it happen time and again.
|| Buyers/ Investors
Transaction Value ($mm)
Group Plc (LSE:QQ.)
Group plc (AIM:GTX)
Forward Inc. (NasdaqGS:PFWD)
Systems, Inc. (NasdaqGS:CSCO)
Telephonetics Plc (AIM:TPH)
Technology, Inc. (NasdaqGS:RVBD)
Coaching Platform Ltd.
Solutions Group plc
Entertainment SA (ENXTPA:IFG)
In Motion Ltd. (NasdaqGS:RIMM)
Networks, Inc. (NasdaqGM:CAVM)
1Q2009 Software Industry M&A Recap
Software M&A Deal Volume and Spending
Software M&A transactions accounted for 16.2% of all U.S. M&A activity in 1Q09,
up from 15.5% in 2008. The first quarter’s 296 software mergers and acquisitions
had an aggregate purchase price of $7.3 billion, compared to 511 transactions
aggregating $24.3 billion in 1Q08.
While the drop in software deal activity represents a hefty but not surprising
42.1% year-over-year decline, total dollars spent plunged 70.0% compared to
1Q08, primarily because of the dearth of software industry mega-deals
(transactions with enterprise values greater than $503 million). Of 1Q09’s $7.3
billion total outlay, $5.4 billion was spent on two major transactions:
Interwoven’s acquisition by Autonomy ($582.3 million, 2.2x TTM revenue), and
Metavante Technologies’ acquisition by Fidelity National Information Services
($4.8 billion, 2.8x TTM revenue. The balance of $1.9 billion dollars was paid
for the remaining 294 software companies acquired. By comparison, 1Q08’s $24.3
billion total price tag included $18.1 billion from six mega-deals, with the
remaining $6.2 billion attributable to smaller transactions. Simply put, there
were approximately three times as many mega-deals and corresponding dollars
spent in 1Q08 than in 1Q09.
A quarter-by-quarter analysis of U.S. software M&A activity is equally
instructive. Through the first three quarters of 2008, aggregate deal activity
trailed 2007 by a modest 4.0%, and the aggregate purchase price was 16.9% less
(Figures 17 and 18). In 4Q08 and 1Q09, however, deal activity and M&A spending
both cratered. In fact, 1Q09 posted the lowest quarterly U.S. software deal
total since post-bubble 4Q03, when 259 deals aggregating $6.7 billion were
Public buyers accounted for approximately 33% of all software M&A purchasers in
1Q09, notably fewer than the previous three quarters (Figure 20). The largest 20
software companies made nine acquisitions in 1Q09, compared with 28 in 1Q08.
Apparently, public buyers, noting reduced IT spending and much less demand for
replacement systems, add-ons and upgrades, felt little pressure to acquire. For
some, reduced M&A spending was a way of signaling caution and conservatism to
watchful investors and analysts. Others were focused on downsizing to preserve
EBITDA margins, and acquisitions were deemed to be distracting and unseemly in
the face of layoffs.
Trends in M&A Valuations
On a TTM basis, the software industry’s benchmark exit metric fell in 1Q09 to
1.3x TTM revenue, down 19% from 1.6x TTM revenue in 4Q08, and down 35% from 2.0x
TTM revenue in 2Q08 (Figure 21).
We also analyzed 1Q09 exit valuations on a multiple of EBITDA basis. There was
insufficient publicly reported data this quarter to ascertain enough private
seller EBITDA multiples to derive a median exit valuation on that basis, so we
analyzed public seller EBITDA multiples only. Public software company sellers
commanded a modest 12.5x TTM EBITDA, down from 4Q08’s 15.6x (Figure 22). Here
again, the median M&A valuation reflected the trend in public market valuation,
which fell from a median EV/EBITDA of 8.0x in 4Q08 to 7.2x in 1Q09. Due to an
array of factors, including liquidity, many private software companies would
likely be valued by buyers at a considerably lower EBITDA valuation multiple
than public sellers.
Once again, we caution our readers about using median TTM revenue and EBITDA
exit multiples to assess the fair market or prospective exit valuation of a
particular software company. It’s more likely than not you’ll be far off the
mark. Examples abound of companies selling for modest multiples in strong
economies and eyebrow-raising multiples in tough economic times. In every
economy, the software company valuation range is wide and the valuation drivers
are many and varied.
Over the past two years, vertical software transactions have comprised an
unprecedented percentage of total software M&A transactions and vertical
software median exit valuations have reached historic highs. Vertical software
deals remained a healthy percentage of total software M&A deal volume in 1Q09,
but the relatively high exit multiples may be abating (Figure 23).
We believe vertical software providers are more vulnerable than their
infrastructure counterparts to a sharp and sustained economic downturn. Many of
the industry sectors targeted by the vertical providers – retail, manufacturing,
state & local government, education and financial services, to name a few – have
been very hard hit by the recession. As these vertical market customers
implement major layoffs and sharp IT spending cuts, vertical software providers
are seeing cutbacks in the number of licensed users and postponed sales and
upgrades. As a result, many vertical software companies are reporting steeper
revenue declines than their horizontal counterparts, and acquirers are taking
advantage by proffering lower offers.
For a complementary copy of Software Equity Group’s 1Q09 Software Industry
Equity Report, which is a comprehensive analysis of public software company
financial performance and software industry mergers and acquisitions, and
includes the previously mentioned figures, please visit
Software Equity Group is an investment bank and M&A advisory
serving the software and technology sectors. Founded in 1992, Software Equity
Group has represented and guided private companies throughout the United States
and Canada, as well as Europe, Asia Pacific, Africa and Israel, and has advised
public companies listed on the NASDAQ, NYSE, American, Toronto, London and
Euronext exchanges. Software Equity Group also represents several of the world's
leading private equity firms and was recently ranked the number one boutique
investment bank worldwide for application software mergers and acquisitions.