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Sector Update
EUROPEAN SAAS – AN ENVIRONMENT RIPE FOR
November 2009
INVESTMENT
Software-as-a-Service
4. Business-
domain SaaS
Provide tenant-
specific
3. Single-app SaaS configuration of
Provide one multiple packaged
SaaS 1.0
packaged business apps and custom
app out of one multi- extensions on a
2. Industrial ASP tenant app to many multi-purpose, multi-
Provide configured clients tenant platform
apps to many clients
1. Manual ASP
Provide similar apps
to multiple clients
0. Outsourcing
Delegate operations
of existing apps
Index Performance
120%
110% Time
100%
The SaaS 2.0 Opportunity
90%
Recently we have seen on-premise only application vendors such as Microsoft,
80%
70%
Oracle, and Adobe embrace the SaaS trend – either via their own offering or through
60%
acquisitions.
50% Despite this, pure-play SaaS vendors have been able to continue to dominate in the
40% near term, with the ongoing rapid entry of new companies into the market. We
Aug-08
Aug-09
Dec-08
Apr-08
Apr-09
believe that SaaS businesses remain attractive investment opportunities and expect
interest in SaaS opportunities to increase as the IPO and M&A activity starts to pick
up.
SaaS
Nasdaq Index Most recently, the acquisition of Gomez, Inc. by Compuware for $299m (sales
multiple of 5.5x) in October and the successful IPO of LogMeIn in June, highlight the
Claudio Alvarez level of activity and interest in the SaaS sector.
claudio@gpbullhound.com
London: +44 (0) 207 101 7571
In this report we discuss why SaaS fundamentals continue to be strong and
why now is the time for investors to seriously consider European SaaS
Per Roman
companies as attractive investments.
per@gpbullhound.com
London: +44 (0) 207 101 7567
WHY SOFTWARE-AS-A-SERVICE
Upfront costs: the upfront license fee paid by the customer was typically
millions of dollars. Thus, once the decision to go with a vendor was made, it
was very hard (and costly) to undo;
Since the on-demand evolution has been a gradual shift from the original
business process outsourcing (BPO) of non-mission-critical areas such as payroll
through the application service provider (ASP) wave to what we now define as
SaaS, we define upfront some of the major flavours of what vendors offer today.
For SaaS there is only one application that multiple users use, as opposed to
different, individual, hosted, versions of an application for each user. All customer
data is co-mingled in databases on the back end.
Software upgrades are painless: under the SaaS delivery model upgrades
occur much more frequently, giving customers continuous access to
innovation. SaaS vendors typically release upgraded applications multiple
times a year. In the multi-tenant case, since all customers are on the same
version of the software, the upgrade for everyone can be easily performed.
This also results in just one version for the vendor to maintain, which cuts
down their R&D costs as well.
In the SaaS model, the vendor takes care of hosting the product and,
thus, incurs the additional costs of hardware, IT professionals, etc.:
these costs are passed on to the customer, but as the vendor is focused on
one application, there are typically synergies to be had from the vendor
managing the back end.
As SaaS has successfully tackled the issues of cost, security and time, it has
been able to grow robustly while taking share from on-premise software
providers.
WHY NOW?
High
SaaS 1.0 – Cost-Effective Software Delivery Enterprise
Routine
Software cost reduction and total cost of ownership
Users
paramount
Service level improvements
Rapid implementation
Match IT expense to business activity
Horizontal solution focus
Stand-alone/configurable SaaS applications
Rudimentary applications/data integration, with some
use of web services
Subscription and PAYG pricing
Adoption
We believe that the SaaS industry is at the mid section of the second part of its
“S-Curve” adoption. However, several factors are contributing to broader adoption
of SaaS software, in our view.
The ubiquity of the Internet and Internet access points coupled with
bandwidth cost reductions has made the use of software on-demand feasible
from both a cost and convenience standpoint.
Security less of a show stopper: with applications being accessed over the
Internet, there comes an increased chance that sensitive data can be
intercepted or tampered with. Current security and identity and access
management solutions have helped alleviate customer fears around SaaS
application security. There are absolutely customers who prefer on-premise
software or are unable to get comfortable with having their data stored
outside their data centre. That said, we believe this will become a shrinking
group of companies as SaaS providers develop a longer track record of
secure service to technology and security savvy customers.
The survey, which was conducted in December 2008 among users and prospects
of SaaS solutions in 333 enterprises in the U.S. and the U.K., found that nearly 6
in 10 companies will maintain their current levels of SaaS in the next two years.
Some 32% will extend SaaS usage and only 5% will decrease levels.
Exhibit 3 – Current and Next Year’s % of Software Licenses Delivered via SaaS
50%
45%
45% 41%
40%
35%
% of Respondents
29%
30%
25%
25%
20%
15%
15%
9% 10%
10% 8% 8%
6%
5% 1% 0% 0% 1%
0%
None 0-5% 6-10% 11-15% 16-20% 21-25% More than
Currently In One Year 25%
Reasons for the relative success of SaaS providers with larger enterprises have
been: (i) SaaS vendors have started providing more customisable business-
critical applications which drive front-office decisions such as, financial
settlement, order fulfilment procurement, supply chain management and logistics;
(ii) the customer can test software with smaller deployment which does not
interrupt incumbent system. This removes a great deal of risk for the customer,
while also allowing for quicker implementation decisions; (iii) the vendor, not the
In this economic environment, lower costs have also been one of the main factors
to contribute to the success of SaaS penetrating the large enterprise market. The
fact that SaaS doesn’t require a large upfront license fee makes a lot easier for
SaaS vendors to displace legacy software platforms. Furthermore, SaaS’ ability to
scale (i.e. add more seats) without the need to increase the customer’s overall IT
footprint as all seats are hosted by the vendor.
Reduce risk
Increase revenue
As the industry moves into SaaS 2.0 we believe that platform functionality and
leveraging of SaaS technology with internal platform will become key topics for
companies looking to use SaaS services. Given this SaaS providers will have to
maintain a good degree of innovation coupled with a high degree of services in
order to maximise functionality and increase the level of integration within large
enterprises.
70-95%. The top performing SaaS companies typically achieve annual customer
renewal rates above 90% - with most of the churn due to bankruptcies or
acquisitions - and over 100% renewals on a dollar value basis due to up-sells into
this installed base.
Solution functionality
System response time
Availability or uptime
Pricing terms and conditions SaaS 1.0
Backup & recovery capability
Accountability for quality of service
Responsiveness to support requests
Security & privacy
Data access & analysis capabilities
Personalisation capabilities
Workflow capabilities SaaS 2.0
Customization capabilities
Integration capabilities
From exhibit 5 we can see that for SaaS 1.0 functionality, response time,
availability and pricing have been the top four categories customers have focused
on. The subscription-based model and high level of satisfaction for the
aforementioned categories have led to high renewal rates, which is integral for
the success of a SaaS business.
As we move into SaaS 2.0 categories such as (i) data access & analysis
capabilities, (ii) personalisation capabilities, (iii) workflow capabilities, (iv)
customisation capabilities and (v) integration capabilities. SaaS companies will
have to continue innovation in these categories in order to further penetrate the
Enterprise market and maintain their high renewal rates.
Large
> 1,000
~84k
Mid-Market
100-1k Employees
~1.2m Firms
Small
< 100 Employees
~55.4m Firms
However, given the much larger size of the SME market – it is estimated that
globally there are ~84k large enterprises versus ~56.6m SMEs – we believe that
higher adoption rates within large enterprises will not necessarily translate into
more financial success for some SaaS vendors as large enterprises will demand
more customised applications which naturally take up more time and resources,
and whose customised platforms are not always transferable to other clients.
6.0%
0.0%
-0.1%
-3.0%
-2.8% -2.9% -2.9% -3.2%
-3.8%
-6.0%
Less than $500m-$1bn $1-10bn $10bn+ Overall
$500m
Given the high level of optimism of IT spending within the SME community and
SaaS vendors ability to generate profitable scale through successfully servicing
the Enterprise segment, we believe that SaaS vendors will try to strike a healthy
balance between Enterprise and SME customers in order to fully optimise their
business plans and scale in a profitable manner.
MARKET UPDATE
According to Gartner, the SaaS market is forecast to reach $8bn in 2009, a
21.9% increase from 2008 revenue of $6.6bn. The market will show consistent
growth through 2013 when worldwide SaaS revenue will total $16 billion for the
enterprise application markets.
The main factor for this solid level of growth has been the continued rate of
adoption of SaaS as vendors continue to evolve within the enterprise application
markets. The increased rate of adoption has been due to tighter capital budgets
in the current economic environment demand leaner alternatives, increased
popularity and heightened interest for platform as a service and cloud computing.
SaaS adoption varies between and within markets. Although usage is expanding,
growth remains most significant in areas characterized by horizontal applications
with common processes, among distributed virtual workforce teams, and within
Web 2.0 initiatives.
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
2007 2008 2009 2010 2011 2012 2013
CCC Offices Suites DCC CRM ERP SCM Other Application Software
Source: Gartner
Office suites and digital content creation (DCC) remain the fastest-growing
markets for SaaS. Office suites are projected to total $512m in 2009, up from
$136m in 2008, while DCC is forecast to total $126m in 2009, up from $70m in
2008.
The traditional DCC market (estimated to be north of $4bn) has started to see the
shift from on-premise to SaaS as the overall market is being defined by a move
away from proprietary systems toward mainstream, desktop-based systems. Most
companies selling professional DCC tools are trying to adjust to this trend
because there is an obvious positive side: as tools become more accessible in
price and ease of use, there are more people who can take advantage of them.
The adoption of SaaS within enterprise resource planning (ERP) and supply
chain management (SCM) varies based on process complexity. SaaS is expected
to represent only about 1% of ERP manufacturing and operations revenue, but
more than 18% of human capital management (HCM) and 30% of the
procurement segment by 2013.
5,000
4,000
4.6% CAGR
3,000
2,000
1,000 7.0% CAGR
0
2008 2009 2010 2011
Maintenance Licenses Subscription
Source: Forrester
The CRM market exhibits more general market adoption, ranging between 9%
and more than 33% of total software revenue, depending on the CRM sub
segment. Overall, SaaS accounted for more than 18% of the CRM market total
revenue in 2008.
SaaS currently accounts for a relatively small component of the overall software
market and most IT budgets. Specifically, SaaS applications accounted for only
3.3% of worldwide software spending in 2008. We expect this market to continue
to gain “wallet share” from traditional software solutions, as organisations adopt
the lower total cost of ownership, increasingly flexible and more agile SaaS
offerings. As such, we expect on-demand software to grow to 5.9% of the
worldwide software market by 2013.
Exhibit 10 – SaaS Market Share 2008 & 2013
2008 2013
SaaS SaaS
3% 6%
Traditional Traditional
Software Software
97% 94%
10
Low cost of sales: another convincing aspect of the SaaS model is the low
total cost of sales associated with these companies. The product is available
for demonstration, evaluation, and long-term use right over the web. While
some customer accounts may still require in-person sales, the vast majority
can at least get up and running without an on-site customer visit. As a result,
a great SaaS company can be very successful at a “land and expand”
strategy.
Customer stickiness: most if not all SaaS offerings require that the
customer input or import data into the service. For example, a human
resources management offering would likely require a customer to import its
organizational data. Having the customer complete the initial work is critical,
and sometimes challenging. But once the customer does this, they are likely
to stick as long as they are getting some value from the product. Having gone
through the process once, they are not likely to switch to another system.
Moreover, extracting and exporting data from service based offerings is
harder than it was with installed software.
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usually in the 90% plus range. On-demand vendors take on the full cost of
delivery and maintenance as well. Hence, spend on data centres and
networks to support the application have a negative impact on cost of goods
sold, lowering gross margin into the 60-80% typically.
Operating costs are front-end loaded: customer acquisition costs for SaaS
companies when compared to their first year of revenue from the customer
are high, since the company is counting on creating a high margin recurring
revenue stream from the customer. Thus, key metrics to watch include: (1)
changes in customer acquisition costs; (2) ASPs; (3) contract lengths; and,
(4) customer churn.
In the early growth stage of a SaaS company, a higher portion of revenue is likely
come from lower margin professional services, as customers need help with the
initial implementation. However, over time as the company builds a base of
renewing subscribers, professional services will become a smaller portion of
revenues increasing gross margins.
Most SaaS companies sell their products not as perpetual licenses, but on a
subscription basis. Users typically sign up to pay a monthly subscription fee for a
period of time (usually somewhere between one and three years). This monthly
subscription fee covers both the license and the maintenance portion of the fee
the user would pay had they purchased a perpetual license. The subscription not
only gives the user the access to the software, it also by default gives them
access to all updates and patches as the provider has just one version of the
software and, thus, all users are on the latest version. It is this different sales
model that in part leads to higher multiples for growing on-demand vendors.
To illustrate this point, we will look at two sample companies that sell the same
software. The first company, “OnPremise Co.” sells the software as a perpetual
license, while the second, SaaS Co. sells its software on a subscription basis.
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We will assume that OnPremise Co. sells its license for a price of $5m with yearly
maintenance of $1m and that SaaS Co. sells its software as a service, for a
subscription price of $2m per year. Exhibit 11 illustrates customer payments to
both companies over the life of the application.
$4 $4
$3 $3
$5
$2 $2
$1 $1 $2 $2 $2 $2 $2
$1 $1 $1 $1
$0 $0
Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5
Source: GP Bullhound
In Exhibit 11 we can see that a customer pays significantly more upfront for the
perpetual license, but over time the subscription fee catches up in total cost, as
the customer is paying for both the license and the maintenance in years two
through five. The sum of the payments over the life of the software is $10 million
for both applications and under our simplified analysis, the OnPremise Co.
customer would need to redeploy a new application beginning year six, starting
this process over again.
We now look at how revenue multiples for these two companies would differ over
a three-year growth period. Again, our analysis simplifies the situation, but allows
us to understand the disparity we see in multiples. For our analysis, we assume
that both companies make one sale in year one, two sales in year two, and four
sales in year three.
Source: GP Bullhound
Exhibit 12 illustrates the revenues we would expect from OnPremise Co. and
SaaS Co. Despite the fact that the two companies are selling the same number of
applications per year, we can see that OnPremise Co. has three times the
revenue of SaaS Co. in year one and nearly twice the revenue of SaaS Co. in
year three. With OnPremise Co. growing revenue at more than 100% over year
one, it would not be unreasonable to see a multiple of 2x placed on its first year-
end license revenues at the beginning of year one. As the companies are selling
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the same number of the same licenses for the same total cost, it would be logical
to assume that the two companies should receive the same value in the
marketplace. This would equate to a 4x revenue multiple for SaaS Co. in year
one.
Our analysis overly simplifies the situation, as many companies who sell
perpetual licenses would only recognise a portion of the license revenue upfront
and would then recognise the remaining portion over the life of the application.
Thus, we would expect lower revenues and higher multiples for a company like
OnPremise Co. The subscription fee for SaaS Co. would also likely be higher
than the $2m we estimate in our example, in order to make the present value of
payments received over our five-year period equal to the value of the payments
that OnPremise Co. would receive over that same period, thus lowering SaaS
Co.’s revenue multiple. That said, these two corrections would bring the two
multiples closer together, but SaaS Co., the on-demand subscription model,
would still have a higher multiple in the growth phase due to the fact that these
two companies should have the same value.
10.0% 9.3%
7.5%
for 2008/09
8.0% 6.4%
6.0%
4.0%
2.0%
-0.2%
0.0%
-2.0% $1B+ Rev Avg. Software $100-1B Rev <$100B Rev SaaS
Source: CapIQ
Given the high-growth nature of SaaS businesses they have historically traded at
a higher sales multiple. However, this has recently changed as growth forecast
for SaaS businesses keep being revised downward.
Exhibit 14 – Average Growth Rates for SaaS Sector and Revised 08/09 Forecasts
60.0% 55.0%
50.0% 46.0%
40.0% 32.0%
30.0% 24.0%
20.0%
20.0% 12.0%
10.0%
0.0%
06/07 07/08 Oct-08 Dec-08 Feb-09 Oct-09
08/09 Growth Projection
Source: CapIQ
14
The current forecasted 08/09 revenue growth rate for SaaS businesses is 12%,
one third of the actual 07/08 growth rate and down from 32% in forecasted in
October 2008. Given the early nature of most SaaS business and the current
economic cycle, changes in growth forecasts has impacted SaaS valuations more
than traditional software valuations.
Exhibit 15 – ‘09 EV / Sales Multiple for Enterprise Software and SaaS Sector
4.3x 4.2x
SaaS
4.0x Enterprise Software
3.4x
3.4x
3.1x
3.1x 2.9x 3.3x 3.3x
2.8x
3.0x
2.8x 3.0x
3.0x
2.9x
2.5x
Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09
Source: CapIQ
We can see the effect of lower growth forecasts on SaaS multiples in the exhibit
above. It shows that since April of this year the SaaS sector has been at a
discount to the Enterprise Software sector. We believe this to be a temporary
state and have already experience a reversal. We anticipate current multiples
trends to continue as market and economic conditions normalise and investors
continue to focus on the predictable nature of SaaS revenues.
15
16
17
Single Sign‐On
Web Services / Features
RC Agents Voice
Backup Survey Bots Chat
DSA Video
Customization Layer
Integration Layer
Welfore GmbH provide small and mid sized enterprises (< 100
Employees) as well as project based environments at larger
enterprises cost effective, standardized and highly automated
modular business processes across all sectors, but with a clear
focus on trade and services. This will be achieved by using intelligent and standardized
process models, which will be offered as time and location independent SaaS.
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SECTOR VALUATIONS
19
M&A Transactions
Consideration Sales
Date Acquirer Target Target Description
($m ) Multiple
Provides on-demand softw are to healthcare
Apr-08 Nuance Comm. eScription 368.1 8.2x
enterprises
Develops, licenses, and supports proprietary
Apr-08 Apax Trizetto Group Inc. 1,258.7 2.8x and third-party softw are products for the
healthcare industry
Provides on demand talent management
May-08 Taleo Corp. Vurv Technology 131.2 2.6x
softw are for businesses
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Analyst Profiles
GP Bullhound is a research centric investment bank headquartered in London
with offices in San Francisco.
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