Revenue trumps earnings as PE mops up B2B SaaS firms

Software-as-a-service companies that cater to business-to-business firms are seeing increased M&A activity as players jostle for superiority, particularly those backed by private equity. This trend has included high-profile platforms such as Access, first backed by Lyceum and now owned by Hg Capital and TA Associates, which has made more than 20 acquisitions under private equity ownership. Advanced, a B2B software firm bought by Vista Equity Partners, has made six bolt-ons, acquiring UK field services management software firm Kirona in April this year. Others include Iris Software, backed by Hg and Intermediate Capital Group in a £1.3bn buyout in 2018, and Advent's Unit4.

"I doubt that in other sectors you have the same degree of aggressiveness in terms of PE pursuing buy-and-build strategies," says Eric Sanschagrin, head of TMT transaction advisory at EY. A feature of the market has been a focus on revenue multiples rather than earnings. "A lot of the SaaS businesses are on a rapid growth trajectory. Most SaaS businesses being valued on a revenue multiple are growing by at least 30-40% per year.

"They acquire subscription customers, which take time to develop into EBITDA contributions. So you see companies with a decent amount of scale growing very fast but with no EBITDA. You can't really value them on an EBITDA basis because in many cases there is no EBITDA. People will take a longer-term view based on the trajectory of the growth rate of these companies – there's a segment of private equity that is perfectly comfortable paying 5-10x revenue."

In the US, deals for such firms have completed on a revenue-multiple basis for some time, according to Wesley Fell-Smith, a director at Clearwater International. He says the so-called rule of 40 for evaluating SaaS firms – the idea that the revenue growth rate plus profit margin should exceed 40% - has crept into everyday language.

Asset gatherers
B2B software has been a key target of private equity for a number of years and many of these consolidators are not on their first private equity owner – LDC first backed IRIS Software in 2000. But recent years have seen a greater focus on consolidation. This consolidation is reflected in Unquote's private equity exit statistics. Exits in the technology sector since the beginning of 2017 – which have been predominantly B2B SaaS firms – have been disproportionately weighted toward trade buyers when compared with exits in other sectors. However, the excess trade interest relative to other sectors can be accounted for by PE, with 27% of these trade buyers backed by PE.

Much of the B2B SaaS market is focused on resource management, information and internal processes like accounting. PE is especially focused on those firms operating in vertical markets. "Workforce and resource management are going to be big growth markets over the coming years," Fell-Smith told Unquote in Clearwater's latest quarterly Multiples Heatmap. "They've been around for a while so the user cases are becoming proven, with scheduling and efficiency increasingly demonstrated to be robust, and the ability to use data more meaningfully is becoming more credible."

There is also potential for cross-selling. "You used to sell a piece of software and that was its end-case, but now you can bolt on packages that manage an ever-broader proportion of your business. It gives opportunity to expand, to use data more efficiently and automate more processes," Fell-Smith said. "PE is excited about it. You've got captive customer bases to which you can cross-sell products and capture proprietary data. There's a lot of sectors in which that's happening."

The information space had been buoyant as well, as evidenced by deals like HG's acquisition of Financial Express, Bridgepoint's acquisition of PEI Media and Synova's investment in Mintec. The option to quickly scale up these businesses through acquisitions in a fragmented market, the attraction of high customer stickiness and the eventual appeal to trade players were all factors in BC Partners' investment in Acuris (the publisher of Unquote), for instance – the company was recently acquired by Ion Group for an estimated EBITDA multiple close to 18x.

Fell-Smith adds that there is plenty of room for growth in the B2B SaaS market as whole, especially in the SME space, where market penetration has been low.

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