restructuring mature software companies to maximize profitability
TRANSCRIPT
Maximizing Profitability From Mature Software Companies in a World of Software as a Service
George Gilbert
Copyright TechStrategyPartners
SUMMARY:Economic model in software is still geared to growth, not maturity: operating margins can be almost doubled
M&A activity by Oracle, private equity, industry consolidation
evidence of new era
Cost structures still reflect pursuit of growth thru NEW
customers
Opex focusshould be redirected
to harvest installed base with new
services
Public market transition difficult: lots of co.’s ripe for restructuring
Source: Customer interviews
New develop-
ment
Enhance-ments
Mainte-nance and support
Data center and network management
Other Total*
Market opportunity exists in much larger operations spending within IT typically captured by SaaS products
100
641
25
23
5
Cost structure of a typical IT department – by activityPercent
IT operations costs = 75% of total: targeted by SaaS
Potential for new license revenue
Maintenance is the most profitable revenue stream for typical mature co.
Relative contribution of maintenance, licenses and services to revenues and profitsPercent
Licenses MaintenanceProfessional Services
52
-18
66
28
47
25
Maintenance share of profits
is 1.4x its share of revenues
Source: TechAlpha Partners analysis – model of a typical mature company
Share of revenues
Share of operating profits
Traditional maintenance is the source of most operating profit already:License revenue is a loss leader to sell maintenance
License revenue income statementPercent of total ISV revenues
Operating margin for new license revenue
is -16%
Revenues Cogs R&D S&M G&A Operating profit
Maintenance income statementPercent of total ISV revenues
Revenues
254
21
-4
2
2
Cogs R&D S&M G&A Operating profit
3
14
14
11
47
5
Operating margin for
maintenance revenues is
+30%
Source: Typical mature software company based on TechAlpha Partners analysis
License revenue from NEW customers requires 2x the S&M expense for 1/2 the revenue of EXISTING CUSTOMERS
License revenue from NEW customers income statementPercent of total ISV revenues
Operating margin for
license revenue from new
customers is -100%
Revenues Cogs R&D S&M G&A Operating profit
License revenue from EXISTING customers income statementPercent of total ISV revenues
Revenues Cogs R&D S&M G&A Operating profit
Operating margin for
license revenue from existing customers is
+25%
Source: Typical mature software company based on conversations with SAP, Oracle
8.33 0.67 1.33
13.86 0.66 -8.19
16.67 1.33 2.67
7.141.34
4.19
Drop Opex associated with NEW customers
Dropping NEW customer license revenue still drives strong maintenance revenue from installed base
* Baseline scenario assumes no change in maintenance pricing, industry standard 85% renewal rate
Mai
nte
nan
ce R
even
ue
Sce
nar
ios
3 Year Horizon By Quarter
0
10
20
30
40
50
60
70
80
90
100
110
1 2 3 4 5 6 7 8 9 10 11 12
Downside: Drop 1/3 of license revenues
Baseline: license revenues flat
Upside: Drop 1/3 of license revenues, add managed services, raise prices, intense focus on renewals
Potential to SIGNIFICANTLY increase operating margins
Percent of total revenues; typical mature company
Yield improve-ment
Offshore maint. R&D
135
42
20
8
Source: Tech Strategy Partners analysis;
Operating profit BEFORE
Lower expense from pursuing EXISTING customers
Managed services (MSP) additional revenues
Operating profit AFTER
Optimize cost to serve
Fix current renewal
processes
Offer “managed services”
(MSP) programs
HYPOTHESIS
Only harvest
the installed
base
Examples of mature co.’s: S&M expense approaches total license revenues
Qtly Gaap Metrics(Most recent 10Q)
Revenue Revenue Growth
License Growth
License Rev%
S&M% Operating Margin
Market Cap
SSA (1/31/06 – acquired by Infor/GGC 7/28/06)
188M 6% 7% 30% 26% 8% Acquired 1.4bn
Kronos (Acquisition announced 3/23 Hellman & Friedman, JMI Equity)
149M 16% 9% 35% 30% 6% Acquired 1.8bn
Serena (7/31/06- Acquired by Silverlake 3/10/06)
59M 0% 0% 32% 31% -8% Acquired 1.2bn
Lawson (11/31/06) 188M (N/A - merger)
(NA – merger)
16% 22% 7% 1.5bn
BEA (4/30/06) 323M 15% 14% 41% 38% 10% 4.6bn
Compuware (12/31/06) 315M 3% 3% 27% 23% 14% 3.25bn
BMC (12/31/06) 413M 9% 15% 38% 33% 18% 6.5bn
Convergys (3/31/06) 675M 1% N/A N/A 20% 9% 3.6bn
Amdocs (9/30/06 Yr) 2.4bn 22% 16% 5% 13% 13% 8bn
Sybase (9/30/06) 209M 5% 8.5% 37% 30% 15% 2.3bn
Tibco (8/31/06) 120M 14% 15% 42% 33% 10% 1.8bn
Parametric (12/31/06) 222M 15% 14% 30% 31% 9% 2.2bn
Citrix (9/30/06) 228M 22% 17% 41% 42% 17% 6bn
Advent (9/30/06) 46M 7% -6% 19% 26% 1% 1bn
Quest (3/31/06) 128M 23% 16% 50% 46% 6% 1.7bn
Informatica (9/30/06) 79M 22% 20% 43% 43% 9% 1.2bn
i2 Technologies (9/30/06)
71M 7% 14% 29% 17% 9% 625M
Identifying most promising restructuring candidates
Customerloyalty
Technology lifecycle
Credibility
Customer due diligence: understand how secure the maintenance revenues are; ultimately be able to quantify maintenance renewal rate
Technical due diligence: understand how much life is left in the technology; ultimately quantify the opportunity for follow-on sales into the installed base
Credibility with management: perceived ability to forge partnership to restructure company for maximum profitability
Alternative investment theses
Restructure mature companies
Consolidateniche SAASvendors
Consolidatemid-market
Reduce S&M expense targeted at growth; increase share of wallet of existing customers through managed services; acquire new customers through mergers
Create end-to-end suite vendor in the Software as a Service marketplace to challenge legacy vendors and SalesForce.com
A relatively under-penetrated marketplace where several mergers can help create a vendor that reaches critical mass before Oracle pursues similar acquisitions
LBO Analysis Of
Company X
Transaction Assumptions & Returns
Aggregate Purchase Price 1,188,258 Identifiable Asset Value 1,188,258 Implied Equity Value 1,243,258 Goodwill Created - Aggregate Value / CY07 EBITDA 14.7 Equity Value / CY07 Net Income (173.22) Debt / CY07 EBITDA 8.8 US Treasury Note (10 yr) 4.70%
Spread Int Rate Amount xC07 EBITDA % of Total Amount % of Total
Debt UST+400bpp 8.7% 712,955 8.8 57% Paid to Target 1,243,258 100%Equity 475,303 5.9 38% Cash Required on Balance Sheet 0 0%Cash on Balance Sheet 55,000 0.7 4% Total Uses of Funds 1,243,258 100%Total Sources of Funds 1,243,258 15.4 100%
Transaction Assumptions
Sources of Funds Uses of Funds
Trailing Exit IRR at End ofEBITDA Multiple EV/Revenue 2010 NPV
10 4.30 12% 31,699 11 4.73 17% 114,053 12 5.16 22% 196,407 13 5.59 26% 278,761 14 6.02 29% 361,116 15 6.45 32% 443,470
Returns to Equity Holders
Revenue and EBITDA Comparison 2005-2010: Cut unprofitable portion of license sales and sell MSP services to installed base
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
2005 2006 2007E 2008E 2009E 2010E
Revenue
EBITDA
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
2005 2006 2007E 2008E 2009E 2010E
Revenue
EBITDA
Street Estimate TechAlpha Estimate
TechAlpha vs Street Estimate
-
10,000
20,000
30,000
40,000
50,000
2007E 2008E 2009E 2010E
Revenue
EBITDA
Additional revenue comes from MSP
Additional EBITDA comes largely from lower opex, some from MSP
Growth in 2010Revenue: 10.3%EBITDA: 12.1%EBITDA Margin: 43%
Significant opportunity to cut S&M spending on unprofitable new customers – new product line spared because of growth opportunity
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
2007E 2008E 2009E 2010E
NEW customers for mature product
EXISTING customers of mature product
NEW customers for new growth product
EXISTING customersfor new growth product Promising growth
product worthy of investment
Mature product worth harvesting: focus on existing customers
Disinvest
MSP adds 20% to revenue and 11% to operating income in 2010
-
20,000
40,000
60,000
80,000
100,000
120,000
2007E 2008E 2009E 2010E
MSP Revenue
MSP Operatingincome
Total operatingincome
License and Maintenance P&L 2006: pre-restructuring license is loss-leader
License revenue income statementPercent of total revenues
Operating margin for new license revenue
is -17%
Revenues Cogs R&D S&M G&A Operating profit
Maintenance income statementPercent of total revenues
Revenues Cogs R&D S&M G&A Operating profit
17.0
18.6
9.9
13.0
69.0
10.6
Operating margin for
maintenance revenues is
+27%
Source: Typical mature software company based on Tech Strategy Partners analysis
20.8 0.84.3 14.8
4.3 -3.5
License and Maintenance P&L 2010: post-restructuring both businesses are profitable
License revenue income statementPercent of total revenues
Operating margin for new license revenue
is +32%
Revenues Cogs R&D S&M G&A Operating profit
Maintenance income statementPercent of total revenues
Revenues
20.1
0.9 3.77.2
1.86.5
Cogs R&D S&M G&A Operating profit
13.0
22.9
4.8
11.2
56.4
4.5
Operating margin for
maintenance revenues is
+41%
Source: Typical mature software company based on Tech Strategy Partners analysis
LBO restructuring: In 2007 26.3% operating margin vs. 13.5% Street estimate (with MSP revenue)
GG estimate income statementPercent of total revenues
Revenue &COGS: Include MSPS&M: 12.7% savingsG&A: 2.2% savings
MSP understates Opex %
Revenues Cogs R&D S&M G&A Operating profit
Street estimate income statementPercent of total revenues
Revenues
100.0
32.0
17.312.2
13.226.3
Cogs R&D S&M G&A Operating profit
28.5
13.5
24.9
17.7100.0
15.4
Operating margins improve by 11.8% in 2007 – (with MSP revenue)
P&L comparison: LBO vs Street 2007Percent of total revenues
COGS: MSPS&M: existing
customersG&A: Closer to industry levels
Cogs R&D S&M G&AOperating profit
-3.50.4
12.72.2 11.8
Operating margins improve by 13.1% in 2007 – (without MSP revenue)
P&L comparison: LBO vs Street 2007Percent of total revenues
COGS: Begin offshoring
S&M: Existing customers
G&A: closer to industry levels
Operating Profit: Lack of MSP
revenue Cogs R&D S&M G&AOperating profit
0.9 -0.8 11.71.4 13.1
LBO restructuring: In 2010 41% operating margin vs. 21% Street estimate (without MSP revenue)
GG estimate income statementPercent of total revenues
Normalized Comparison
Revenue: No MSPCOGS: Offshoring
S&M: Existing customers
G&A: Industry levels
Revenues Cogs R&D S&M G&A Operating profit
Street estimate income statementPercent of total revenues
Revenues
100.0
19.118.0
14.48.0
40.6
Cogs R&D S&M G&A Operating profit
24.5
20.5
25.0
18.0100.0
12.0
Operating margins improve by 20% in 2010 – (without MSP revenue)
P&L comparison: LBO vs Street 2010Percent of total revenues
Cogs R&D S&M G&A Operating profit
5.4 0.0
10.6 4.020.0
LBO restructuring: In 2010 33.8% operating margin vs. 21% Street estimate (with MSP revenue)
GG estimate income statementPercent of total revenues
Revenue &COGS: Include MSP
Other Opex: Same $, higher revenue base
including MSP: understates percentages
Revenues Cogs R&D S&M G&A Operating profit
Street estimate income statementPercent of total revenues
Revenues
100.0
32.7
15.012.0
6.633.8
Cogs R&D S&M G&A Operating profit
24.5
20.5
25.0
18.0100.0
12.0
Operating margins improve by 13.2% in 2010 – (with MSP revenue)
P&L comparison: LBO vs Street 2010Percent of total revenues
Cogs R&D S&M G&AOperating profit
-8.23.0
13.0 5.413.2