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Software & SaaS Trends & Growth

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Historical Trends

From the years 1997 to 2012, the U.S. software industry production grew from $149 billion to more than $400 billion. This contributed a total of 3.2% U.S. GDP in 2012. The software industry and related services has created over a million jobs within the United States alone. Along with the software explosion, other U.S. industries became more efficient, resulting in higher overall production. Over the last 5 years (Jan. 2010 – Jan. 2015), software industry growth is as follows:

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Growth in Revenues:
Entertainment Software = 1.95%
Internet Software = 11.52%
System/Application Software = 15.90%

Growth in net income:
Entertainment Software = 14.60%,
Internet Software = 23.92%
System & Application Software = 19.37%

The software industry has become highly segmented over its lifetime. The main software industry categories are: Billing & Service Management, Business Intelligence, Developmental Platforms, Engineering & PLM, Enterprise Resource Planning, Financial & Accounting, Gaming, Healthcare, IT Conglomerates, Mobile Solutions, Network Performance Management, Security, Storage/Data Management, Supply Chain Management, Systems Management, and Vertical.

Current Trends

Consolidation of the Software Industry is occurring rapidly as major players acquire small and medium sized businesses to keep up with emerging technologies. Leading companies continue to command huge market share and in order to sustain their shares, the software powerhouses are constantly seeking innovative technologies for acquisition. Of the top 100 global players, 66 companies are based in the U.S. The top three software companies are (in order of Software Revenue) Microsoft, IBM, and Oracle. SaaS is starting to become a major revenue driver for the largest software firms. Microsoft’s SaaS revenue in 2012 was $1.463 billion, accounting for 2.5% of total software revenue. This is evidence of the shifting model for software companies; traditional license models are now moving to service models.

Mergers and acquisitions are creating the future outlay of the software industry as price drives consumer’s decisions. In 2013, total transaction volume for acquisitions was 1,598 with a deal size of $88 billion. In 2014, M&A volume rose to 1,840 transactions and an overall deal size of 120.18 billion. The top leading segment is business software with a 20% rise in deals from 2013 to 2014. Four out of ten of the highest value deals in 2014 were in the business software segment. This landscape is constantly evolving with cloud based and free models driving innovation.

The software industry has become highly segmented over its lifetime. The main software industry categories are: Billing & Service Management, Business Intelligence, Developmental Platforms, Engineering & PLM, Enterprise Resource Planning, Financial & Accounting, Gaming, Healthcare, IT Conglomerates, Mobile Solutions, Network Performance Management, Security, Storage/Data Management, Supply Chain Management, Systems Management, and Vertical.

Valuation of software companies is typically based on the market value approach (multiples of revenues or earnings.) These valuations are primarily focused on future revenue growth and profitability, usually based on gross margins. Valuing software companies can vary greatly based on if the company is an on-premise software or if it is a SaaS company. On-premise software can have a hefty upfront payment and this may be realized over the duration of the contract. On the contrary, cloud-based, SaaS companies realize their earnings each month, based on subscription models. According to Software Equity Group, in 2014, the median exit multiple for on-premise companies was 2.4x revenue and SaaS was 4.1x revenue. On a TTM valuation basis, the highest multiples were in situations where a large company would acquire a small target (less than $20 million revenue) with a median of 3.4x revenue for both on-premise and SaaS.

Future Trends & Growth

According to PWC, the future of software companies will depend on outpacing competitors in high-growth areas like XaaS (everything as a service), cybersecurity, big data analytics, cloud computing, digital content, etc. It will be more about increasing revenue and less about increasing margins. Companies will continue to increase shareholder value via innovation. The fastest growing software segment will continue to be SaaS. PWC expects SaaS revenue to “grow at a compound annual rate of more than 20 percent throughout this decade.” While Forrester predicts that overall software industry revenue growth will be 7.1% annually. In this consumer’s market, buyers are consistently seeking for more flexible ways to access XaaS and some companies are creating models where you are able to pay by usage rather than a subscription per user. Nonetheless, major corporation IT departments still rely heavily on on-premise packages that have been used for decades. Large software corporations are also having to restructure the way they deliver their products and this will take multiple years to have full effect. Large players will need to start acting nimbler as they innovate and software start-ups will need to build scalable operating models with deliberate strategy.