Why Cloud Software’s M&A is Coming Soon

With valuations for many cloud software names at levels last seen a few years ago, and with many of these companies still delivering impressive top-line growth, a recent increase in software M&A can prove a sign of things to come.

So far in 2022, we’ve seen three major cloud software M&A deals signed by private equity firms: Thoma Bravo’s closed deal to buy financial planning software firm Anaplan and a pending deal to buy identity security software firm SailPoint ( SAIL), and a pending deal to acquire customer service software provider Zendesk (ZEN) involving a group of investment firms led by Permira and Hellman & Friedman. In addition, tax/compliance software provider Avalara (AVLR) reported on Thursday that PE firm Vista Equity had approached about a potential purchase.

Notably, deals with Anaplan and SailPoint were signed before the bloodletting on cloud software/SaaS stocks that began in November. completely run its course. As a result, the deals featured valuations that were higher than those currently used by most SaaS companies. SailPoint is taken for an enterprise value (EV – market cap minus net cash) that is approximately 12 times the fiscal 2023 (ending January 2023) agreement on the sale, and even following a small discount that discussed in June by Thoma Bravo, sold Anaplan for an EV is equivalent to approximately 13 times the fiscal 2023 sale agreement.

True, Zendesk, which is under pressure to sell by activist Jana Partners after an initial sale effort failed to attract a buyer, is taking for an EV that is only 6 times the fiscal 2023 agreed. on sale. For its part, Avalara has an EV equivalent of 8 times its 2022 calendar sale agreement, after climbing in response to the Vista Equity report (it’s worth noting here that many think Avalara, which continues to engaged in its primary market, will require a significant premium from current levels to agree to a sale).

Depending on their growth rates, market sizes met, margins and competitive position, different SaaS companies will take different buyout multiples, of course. And given the massive compression overall that tech stocks have seen in recent months, as well as how big Treasury yields are, it’s possible that not too many SaaS companies will take on the types of multiples that Anaplan has acquired. and SailPoint. .

But either way, there are now some software firms that are posting 20%-plus sales and billing growth, have high gross margins and which can be said to have market-leading offers, that sport is less multiple than what Avalara currently trades, never mind. what Thoma Bravo is willing to pay for Anaplan and SailPoint.

For example, search, observability and security software provider Elastic (ESTC), data security software firm Varonis Systems (VRNS), CRM software firm Freshworks (FRSH) and incident-response/alerting software provider PagerDuty (PD) sport forward EV/sales multiples in between 6 and 7. And machine data analytics software leader Splunk (SPLK) (long topic of M&A rumors), survey software provider Qualtrics (XM) and work management software provider Smartsheet (SMAR) are driving EV/sales multiples between 5 and 6.

The fact that most enterprise software companies now get most (if not the bulk) of their revenue from recurring revenue streams that (compared to traditional software license sales) provide a measure of shrinkage-protection is naturally enticing to potential gains.

So is the fact that – as IT spending forecasts go home – spending on software, security (which is now mostly related to software) and cloud services continues to grow with total IT spending, and the CIO surveys are relatively consistent showing different software fields as areas likely to see high spending growth. See, for example, the following results from Credit Suisse’s Mid-Year CIO Survey:

CIO responses about their 2021, 2022 and 5-year IT spending plans. Source: Credit Suisse.

Along with PE firms, the massive multiple-compression seen by many high-growth SaaS companies could spark the interest of some of the tech giants (even if they think they’re likely to sign off. regulator in a particular deal), or a larger, pure-play, enterprise software firm such as Salesforce.com (CRM), ServiceNow (NOW) or SAP (SAP).

While it’s impossible to be sure which companies will eventually get purchase offers, continued interest in M&A with reasonably priced software firms that are still seeing healthy growth could easily provide some appreciation support. in the group after a very difficult eight-month stretch.

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