The Valuation Pendulum – Growth or Profitability ?
Anik Bose and Yash Hemaraj BGV colleagues share their perspective on the valuation pendulum. During Bull market cycles, private companies tend to be valued at far higher multiples than public companies. While we do not believe that private valuations should match public valuations (hyper-growth companies in new and exciting markets should deserve a premium) we do believe that as companies mature and scale, profitable growth has to enter the valuation equation. While early stage companies may attract higher valuation multiples based solely on top-line growth in up equity market cycles, the picture changes in down equity market cycles – empirical data from the recent past provides good validation. Up Market Cycle To better understand the valuation sentiments of the market and how valuations were driven by growth and profitability during the up equity market cycle, we looked at data from 180 publicly traded technology companies in April 2015. The companies ranged from sectors such as Application software, Security, Data Processing & Warehousing, Research and Data Services, IT Services as well as Computer hardware and Peripherals. The sample set was large enough for statistical significance and included public companies founded in the early 1900s as well as public companies founded as recently as 2010. In April 2015 at the peak of the Bull market, the technology industry performance was characterized as follows:
- 1 Year Revenue Growth: 16.8%
- Gross Margins – 65%, Profitable Industry: EBITDA Margin = 12.8%
- Total Enterprise Value (TEV)/LTM Revenues – 3.9X
- Total Enterprise Value (TEV)/FTM Revenues – 3.67X (~90% of LTM Multiple)
- Total Enterprise Value (TEV)/LTM EBITDA – 17X
- Industry Beta: 5 year Beta = 1.06 (markets have a beta of 1)
- Analysts expecting target price to appreciate by 11.2%
- 1 Year Revenue Growth Rate has fallen to 8.3% YoY.
- Gross Margins remain close 64%, It is still a Profitable Industry: EBITDA Margin = 12%
- Total Enterprise Value (TEV)/LTM Revenues has shrunk to 3.1X
- Total Enterprise Value (TEV)/FTM Revenues – 2.86X (~92% of LTM Multiple)
- Total Enterprise Value (TEV)/LTM EBITDA – 15.8X
- Industry Beta: 5 year Beta = 1.2 (up from 1.06) (markets have a beta of 1).
- Demonstrating revenue growth potential continues to be important, although no longer the only dimension to optimize
- Cultivating a longer-term profitable growth mindset and culture by engaging the full team in the profitability discussion
- Operations teams should think about cycle times, software release frequencies, inventory costs etc. and tie these discussions to the bottom line.
- Product managers should think about every feature they incorporate for development in terms of incremental value it delivers.
- Sales team should think about sales/channel productivity, sales cycles and cost of customer acquisition. This will ensure that the longer term business plan shows a path to profitable growth