Of course you can't generalize when it comes to assessing
the value of a business, but there are two items of note in the
title: (i) the valuation metric; a multiple of revenues and (ii),
the notion that technology companies are somehow different from
Why do people speak of a multiple of revenues when they are
referring to the value of a technology company? Two main reasons;
first, if there are no earnings to speak of (i.e. the company is in
a loss position/operating with a burn rate), then a multiple of
earnings would be meaningless; and, second, what if the profit
margin is at a very low level, much lower than the long term
expected average? A fast growing company, operating at near
break-even might technically be valued at 50 times earnings. In a
case like this revenues are a much more stable metric to use.
What we are really describing here are two early stage phases
that many technology companies go through. The first stage is the
start-up phase where companies incur a burn rate and the second
stage is the initial growth phase, where they enjoy rapid growth
but have not yet achieved the economies of scale to cover their
relatively large product development (R&D) and marketing
(product/service launch) costs. In cases like this, while it
doesn't account for many possible differences in business
models, the multiple applied to revenues is used as a proxy of
future normalized Earnings Before Interest, Depreciation and
Many established software companies generate very healthy
margins. EBITDA Margins of 40% - 50% are not unusual (both
Microsoft and Google EBITDA margins approximated 40% in recent
years). Equally revenue growth can be very strong, particularly in
the early stages. So what does a growth multiple combined with
strong margins translate to, in terms of a revenue multiple? It
could well be three times revenues. Three times revenues with 50%
EBITDA margins equates to six times EBITDA, not that different from
traditional company metrics.
But how does one rationalize even higher multiples? Say 10 times
revenues? (for example Goldman Sachs buying into Facebook at a $50
billion valuation - over 30 times run-rate revenues, and HP buying
3PAR in 2010 for 11 times revenues). In cases like this companies
are paying a scarcity premium. The argument being that, either by
way of market position (i.e. if all your friends are on Facebook
there is no point being on Orkut) or by way of proprietary
technology, these targets have something the acquirer can only
attain by buying them.
At this point a buyer is paying beyond the notional value and is
encroaching on the value to the buyer. The notional value is a
company's value independent of the potential strategic benefits
to a particular buyer. The value to the buyer is that amount of
value the acquirer can produce with the target. Not something they
typically pay for unless forced to in a competitive situation.
To consider this by way of an example, let's assume a
billion dollar revenue company is paying 10 times revenue for an
early stage company generating $1 million in revenues. The target
company's technology will allow the billion dollar revenue
company to increase its market share by 10%; a value of $100
million in revenues. You can understand why the acquirer might pay
$10 million for this company.
The conclusion is that a buyer paying a price below the value to
the buyer makes economic sense, even though the multiple of
revenues or earnings may sound astronomical.
Are Technology Companies Different?
At this point traditional manufacturing, service, retail and
distribution income statement ratios are all in well established
ranges but technology companies can typically achieve stronger
margins, quicker growth and, in some cases, generate sticky
recurring revenues which reduce the risk associated with these
There are consumer product innovations from time to time that
are low-tech and achieve tremendous growth (think of infomercial
products like Sham-wow or Spanks) but in general the growth sectors
in the North American economy are technology sectors like Software
as a Service (SaaS) and Platform as a Service (PaaS) as well as
social media, search/comparison engines, e-commerce, and mobile
applications. Companies in these sectors can leverage digital
distribution (where the cost of manufacturing and delivering an
incremental copy is negligible) and the reach of 80% broadband and
90% mobile consumer penetration to generate very robust growth.
So are technology companies different from other companies? In a
word, yes. Many are venture funded and achieve substantial market
penetration, creating tremendous value while still unprofitable and
therefore, while nowhere near perfect, a multiple of revenues can
be used as a common metric for technology companies in various
stages of growth.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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