Download - Restructuring Mature Software Companies To Maximize Profitability

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


license revenue from new

customers is -100%


License revenue from EXISTING customers income statementPercent of total ISV revenues



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


is -17%


Maintenance income statementPercent of total revenues


17.0

18.6

9.9

13.0

69.0

10.6



+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


is +32%


Maintenance income statementPercent of total revenues

Revenues

20.1

0.9 3.77.2

1.86.5


13.0

22.9

4.8

11.2

56.4

4.5



+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 %


Street estimate income statementPercent of total revenues

Revenues

100.0

32.0

17.312.2

13.226.3


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)


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)


Normalized Comparison

Revenue: No MSPCOGS: Offshoring

S&M: Existing customers

G&A: Industry levels



Revenues

100.0

19.118.0

14.48.0

40.6


24.5

20.5

25.0

18.0100.0

12.0

Operating margins improve by 20% in 2010 – (without MSP revenue)



5.4 0.0

10.6 4.020.0

LBO restructuring: In 2010 33.8% operating margin vs. 21% Street estimate (with MSP revenue)


Revenue &COGS: Include MSP

Other Opex: Same $, higher revenue base

including MSP: understates percentages



Revenues

100.0

32.7

15.012.0

6.633.8


24.5

20.5

25.0

18.0100.0

12.0

Operating margins improve by 13.2% in 2010 – (with MSP revenue)


Cogs R&D S&M G&AOperating profit

-8.23.0

13.0 5.413.2

Download - Restructuring Mature Software Companies To Maximize Profitability

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