Transaction insights for the Canadian technology sector
Canada is an attractive investment destination for technology companies
Canada's economy, access to incubators and top talent makes it an attractive investment destination for technologies companies, according to Derek van der Plaat, EY Canada's Transactions Leader for Technology, Media and Telecom (TMT).
What’s driving value at North American software companies?
We recently did an analysis of over 200 US and Canadian publicly traded software companies to see how solution type, revenue growth, margins and size impact valuation. What we found was in some cases surprising.Solution type: application software vs. internet software and services vs. systems software
Software companies have traditionally been segmented as application software, for example customer relationship management (CRM) or enterprise resource planning (ERP) software; internet software such as search engines and online market places; and systems software, which is software designed to provide services to other software such as operating systems.
Application software companies, including software-as-a-service (SaaS) companies, were the highest valued group at 3.8 times revenues. This might be viewed as an unexpected result, as internet companies could be interpreted as being exclusively cloud whereas the other classifications include on-premise solutions. What we think is happening here is that these classifications were designed when hosted solutions were emerging and today many traditional on-premise solutions are now, at least partially, cloud. Today, these classifications overlap in terms of revenue model and market potential. And, it is our view that this categorization is not very defining as a value driver.
Generally speaking, North American software companies are valued higher than most other companies based on their attractive revenue qualities, growth prospects and margin profiles. Other factors to be considered include market potential, competitive environment, private company discounts and control premiums. However, when looking at a company’s valuation, it is now more relevant to delineate companies by revenue quality, size, margins and growth rather than just solution type.
In this article, we look at the impact of these three drivers on the valuation of North American software companies:
- Growth: historical vs. forecast
- Margins: Gross margin vs. EBITDA
- Size: large vs. small