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Software continues to create tremendous value for investors

November 25th, 2021

Software continues to create tremendous value for investors

Bain’s analysis of technology deals over the past decade shows that software investments have been more likely to overperform than most investments in other sectors.

One of the few winners during the pandemic was software-as-a-service (SaaS), the cloud-based tools that weld digital channels into highly creative, centralised platforms that bind products and people.

As armies of workers around the world fled their offices, vendors of SaaS stepped up to the mark with remarkably innovative solutions that helped oil the wheels of commerce during trying times.

The result was a turbo-boosting of SaaS sales following years of steady progress. “Over the past decade, software has created tremendous value for investors and businesses thanks largely to its transformative effect on the economy, its role in developing new cloud-based business models, and its ability to increase efficiency in operations,” noted Bain & Company in September.

But then in 2020, the gears turned faster. “For many buyers the pandemic accelerated their migration to SaaS applications and cloud infrastructure,” according to Bain.

What’s surprising, then, is that private equity firms may still be underestimating the value of SaaS providers – as indicated below.

Source: DealEdge, a partnership product of CEPRES and Bain & Company

“The SaaS model allows companies to focus on new ways to create value and, since many companies are early on their journey, more gains may lie ahead,” Bain suggests, citing how software companies that increase their share of revenue from these much-desired subscription models show a stronger growth in share price.

The ‘free trial’ revolution

Their analysis underlines why subscription-based services like SaaS have done so well despite earlier reservations. “Customers like the ability to try before buying and avoiding large, up-front license fees,” the report notes.

Other attractions include faster deployment, offloading of a lot of IT tasks to a remote vendor, and the confidence in having the latest, secure version.

Many other observers are singing the same tune. “Cloud adoption was on the rise well before the pandemic,” Gartner pointed out recently[1]. “We now predict public cloud deployments will outnumber private data centre workloads by the end of 2021.”

However, Gartner also cites as a consequence the urgency of improving the security of cloud services and cloud-native applications. There’s no doubt about the direction, though. “Cloud-first strategies are now common, even among risk-averse organisations,” says Tom Croll, senior director analyst at Gartner, in the same report.

Elsewhere, American software group BMC expect that 99% of organisations will use one or more SaaS solutions by the close of this year.[2]

And PwC agree: “Despite the devastation wrought by the global pandemic, the tech sector was largely unscathed, and, in many ways, it benefited from the crisis,” continuing to remark that “consumers increasingly embraced digital channels, which forced many companies to adopt a cloud-based offering, and that resulted in increased deal activity.” [3]

The proof is in the numbers.

A piece of 2017 analysis by BCC Research, a technology specialist, predicted that the size of the SaaS market would hit nearly $95bn in 2022, up from $44bn that year[4]. At the time this was considered impressive. However, if their analysis was re-done today, we would expect it to show a bigger market in waiting.

Right on cue, Gartner have forecasted client spending on public cloud services, which includes SaaS, to hit $482bn in 2022[5].

Gartner expects all kinds of organisations to accelerate investment in digital projects that take them to the cloud. “[This] is an effort to modernise environments, improve system reliability, support hybrid work models and address other new realities compelled by the pandemic,” explains Brandon Medford, senior principal analyst at Gartner.

And in this endeavour SaaS will dominate, he adds. After all, it was the first cloud service to take off and still has a handy lead.

A role for active investment

Putting that ascendancy in dollars, Gartner expects worldwide end-user spend on SaaS alone to hit nearly $172bn. Meanwhile, the giants of SaaS will continue to grow.

According to BMC, the runaway market leader is Adobe with a market capitalisation of $315bn followed by Salesforce ($252bn), Shopify ($185.4bn) and Intuit ($155bn). As Bain points out, Intuit spotted the trend years ago and adroitly changed strategies. The much-cited Zoom, another winner from the pandemic, comes in at $89bn.

As the competition for software investment intensifies, value creation for private equity investors is less straightforward than it once was. For a while now PE experts have extoled the virtues of active management, but how many investors have made strides in building the mindset or the muscle needed to actively manage their assets?

“Historically, software has been undervalued but investors should not, however, make unfocused bets on the overall trend,” Bain summarises.

“Once they own a business, PE investors should be active owners, helping their portfolio grow rapidly, moving to SaaS models, and making use of best practices in selling and product development. More-passive investors are evolving or getting competed out of the market.”

 

Patrick Jones
Director, Technology & Technology-Enabled
pj@draxexecutive.com

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[1] https://www.gartner.com/smarterwithgartner/4-must-have-technologies-that-made-the-gartner-hype-cycle-for-cloud-security-2021
[2] https://www.bmc.com/blogs/saas-growth-trends/
[3] https://www.pwc.com/us/en/industries/tmt/library/technology-deals-insights.html
[4] https://www.bccresearch.com/market-research/information-technology/software-as-a-service-technologies-market-report.html
[5] https://www.gartner.com/en/newsroom/press-releases/2021-08-02-gartner-says-four-trends-are-shaping-the-future-of-public-cloud

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