Deferred revenue question in Investment and M&A

Hi,

Could someone help me make sense of DRs in the context of software companies from an Investment and M&A standpoint please?

I assume the bulk of DRs - cash paid upfront for a service which will be rendered gradually over time (think SAAS or software company selling multi-year contracts with cash upfront payments). This would mean that customers have paid upfront and the company is left with only a liability.

Some IMs show "DRs collected 1 year" in % terms. is it better to have a DRs collected in 1 year?

In a number of IMs I have seen the DRs cited as a positive factor (DRs = 30% of revenue and growing etc for instance).

This gets even more confusing in M&A as, from what I read, a bidder will apply a haircut to the Target's DRs as these revenue will never be collected.

So my questions are:
1. Are high and/or growing DRs a positive?
2. What are the implication when DRs collected 1 year?
3. How to analyze DRs in the context of an investment and/or an M&A transaction?
4. How to calculate the haircut to DRs in M&A? (should DRs be reset to "maintenance/service cost"? in which case they should be deflated by something like 90%...)

I hope you guys can shed some light on this topic! :)
Thanks much!

 

I want to state I am by no means an expert on DR. 1. Really depends on business model. If you have a software that you sell a yearly subscription too. you want a higher DR. You get cash today and then just have to recognize the revenue later,(which is guaranteed). however this doesn't mean that the company is going to be profitable.

  1. Really depends on the types of contracts that you have. Revenue and cash today is generally looked at as better. Hence, time value of money.

  2. It is a liability and is usually considered a short term liability. This will affect your NWC accounts. from an investor standpoint. Revenue is somewhat locked in.

  3. A haircut is not needed, because its a liability. It's not like AR where you might not collect. You have collected the money and have to provide the service.

 

Thanks mate for your reply, much appreciated. 1-3 makes sense. 4: in software, DR haircut seem to be a thing as buyer would get target co with 0 revenue and . cash from the DRs (cow has been milked) and only liabilities (I assume that the worst case scenario for DR Haircut would be to treat it at "cost"). Cash and Revenue should start rolling in again when contracts are renewed.

 

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