How do you value Technology companies?

fuego's picture
Rank: Monkey | 34

I've always been interested in reading about the technology industry but I don't have much expertise on valuing the companies in that industry. Does anyone cover companies in the technology industry? The only thing I can think of is that most technology companies have negative earnings so it might be a better idea so look at multiples like EV/Sales or something. What about solvency ratios, efficiency ratios, profitability ratios? Any information on how to value tech companies would be greatly appreciated.

Comments (25)

Feb 9, 2008

A lot of it will depend on what sector they're in as well as their stage in development.

For example, a company that relies on subscriptions for revenues won't necessarily be able to show profit due to accounting measures of their subscriptions since they can't recognize it all upfront so one metric you could use there is the number of new subscriptions. From that, figure out what the attrition rate is and you can get a sense of how the company is doing vs competition.

To value a startup internet company, we might look at metrics like user growth, % conversions to paid programs, reach, page views + visit length, etc.

Other times, it might be as simple as looking to how much it would cost to develop the code - ideas be damned. A lowball valuation we used to acquire a software company recently was to look at the source code and then work backwards to figure out the cost to develop the software had we started from scratch.. we then threw in a liquidity discount pitched that to the management.

Feb 9, 2008

As mentioned above, it's highly dependent on the sector... internet companies are valued completely differently from semiconductor companies, for example. But generally revenue multiples, EBITDA multiples and Free Cash Flow multiples are used, much like anything else. P/E can be a bit less relevant but it really depends on the specific company.

For early stage startups, revenue synergies with a potential acquirer are very important and can be the principal value driver. If they think they can sell a lot of the product, higher value results.

As mentioned above, for Internet companies, registered users, pageviews, conversions, etc. can all be used for valuation.

For subscription companies, Free Cash Flow is often a more relevant metric than EBITDA because cash that is collected upfront but not recorded as revenue will flow through to FCF but not EBITDA. Bookings can also be used in place of revenue.

For hardware companies, gross margin is very important and gross profit multiples can even be used because it's very easy to lose money when your COGS is really high.

Finally, you said "most technology companies have negative earnings..." This is not really the case anymore as the technology has matured significantly. There are numerous buyout shops that acquire profitable, cash-flow positive tech companies and will continue to do so (Silver Lake, Francisco Partners, etc.).

Many people don't realize the extent to which the tech industry has matured. Sure, some sectors such as Internet will have more startups and unprofitable companies, but in general profitable tech companies are valued much like companies in any other industry: pub comps, M&A comps, DCFs, LBO models.

The main thing that makes tech different is that there ARE early stage "hot" companies that can be acquired for what look like ridiculous multiples (e.g. YouTube which went for like 600x revenue).

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Feb 9, 2008

You're on the right track, but you forgot to ask "Are tech stocks in another retarded bubble?" If so, make sure you multiple all your cash flow assumptions by 4.

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Best Response
Feb 9, 2008
OpsDude:

You're on the right track, but you forgot to ask "Are tech stocks in another retarded bubble?" If so, make sure you multiple all your cash flow assumptions by 4.

    • 2
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Feb 9, 2008

Technology is a really broad term, but in general, you could look at EV to revenue, subscribers, clicks, views, etc. You could also think about an attach rate in the context of an acquisition. Top line growth, billings, customer acquisition costs, and customer lifetime value are good things to think about to put things in perspective.

Feb 9, 2008

Basically, the idea here is to go as high up the income statement as you need in order to get a positive earnings measure (sales/gross margin/ebitda/ebit/etc.).

If the company is pre-revenue, you would want to connect the multiple to a figure/metric that can be justified as tied to the profit making potential of a business (so something like a social media company, the number of users).

alternatively, you can use a DCF to justify whatever valuation you want.

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Feb 9, 2008

discount all future cash flow that this company can generate with the platform.

Feb 9, 2008

Most girls tell me that multiples are a myth.. maybe they are just trying to make me feel better :(

Feb 9, 2008

Jk no they dont

Feb 9, 2008

You really can't, from an "underlying value" POV. Both the failure rate, and the valuation of the successful ones are so wild that there is no way to take just one and say "it's aiming to be this big and has this % chance of failure". Read: http://paulgraham.com/growth.html - he points out that most VC funds have had maybe 1 or 2 big successes (e.g. GOOG - Doerr) that basically financed all the rest. You can sort of value a bunch of startups, in the form of a VC fund or an incubator (YCombinator might hit a few home runs). There's no way to really value Google or Facebook at early stage...

The best approach for the less disruptive stuff is to think like a trader rather than a business owner, and think about who is likely to pay for this thing even as it is unprofitable. For example, if you are building an e-commerce company, don't look at your profitability and EBITDA projections and multiples. You are much more likely to sell it to a. idiots during a bubble (1999) b. a scared competitor who is for some reason not smart enough to crunch the numbers and your real chance of success, which is why sales growth is more important at the cost of large negative cash flow initially. See for example the sale of Citydeal/Gaopeng/etc. by the Samwer brothers to Groupon. The company was junk, but they got 100m EUR+ out of it because they scared Groupon with their growth rate, and took advantage of both Mason's lack of experience and belief in the business model of group deals. Such a deal is unlikely to happen again as anybody else in that space will know what happened next.

Feb 9, 2008

I rarely look at early-stage stuff myself, but analysis probably starts with:

  • Size of addressable market (TAM)
  • Estimate of market share - what does the competitive environment look like?
  • Profitability bogey under various scenarios - what do mature businesses in this market earn?
  • From there you can probably back into a reasonable multiple, cost of capital etc...
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Feb 9, 2008

Andreessen seems like a really smart guy, but i just want to mention that he also has more incentive than anybody make this claim. All this guy does is try to sell his unprofitable companies for as much as possible, touting 'bigger picture' and 'long term thinking'. He could be right, I don't know, but that belief is something he relies on to make his money.

Also studies have shown that acquisitions tend to decrease shareholder value for the acquirer, and increase it for the target (Andreessen)

Feb 9, 2008

In the example of FB zuckerberg and co has a vision for technology beyond Facebook. All about building the pipeline. People are willing to pay absurd valuations because they believe in the future. Whether or not this materializes you have to wait and see.

Feb 9, 2008

Tech firms are high growth, I would go EV/Rev or EV/EBITDA. I guess if you wanted to be pretty you could perhaps tailor your denominator based on your comp groups? IE maybe if you had a website comp group (being vague here), you could EV/page hits or something. Bad example, but hope it helps

Feb 9, 2008

I worked at a tech boutique this summer mostly in the Internet and DIgital Media group. For internet companies you look at EV / unique visitors of EV / Page views (really fun to look up for a comp set). I do no believe there are industry specific valuation multiples for software companies. I just remember the usual suspects EV/EBITDA, EV/Rev and EV/FCF.

Feb 9, 2008

If you've been long FB or ZNGA, dilution is the least of your worries.

Feb 9, 2008
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Feb 9, 2008
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