VALUATION OF AUSTRALIAN LISTED AND PRIVATE TECHNOLOGY SECTOR COMPANIES. The Copyrights and Authorship Rights to this material are vested in Newport Capital Group Pty Ltd. This paper has been prepared by Newport Capital Group to assist clients and intending clients to understand prevailing factors which drive and determine achievable valuations for Australian listed and privately held technology markets companies. This paper is focused on companies operating in the following business sectors Information Technology services and technologies. Telecommunications services and technologies. New Media sector companies, which includes mobile content and marketing, Internet based businesses (online retail etc.) and a variety of other digital media companies. Newport refers to the above business sectors as TMT. It is very difficult to generalise regarding prevailing TMT market valuations, as each transaction has its own particular drivers and characteristics. Valuations can vary dramatically for various assets, particularly in the new media sector. However, Newport Capital hopes that the views and assessments expressed in this discussion paper are of general assistance. The views expressed in this paper relate to valuations for the purpose of transactions, versus valuations for other purposes. LISTED TMT SECTOR COMPANY VALUATIONS. It is obvious that the market values listed TMT sector companies on the basis of their share prices and the resulting market capitalisations. Investors, including professional investors such as fund managers, and analysts, value listed TMT companies on the basis of their projected earnings per share (EPS), based on company announcements, guidance provided to the market and other research. On the basis of the projected EPS, valuations are calculated at what are considered to be appropriate price/earnings multiples (P/E ratios). P/E s can be based on prevailing P/E s for comparable companies operating in the same or similar business sectors. Most Boards of ASX listed TMT sector companies consider their market values to be too low. Potential acquirers of any ASX listed TMT sector company generally consider such targets to be over-valued. Where ASX listed TMT sector companies are acquired, the valuations tend to be mostly at a premium to the share price and market capitalisation, but not always. Boards typically engage advisers to mount a defence to any takeover offer which they consider to be hostile, or below the proper valuation. Defence typically involves the adviser in seeking higher offers. Valuations of TMT sector listed companies are influenced by various factors including projected EPS growth, valuations of comparable ASX same sector companies and perceived risk. Risk is higher in project companies which undertake specific, non-recurring projects for clients. Project income tends to be variable based on selling success and market conditions. Companies with substantial annuity income streams ( make money while you sleep ) tend to achieved higher valuations and more inbound interest in acquiring them from strategic (trade) buyers and also private equity firms. Companies which high ball earnings guidance tend to fall from the sky over time, as the market learns not to trust their earnings guidance.
Some ASX listed TMT sector companies, with poor earnings histories and expectations, can be valued at a discount to the cash in their bank accounts, particularly if the cash is burning. Micro cap listed companies with low market capitalisations of less than say $50M are not followed by professional investors and analysts, and are subject to the speculative activities of day traders. Theoretically, listed TMT sector companies have a value to parties which may use them as back door listing opportunities. Back door listings involve the target in selling its business to the ASX listed entity with consideration being mainly newly issued shares. Valuations of listed en7tities for back door listings may involve valuation elements for the actual listed entity. If an ASX listing (IPO) costs say $1M in fees and costs, then there can be value in a listed shell, in addition to the value of whatever business may be oper6ating in the listed entity which can be positive or negative, depending on cash burn. PRIVATE TMT SECTOR COMPANIES The valuation of privately held TMT sector companies is as much art as science. However, Newport Capital Group has developed a variety of methodologies and techniques for the valuation of TMT sector privately held companies, backed up by 23 years of intensive involvement in TMT sector M&A transactions including sales, acquisitions, IPO s and capital raisings and placements. Business Sector/Sub-sector The particular sector or sub-sector in which a company operates has a material bearing on its likely valuation. Some sectors and sub-sectors are considered hot, and hot sectors arise and change. For example, Internet based businesses, including social networking businesses such as Face Book, Linked In etc., achieve remarkable valuations based on market sentiment and market expectations- not necessarily underpinned by conventional metrics such as revenues and earnings. Possibly the bottom end of the IT products (hardware or software) distribution market represents the low end of TMT sector valuations. A small (revenues of say <$5M) and marginally profitable businesses without a definable market franchise ( exclusivity ) are valued at whatever a buyer will pay and a seller will accept. Earnings multiples of say 2x EBIT are not uncommon valuations at this level. Telecommunications companies of various types and sizes tend to achieve modest valuations but exceptions such as Vocus, Macquarie, PIPE and iinet exist. The relatively modest valuations of Australian telecommunications businesses is driven partly by the highly competitive nature of the market, dominated by large players such as Telstra and Singtel Optus. Smaller companies struggle for oxygen. IT companies represent a very diverse market sector, with valuations ranging from modest EBIT multiples of say 4x EBIT up to as much as 8x EBITDA for high growth, well managed companies with high profit extraction rates on revenues. It is not feasible to set a reliable scale of valuation metrics for all sectors and sub-sectors of the IT market. VALUATION DRIVERS Revenue and Earnings Growth Rates The apparent, sustainable rate of acceleration of revenues and earnings is a key factor in determining valuations. Private equity ( PE ) firms, which can buy 100% of a target, are particularly focused on revenue
and earnings growth rates. High growth rates enable a PE to buy at a fully priced valuation, but exit downstream at a substantial profit particularly if the acquisition is highly debt leveraged, to magnify the return on actual equity. Synergies and Leverage A buyer may perceive synergies and leverage opportunities which influence the buyer s valuation of a target. Synergies may be related to costs (cost cutting by removing duplicated costs such as staff or infrastructure) or revenues. Revenue synergies ( top line synergies ) and leverage can relate to perceived cross sell opportunities into the acquired customer base, where the buyer sells more of the buyer s offerings into the acquired customer base, and sells the acquired offerings into the buyer s existing customer base. Top line synergies can be material and powerful. IP is often a driver of perceived synergies. The buyer may view the targets IP as adding value to the buyers offerings/ip, by providing expanded features and functions, or by broadening the market appeal of a merged (integrated) version of the buyer s and the target s IP. Some buyers will see leverage in removing a competitor from the buyer s market, enabling the buyer to sell more or sell at higher prices. Most market sectors are however relatively competitive and removing a competitor does not typically substantially benefit a buyer. Some buyers see leverage in the human capital of the target. A relatively moribund buyer, with less than a stellar management team, may see high value in a target s intellectual capital. This is probably the most powerful, but often overlooked, potential synergy from an acquisition. Diversification All Boards and CEO s of TMT sector companies must frequently ask themselves What business will I, in retrospect, wish I was in in 3 years? Based on their answers to this question, companies will target acquisitions in perceived hot business sectors. Guessing trends in the TMT market is not easy, as the hearth lives of TMT hot sectors tend to be reducing. What was hot yesterday, may be luke warm or cold in 6 months time. Never-the less, the question must be asked. Geographic Expansion Boards and CEO s frequently seek growth through acquisition of targets with footprints in new (for the buyer) markets, if geographic location is pertinent to the nature of the business. An IT services business will seek acquisitions to expand geographically, as feet on the ground in a location remote to the buyer s established presence is an essential business requirement. Product companies, hardware and [particularly software companies, are less driven to geographically expand by acquisitions, often preferring to access remote markets through channel partnerships. Offshore (outside of Australia) expansion, particularly into emerging, high growth markets such as China, can be seen as the Holy Grail, or high risk options to be avoided. Build Versus Buy Many potential acquirers will undertake build or buy assessments of potential acquisitions. The viability of builds (viz. new business start-ups) can be very complex and potentially loss generating for extended
periods particularly if the goal is to establish in foreign markets. A start-up in China would be seen as particularly high risk. Build or buy assessments can be plagued by a lack of understanding of the targeted (new) business. Existing businesses, which are well known to a potential buyer, are generally seen as difficult and complex. A new business of which a potential buyer has very little knowledge or understanding, is often seen as easy and simplex until it is better understood. In some sectors of the TMT market, building new operations is to a level of necessary critical mass is not realistically viable. For example, building a global IT services business such as Computer Sciences Corporation ( CSC ) is virtually mission impossible. Far better to consider an acquisitions strategy and program for a progressive creation of such an enterprise, or to consider acquisition of CSC itself which has encountered material headwinds in recent times, with a dramatic impact on CSC s listing valuation. Competitive Tension Through an M&A Process It is not uncommon for owners and Boards of TMT companies to wait for the knock at the door as an exit strategy. This approach is generally flawed. A single buyer expressing (opportunistic) interest in a target is unlikely to produce a premium valuation. Experienced buyers can detect the lack of competitive tension which is why large TMT sector companies (and larger PE firms) employ corporate M&A teams to identify and approach targets. Generally, M&A advisory firms such as Newport Capital, and seasoned serial entrepreneurs, recognise that a robust process to sell or buy is a far better and more productive approach. Of course, buyers and sellers may be reticent to embark on a robust process to sell or buy, for a multiplicity of perceived potential issues. These issues range from concerns over leakage to the market and competitors, concerns over costs, or even concerns that a robust process is far more likely to produce an outcome. Buyers and sellers sometimes have difficulty in facing the higher probabili0ty of an outcome (viz. a transaction) through a robust process. In all forms of transaction processes - buy, sell, capital raising/placement and IPO competitive tension will lead to a better outcome for client. Better outcomes include higher probability of a targeted transaction completing, a shorter period to complete (based on an established schedule), a higher valuation on sale, a lower valuation on an acquisition etc., and a superior transaction structure. Advisers with skills and experience know how to effectively cr6eate compet7itive tension, without scaring the horses. Comparable Transactions TMT sector comparable transactions, which assist valuation negotiations for transactions, are less than readily available. Listed company transactions are readily available, but privately held company comparables are not readily available. Even when a listed company acquires a privately held target, the full details of the transaction structure and valuation may be obscured for various reasons. Identification of proper comparables is also not easy. Quite frequently, Australian privately held TMT companies will promote US market transactions involving US listed buyers and sellers (or just US market listing valuation metrics) as comparables. This is of course futile and irrelevant. Finding genuine, proper, Australian market comparables is facilitated by deep involvement in the Australian TMT market over an extended period.
Where valid, proper and appropriately selected comparable transactions can have a material and beneficial impact on TMT market valuations achieved in a robust transaction process. Buyer and Seller Appetites The level of appetite of buyer and seller has a material impact on achievable valuations in TMT market transactions. A highly motivated buyer will pay a premium valuation on an attractive transaction structure. Poorly motivated buyers and sellers seeking opportunistic transactions at off-market valuation metrics will fall away in a robust transaction process. Valuation Modelling Experienced TMT market M&A advisers will have skills in valuation modelling. Valuation models involve say 5 year trading projections for the target, which are used to calculate the net present value ( NPV ) of the target, using a discount factor equal to the buyers weighted average cost of capital ( WAAC ) or a WACC seen as representative of the prevailing funding market. The model produces an NPV of the projected free cash flow of the target based on projected EBITDA (earnings before interest, tax, depreciation and amortisation) or EBITDAC (EBITDA minus capitalisations). The difficulty in such valuation modelling is of course the say 5 year trading projections on which the NPV model is based. Buyers and investors will regularly discount or hedge the projected EBITDA or EBITDAC projections on the basis of their assessed risks of achieving the projections. Valuation models for larger, well-established TMT sector businesses are useful. Valuation models for relatively early stage TMT sector businesses are generally ignored. SUMMARY Valuation of Australian TMT sector companies listed and privately held is a mixture or art and science. No one size fits all. The most cogent and meaningful basis of TMT sector company valuations is what a robust process can produce for IPO s, capital raisings/placements, acquisitions and sales. Deep knowledge and experience in the Australian TMT& market, and excellence in execution of a robust process, are key determinants of achievable valuations and transaction structures. Any transaction process is assisted by science in the form of valuation modelling, selection and presentation of valid comparables and use of a proven execution methodology add material value to valuations and transaction structures.