Margins in tech are horrible, but can earn you a premium

If you’re a tech business, chances are your EBITDA margins are never going to impress anyone.  I don’t say that to be rude, rather that’s just what the data says.  We took a look at 76 tech companies in various sectors, from SaaS to Gaming, and the EBITDA margins across all sectors are anemic ranging from a median as low as -8% for SaaS to as high as 17% for Gaming.  In spite of the very weak margins, revenue multiples are still very attractive, meaning investors don’t care that your margin is low so long as the business has offsetting attractive factors.  The data is below. 

 

    TTM TTM  TTM  Q2 2016 Q2 2016       TTM TTM  TTM  Q2 2016 Q2 2016
Name Ticker Revenue EBITDA FCF EBITDA/REV Rev Multiple   Name Ticker Revenue EBITDA FCF EBITDA/REV Rev Multiple
Social               SaaS            
Facebook FB $22,160 $11,080 $11,200 50% 15.02x   Qualys, Inc. QLYS $182 $43 $75 24% 4.93x
Line Corp LN $1,300 $159 $206 12% 7.59x   Fleetmatics Group PLC FLTX $311 $67 $99 22% 6.95x
Linkedin LNKD $3,430 $396 $1,000 12% 6.89x   Veeva Systems Inc. VEEV $439 $87 $148 20% 10.89x
Twitter TWTR $2,480 -$4,890 $578 -197% 4.70x   RealPage, Inc. RP $514 $68 $108 13% 4.06x
                Medidata Solutions, Inc. MDSO $421 $52 $96 12% 7.24x
Median   $2,955 $277 $789 12% 7.24x   BroadSoft, Inc.  BSFT $314 $38 $64 12% 3.77x
                LogMeIN, Inc. LOGM $309 $37 $91 12% 6.19x
                LinkedIn Corp. LNKD $3,430 $396 $1,000 12% 6.85x
Marketplaces               SPS Commerce, Inc. SPSC $176 $18 $21 10% 5.65x
Priceline PCLN $9,810 $3,710 $3,500 38% 7.57x   The Ultimate Software Group, Inc. ULTI $700 $66 $120 9% 8.66x
eBay EBAY $8,790 $3,070 $3,130 35% 4.04x   Athenahealth, Inc. ATHN $1,010 $85 $171 8% 5.11x
Match Group MTCH $1,120 $289 $229 26% 4.09x   salesforce.com, Inc.  CRM $7,070 $522 $1,930 7% 7.75x
Sabre SABR $3,250 $739 $539 23% 3.29x   LivePerson Inc. LPSN $232 $16 $36 7% 1.58x
GrubHub GRUB $418 $94 $51 23% 7.03x   Lifelock LOCK $632 $35 -$38 5% 2.27x
TripAdvisor TRIP $1,470 $205 $440 14% 5.66x   IntraLinks Holdings, Inc. IL $285 $14 $35 5% 1.87x
Shutterstock SSTK $464 $61 $87 13% 3.97x   Cvent, Inc.  CVT $211 $8 $46 4% 5.60x
IAC IAC $3,250 $381 $330 12% 1.54x   Atlassian Corporation TEAM $457 $9 $130 2% 12.07x
Expedia EXPE $7,740 $838 $1,430 11% 2.34x   RingCentral, Inc. RNG $339 -$9 $19 -3% 4.60x
Angie's List ANGI $340 $33 $18 10% 1.67x   Five9, Inc.  FIVN $145 -$5 -$1 -4% 4.87x
Etsy ETSY $321 $30 $35 9% 4.16x   Jive Software, Inc. JIVE $202 -$14 -$10 -7% 1.02x
Zillow Z $741 $7 -$54 1% 8.08x   NetSuite Inc. N $846 -$59 $117 -7% 10.18x
Groupon GRPN $3,120 $7 $85 0% 0.83x   Shopify SHOP $282 -$21 $11 -7% 11.05x
Lending Club LC $508 $0 $52 0% 3.09x   Bazaarvoice, Inc. BV $200 -$15 $19 -8% 1.43x
Care.com CRCM $151 $0 $14 0% 1.59x   Marin Software, Inc. MRIN $108 -$8 $5 -8% 0.61x
                ServiceNow, Inc. NOW $1,190 -$91 $98 -8% 10.14x
Median   $1,120 $94 $87 12% 3.97x   Appfolio, Inc. APPF $90 -$8 -$2 -9% 6.82x
                2U TWOU $177 -$22 -$4 -12% 8.38x
                Cornerstone OnDemand, Inc. CSOD $389 -$52 $48 -13% 6.26x
Content Distributors               Twilio TWLO $219 -$30 -$2 -14% 21.23x
Google GOOGL $81,760 $26,900 $28,980 33% 5.83x   WorkDay, Inc. WDAY $1,260 -$194 $328 -15% 11.75x
WebMD WBMD $671 $163 $151 24% 2.88x   Secureworks SCWX $362 -$57 -$18 -16% 2.81x
Netflix NFLX $7,620 $314 -$896 4% 5.43x   Benefitfocus, Inc. BNFT $212 -$36 -$35 -17% 5.82x
Yahoo! YHOO $4,890 $151 $1,050 3% 7.23x   HubSpot, Inc. HUBS $225 -$41 $11 -18% 8.47x
Yelp YELP $629 -$9 $60 -1% 4.02x   Wix.com Ltd. WIX $241 -$45 $27 -19% 6.03x
Pandora P $1,290 -$159 -$118 -12% 2.41x   Proofpoint, Inc. PFPT $313 -$60 $57 -19% 9.82x
TrueCar TRUE $264 -$34 -$1 -13% 3.12x   Mindbody, Inc MB $120 -$24 -$13 -20% 7.90x
                Xactly XTLY $81 -$17 -$7 -21% 4.83x
Median   $1,290 $151 $60 3% 4.02x   Marketo, Inc. MKTO $241 -$51 -$4 -21% 6.14x
                Zendesk, Inc. ZEN $261 -$78 $15 -30% 10.22x
                New Relic, Inc. NEWR $202 -$61 $10 -30% 7.95x
Gaming               Splunk, Inc. SPLK $729 -$291 $163 -40% 10.03x
Activision Blizzard ATVI $5,370 $1,520 $1,640 28% 6.05x   MobileIron, Inc. MOBL $158 -$65 -$35 -41% 1.43x
Electronic Arts EA $4,460 $1,120 $1,050 25% 4.98x   Box, Inc. BOX $327 -$156 -$38 -48% 4.16x
Take-Two Interactive TTWO $1,450 $121 $109 8% 1.98x   Instructure INST $92 -$48 -$21 -52% 6.64x
Zynga ZNGA $750 -$20 $10 -3% 1.96x   Castlight Health, Inc.  CSLT $82 -$77 -$58 -94% 3.01x
                Hortonworks, Inc. HDP $155 -$219 -$98 -141% 2.99x
Median   $2,955 $621 $579 17% 3.48x                
                Median   $272 -$16 $20 -8% 6.16x

 

A few observations:

 

-Companies in Social Media, Marketplaces, and Content Distribution had median EBITDA margins of 12%, 12%, and 3% respectively.  SaaS was even worse at -8% and Gaming was the best at a respectable 17%.  In general, the margins for tech companies aren’t great because the cost of hiring developers and maintaining a tech stack is a burden that typical brick and mortar businesses don’t have to bear.  Hence while gross profit margins may look great because there are no COGS, EBITDA margins suffer because the expenses of maintaining a tech stack and paying developer salaries weigh on the bottom line.  

 

-In spite of the weak margins, the businesses above enjoy very nice revenue multiples.  Valuations for Social Media, Marketplaces, and Content Distribution had a median revenue multiple of 7.24x, 3.97x, and 4.02x.   Interestingly, Gaming which has the best margin at 17% has the worst revenue multiple at 3.48x (although that’s still respectable).  SaaS, which has the worst margin at -8% has the 2nd highest multiple at 6.16x. 

 

So does this mean you shouldn’t care about margins because investors are still paying high multiples for tech businesses in spite of weak margins? No, for a few reasons: i) many of the companies with the best margins enjoy extremely high multiples such as Facebook (15x with margin of 50%), Priceline (7.6x with margin of 38%), and Google (5.8x with margin of 33%).  While the margin alone isn’t the driver of the multiple, it certainly is part of the equation; ii) public tech companies can get away with poor margins because they have fantastic growth characteristics.  Indeed growth covers a lot of warts, but if you stop growing AND you have poor margins/cash flow, then you’re dead; and iii) generating a real margin means you’re generating real cash to fund the business which in turn means you don’t have to suffer as much dilution from fundraising. 

 

In conclusion, tech margins are generally awful, so if you can be the stand out company with a great margin, not only will you earn a higher valuation but you’ll also have to raise less capital to grow.     

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