Software Finance: Outlook for the Second Half of 2005
An analysis of the latest data on software markets, M&A and venture capital finds the second half of 2005 will beat most observers? expectations.
By M.R. Rangaswami, Sand Hill Group
May 24, 2005
It?s like clockwork. Around this time, almost every year, many software industry observers begin to pronounce the year?s downfall. It goes something like, ?We thought this year would hit $X in I.T. spending but it look?s like we?ll miss that mark due to Y and Z.? 2005 is proving no exception to this trend. But a look at the latest software finance data shows that there are several causes to be optimistic about the year?s potential.
There?s no doubt that the outlook for second quarter looks dull. Goldman Sachs? survey of I.T. managers shows a pullback in 2005 technology spending plans, down from the 3.9 percent growth forecast in December to 3.0 percent in April. IDC also downgraded their 2005 U.S. I.T. market forecast from 5.8 percent growth to 5.0 percent. And Europe?s economic troubles have dampened its 2005 I.T. prospects as well, from IDC?s original prediction of 5.6 percent growth to 4.0 percent.
It appears that I.T. executives remain cautious. Goldman points to two problems. The survey found a slight increase in price discounting among tech vendors. Prior to April, this metric had been declining for the past 6 months. The upturn could signal the start of a new wave of price cutting. At the same time, Goldman?s panel reported a continued interest in vendor consolidation. The target of these efforts? Software companies. Among I.T. execs who want to consolidate, 74 percent want fewer application vendors and 50 percent want fewer infrastructure software vendors.
But is all this bad or good? The big challenge for analysts is reconciling the advance of new revenue models and new products within the software industry on overall market growth. The software business is rapidly transitioning to a mature, service-style, open source-embracing, offshore-intensive industry (see ?Seismic Shifts for the Software Market? from April 2005.) These shifts are all based on making spending more efficient. Therefore, the software market may very well continue to register depressed spending figures until the new models take over and gain widespread traction.
The word on the street is not quite so bad. A SandHill.com Pulse Poll of software executives conducted earlier this month registered above average growth for 2005. A total of 46 percent of visitors said 2005 I.T. spending appeared to be higher than 2004, and another 12 percent said it appeared to be much higher. Quarterly revenue numbers have been strong for software vendors offering the right solutions for today?s buyers ? and not as strong for those still struggling to find the right offerings.
The overarching problem is the U.S. economy. A look at the trend in technology share prices shows that oil prices and other macroeconomic conditions are holding down stocks overall and that pressure has a trickledown effect which most certainly constricts I.T. managers and their purse strings.
Looking forward, I.T. managers will re-open their checkbooks and continue their commitment to business-changing, more efficient software purchases. This won?t float all boats but it will float the best of them.
The second half of 2005 will bring what has also become like clockwork: the second half rally. Goldman Sachs shows a big lift for tech stocks has occurred in six out of the last seven years. Last year, tech stocks gained 26 percent between August and December. This year?s rally will likely be on the order of 20 to 30 percent ? perhaps higher if the U.S. can keep oil prices in check.
Merger-and-acquisition activity has also caused its share of market moves this year. Analysts have long predicted the advent of consolidation and its potential impact on the software business. But it seems that only now is the ramp up in activity finally gaining steam. The value of U.S. software M&As hit $30 billion in 2004 ? that?s triple 2002?s total. Not only is the value increasing but so is the deal size (which has also doubled over the past two years.) Leverage buyouts are also a significant factor. As of April, the value of technology LBOs year-to-date already surpassed that of 2004 overall.
Another acceleration factor to consider is global software M&A. According to an analysis by SVB Alliant, the number of non-U.S. deals in first quarter exceeded the number of U.S. deals by more than 50 percent. That?s quite a change from the start of first quarter 2002 when the number of deals was roughly similar.
The globalization of consolidation means 27 percent of software deals are now cross-border transactions. Although the international nature of consolidation translates to increased deal complexity, the enlarged playing field and number of players makes for a much more interesting and fast-paced game.
The M&A frenzy is having a positive effect on software venture capital. Despite the threat of industry consolidation, numerous new market opportunities continue to give birth to new software startups. Investment in 2004 hit nearly $5.2 billion. Software continues to be the largest category of VC and its share of overall investment hit a new high of 27 percent during first quarter. Look for 2005 U.S. software M&A to reach $40 to $50 billion by year?s end, while VC investment will likely top $6 billion.
The dynamic is obvious: startups are anxiously positioning themselves to be scooped up by larger suitors who are eager to provide more offerings to discriminating I.T. execs who don?t want to up their vendor count. Exit-wise, startups are far more likely to be purchased than to go public. Where the number of venture-backed software IPOs and acquisitions was roughly comparable in the mid-1990s, the balance has shifted entirely to acquisitions. According to SVB Alliant, first quarter saw nearly 200 software acquisitions and not a single IPO.
The second half will get even better for both M&A and VC. Here?s why: VentureOne says the median exit value of a venture-backed startup hit $60 million, the highest since the third quarter of 2000. As long as the exit opportunity remains compelling, investment in the sector ? both from venture investors and LBO firms ? will edge upwards. The influx of capital will surely birth many extraneous vendors. But it will also fuel the new technologies and business models which will drive the software industry to the next level of efficacy and efficiency. And a energized second half of 2005 will create a strong foundation for a healthy uptick in 2006 growth. Just like clockwork.
M.R. Rangaswami is co-founder of Sand Hill Group and publisher of SandHill.com. Send us your opinion about how the second half will shape up. Email editor@sandhill.com
There?s no doubt that the outlook for second quarter looks dull. Goldman Sachs? survey of I.T. managers shows a pullback in 2005 technology spending plans, down from the 3.9 percent growth forecast in December to 3.0 percent in April. IDC also downgraded their 2005 U.S. I.T. market forecast from 5.8 percent growth to 5.0 percent. And Europe?s economic troubles have dampened its 2005 I.T. prospects as well, from IDC?s original prediction of 5.6 percent growth to 4.0 percent.
It appears that I.T. executives remain cautious. Goldman points to two problems. The survey found a slight increase in price discounting among tech vendors. Prior to April, this metric had been declining for the past 6 months. The upturn could signal the start of a new wave of price cutting. At the same time, Goldman?s panel reported a continued interest in vendor consolidation. The target of these efforts? Software companies. Among I.T. execs who want to consolidate, 74 percent want fewer application vendors and 50 percent want fewer infrastructure software vendors.
But is all this bad or good? The big challenge for analysts is reconciling the advance of new revenue models and new products within the software industry on overall market growth. The software business is rapidly transitioning to a mature, service-style, open source-embracing, offshore-intensive industry (see ?Seismic Shifts for the Software Market? from April 2005.) These shifts are all based on making spending more efficient. Therefore, the software market may very well continue to register depressed spending figures until the new models take over and gain widespread traction.
The word on the street is not quite so bad. A SandHill.com Pulse Poll of software executives conducted earlier this month registered above average growth for 2005. A total of 46 percent of visitors said 2005 I.T. spending appeared to be higher than 2004, and another 12 percent said it appeared to be much higher. Quarterly revenue numbers have been strong for software vendors offering the right solutions for today?s buyers ? and not as strong for those still struggling to find the right offerings.
The overarching problem is the U.S. economy. A look at the trend in technology share prices shows that oil prices and other macroeconomic conditions are holding down stocks overall and that pressure has a trickledown effect which most certainly constricts I.T. managers and their purse strings.
Looking forward, I.T. managers will re-open their checkbooks and continue their commitment to business-changing, more efficient software purchases. This won?t float all boats but it will float the best of them.
The second half of 2005 will bring what has also become like clockwork: the second half rally. Goldman Sachs shows a big lift for tech stocks has occurred in six out of the last seven years. Last year, tech stocks gained 26 percent between August and December. This year?s rally will likely be on the order of 20 to 30 percent ? perhaps higher if the U.S. can keep oil prices in check.
Merger-and-acquisition activity has also caused its share of market moves this year. Analysts have long predicted the advent of consolidation and its potential impact on the software business. But it seems that only now is the ramp up in activity finally gaining steam. The value of U.S. software M&As hit $30 billion in 2004 ? that?s triple 2002?s total. Not only is the value increasing but so is the deal size (which has also doubled over the past two years.) Leverage buyouts are also a significant factor. As of April, the value of technology LBOs year-to-date already surpassed that of 2004 overall.
Another acceleration factor to consider is global software M&A. According to an analysis by SVB Alliant, the number of non-U.S. deals in first quarter exceeded the number of U.S. deals by more than 50 percent. That?s quite a change from the start of first quarter 2002 when the number of deals was roughly similar.
The globalization of consolidation means 27 percent of software deals are now cross-border transactions. Although the international nature of consolidation translates to increased deal complexity, the enlarged playing field and number of players makes for a much more interesting and fast-paced game.
The M&A frenzy is having a positive effect on software venture capital. Despite the threat of industry consolidation, numerous new market opportunities continue to give birth to new software startups. Investment in 2004 hit nearly $5.2 billion. Software continues to be the largest category of VC and its share of overall investment hit a new high of 27 percent during first quarter. Look for 2005 U.S. software M&A to reach $40 to $50 billion by year?s end, while VC investment will likely top $6 billion.
The dynamic is obvious: startups are anxiously positioning themselves to be scooped up by larger suitors who are eager to provide more offerings to discriminating I.T. execs who don?t want to up their vendor count. Exit-wise, startups are far more likely to be purchased than to go public. Where the number of venture-backed software IPOs and acquisitions was roughly comparable in the mid-1990s, the balance has shifted entirely to acquisitions. According to SVB Alliant, first quarter saw nearly 200 software acquisitions and not a single IPO.
The second half will get even better for both M&A and VC. Here?s why: VentureOne says the median exit value of a venture-backed startup hit $60 million, the highest since the third quarter of 2000. As long as the exit opportunity remains compelling, investment in the sector ? both from venture investors and LBO firms ? will edge upwards. The influx of capital will surely birth many extraneous vendors. But it will also fuel the new technologies and business models which will drive the software industry to the next level of efficacy and efficiency. And a energized second half of 2005 will create a strong foundation for a healthy uptick in 2006 growth. Just like clockwork.
M.R. Rangaswami is co-founder of Sand Hill Group and publisher of SandHill.com. Send us your opinion about how the second half will shape up. Email editor@sandhill.com
