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Summary
Media coverage and investor appetite for growth in
the technology sector has intensified, leading some
individuals to reflect on bubble-like developments.
Some signals of enthusiasm include the steady
increase in the number of merger-and-acquisition
(M&A) transactions within the software and
internet industry since 2009, a recent upturn in
venture capital investment in 2014, and stong IPO
performance.
On the other hand, many indicators are nowhere
near the extreme activity of the prior tech bubble in
the late 1990s/early 2000s, while fundamentals and
valuations of the technology sector remain healthy
in the aggregate.
We are in the middle of a generational platform
shift toward the mobile/cloud era. Many investors
are seeking to capitalize on opportunities related
to this trend, thereby driving some valuations up.
While we continue to evaluate these disruptive
players, we are still finding many compelling
opportunities in other technology companies,
primarily those with strong balance sheets,
profitability, and consistent revenue growth.
Lazard Insights is an ongoing series designed to share valueadded insights from Lazards thought leaders around the
world and is not specific to any Lazard product or service.
This paper is published in conjunction with a presentation
featuring the author. The presentation can be accessed via
www.LazardNet.com.
Exhibit 1
Renewed M&A Activity in Internet and Software Industries
Exhibit 3
Startup and IPO Valuations, 2014 Transactions
Deal Count
300
($B)
168
30
IPOs
238
240
Capital Raise
24
Acquisition
18
Internet
194
12
180
2012
2013
2014
Airwatch
Trulia
Oculus
GrubHub
GoPro
Square
Palantir
Dropbox
Airbnb
OpenTable
2011
Nest Labs
2010
Pinterest
Arista
Networks
Cloudera
2009
Snapchat
60
2008
Uber
120
Alibaba
Software
As of 19 September 2014
As of 31 July 2014
The securities mentioned are not necessarily held by Lazard for all client portfolios,
and their mention should not be considered a recommendation or solicitation to purchase or sell these securities. It should not be assumed that any investment in these
securities was, or will prove to be, profitable.
Exhibit 2
The Valuation Gap Appears to Be Widening in the Technology
Sector
Valuation and Revenue Growth, Russell 3000 Index Technology Sector
EV/Sales
(%)
20
60
15
40
10
20
5
0
0
2009
2010
2011
2012
2013
2014
Exhibit 4
Venture Capital Financing and Global Technology IPO Issuance Are Well Below 19992000 Levels
Number of US Companies receiving VC Financing
6000
5,476
50% Lower
4000
2,746
2000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Number of Global IPOs
400
310
300
87% Lower
200
100
41
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Thomson ONE, Morgan Stanley Equity Capital Markets. Data per Dealogic, Bloomberg, and Capital IQ
Exhibit 5
Comparison of IPO Characteristics, 19992000 versus 2013
19992000
2013
12
17
91
28
63
18
77
49
Exhibit 6
Technology Fundamentals Are Attractive in the Aggregate
S&P 500 Index
Technology Sector
December December
1999
2007
S&P 500
Index
August
2014
August
2014
Valuation
P/E , CY
Gross Margin (%)
22.2
16.7
16.7
40
43
52
42
20
20
31
20
ROE (%)
21
18
24
15
Balance Sheet
Cash/Market Cap (%)
recent IPOs has been $91 million, more than 5 times the size of the
median sales of IPOs in 19992000. Other key metrics highlighting
this divergence are shown in Exhibit 5.
64.7
Debt/EBITDA
11
13
0.9
0.9
0.8
1.9
As of 28 August 2014
Source: Lazard, Bloomberg
to the S&P 500 Index as a whole, the valuations of the broader technology sector are currently in line with the benchmark.
While there may be some signs of stretched valuations within the
startup market and recent IPOs, we believe the data show that
any potential froth in the market would be narrow in scope, as the
broader investable technology universe remains solid with attractive
valuations and strong fundamentals.
Exhibit 7
A Generational Shift in Technology Platforms
Mainframe
Client-Server
Thousands of Users
Hundreds of Apps
Millions of Users
Thousands of Apps
Mobile-Cloud
Billions of Users
Millions of Apps
private data centers given the sensitivity of data and years of historical
investment in their own infrastructure.
Exhibit 8
The Mobile Advertising Gap
(% of Total)
50
Time Spent
Ad Spend
40
30
20
10
0
Radio
TV
Internet
Mobile
As of 31 December 2013
Data are for the United States only.
Source: KPCB
Exhibit 9
Figures as Share of
Total Revenue (%)
Figures as Share of
Total Revenue (%)
Revenue
100
Revenue
100
COGS
25
COGS
20
Gross Margin
75
S&M
40
R&D
G&A
Operating Margin
Gross Margin
80
S&M
15
R&D
10
G&A
10
Underlying Operating
Margin
Figures as Share of
Total Revenue (%)
COGS
Gross Margin
-5
S&M
35
15
R&D
10
G&A
50
Customer Acquisition
Costs
0
-40
sales and marketing cost to acquire those customers, and the ultimate
contribution margin of the customers after they have been acquired.
Finally, we use scenario analysis to understand the sensitivity of valuation to key metrics such as renewal rates, underlying contribution
margin, new customer growth, and the cost to acquire those new
customers.
Exhibit 9 illustrates the philosophy behind this valuation framework. A
hypothetical cloud software company might only have 10% operating
margins today, and therefore looks expensive on any valuation multiple
of their earnings. But once we separate that income statement into two
parts, the existing customer base and customer-acquisition costs, we
can then see that the underlying contribution margin of the existing
business is often much higher at 50%. This example shows that the
majority of the sales and marketing (S&M) costs and some of the cost
of goods sold (COGS) are used to drive new customer acquisition, and
actually do not support the existing business. This analysis allows us to
evaluate the entire customer lifetime value, giving us more confidence
in the long-term future profitability of a business.
Conclusion
Technology fundamentals are compelling and appear favorable when
compared to the market as a whole. These valuations are nowhere near
the extremes of the late 1990s. However, we are in the middle of a
powerful platform shift from a PC and clientserver era, to a mobile/
cloud era. To the extent a bubble exists, it would be much narrower
in scope, as some investors are aggressively seeking companies that are
taking advantage of these new secular trends, which will only grow
in size and importance over time. There will be some winners, as well
as many losers who are not able to execute on the opportunity in this
highly innovative but competitive space.
We believe investors recognize this opportunity and are paying a
premium to place option-like bets on potential winners. We continue
to gain a broad and deep understanding of mobile and cloud trends in
order to appreciate industry implications. We plan to continue evaluating the full range of technology investment opportunities using our
investment process, which focuses on future returns, valuation, and
scenario analysis. While we have currently found some opportunities
in pure plays levered to the mobile and cloud trends, we are also seeing
very good risk/reward in many technology companies that feature sustainable recurring revenue growth, high levels of profitability, strong
balance sheets, improving capital allocation, and attractive valuation.
Notes
1 Source: Mobile Future Forward. As of September 2012.
2 Source: Gartner (analysts: Mikako Kitagawa, et al.) Market Share: Devices, All Countries, 1Q14. 23 May 2014
3 Source: Gartner (analysts: Ken Newbury, et al.) Gartner Market Databook, 2Q14 Update. 23 June 2014; Morgan Stanley January 2014 CIO Survey.
Important Information
Originally published on 24 September 2014. Revised and republished on 25 September 2014.
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