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VALUATION: THE COMPARABLES MELTDOWN.

Whenever a software company sells stock--to private investors, to an acquirer, or through a public offering--the inevitable first question is, What are the comparables? Since no two companies are identical, selecting supposedly similar firms is often a tough judgment call. Sellers always like to compare their company's value to the best of the high-flyers, while would-be buyers beat down prices by comparing the company to the worst dogs they can round up.

The comparables process tends to inflate--or deflate--whole market segments, often without much regard for individual company performance. Internet stocks zoomed upward as a pack over the past few years, then more recently suffered a common collapse in value.

It wasn't that individual companies screwed up; the investment community simply decided to assign a lower value model to all "comparable" Internet ventures.

Meanwhile, what's happened to the comparables of traditional PC software companies? Conventional wisdom says the PC software segment has lost substantial value in the last year or so. And in fact more than 60% of the public companies from this year's Soft*letter 100 have suffered a decline in share price in the past twelve months, ranging from modest erosion to near-total collapse (see page 2). As of the end of October, the 50 public companies on our list had lost 18% (median) of their value, a trend line that looks pretty scary.

It's harder to measure valuation trends in the world of privately-held companies and venture-financed startups, but there's plenty of anecdotal evidence that points to a similar meltdown.

Venture firms (who claim to be awash in cash) have become especially tough about how they price investments in early-stage companies, often cutting deals that represent almost no premium over the price that founders and angels paid for their stock. In addition, VCs have become more aggressive about liquidation preferences--which end up giving later investors an even better payback than the founders for anything less than a wildly successful IPO.

Worse, wildly successful IPOs seem to be increasingly rare.

Broadview Associates recently reported that the number of software IPOs has stayed relatively constant over the past six years, while the ratio of acquisitions to IPOs has jumped from less than 3:1 to 12:1 (Soft*letter, 9/23/98). As a result, many more entrepreneurs (and their angel partners) these days end up with a modest one-time payout instead of a constantly growing stake in the companies they build. Lately, a good many entrepreneurs have learned a hard lesson:

Concessions that lower their investors' risk almost always come out of the founder's hide.

But the retreating tide hasn't left all boats stranded on the beach.

Thirteen of the public companies on our list--a quarter of the total--actually gained more than 30% in valuation during the past year. These weren't newly-minted Web startups, either. Besides

Microsoft (with its relentless 64% rise in value), the list of valuation stars includes a typical cross-section of mature PC software companies--a few turnaround cases (Novell, up 77%; Macromedia, up 64%), various business and consumer publishers (Intuit and Great Plains, both up 50%; MySoftware, up 39%), and--perhaps surprisingly--a good many vertical market firms in low-visibility niches (Eagle Point, with a 159% jump in valuation, develops software for civil engineers; Best Software, up 142%, sells fixed-asset accounting products). Clearly, there seems to be plenty of upside left to the classic PC software business.

In turn, these high-valuation companies create a curious double standard for comparables analysis. If we look at the full spectrum of PC software firms, it's probably time to bail out of software investments altogether. But there are also enough ongoing success stories to suggest that software remains a powerful engine for wealth creation. In the short run, we suspect the pessimists will manage to drive public and private valuations even lower than they are today. But eventually the survivors--those who don't exit the market or sell out based on today's bargain-basement comparables--may find that software valuations have bounced back to their traditionally lofty levels.

Wall Street Winners and Losers

Share Price

 10/31/97 10/29/98 CHANGE

Eagle Point Software $ 3.09 $ 8.0015 8.6%

Best Software 10.38 25.13 142.2%

Novell 8.44 14.947 7.0%

Macromedia 10.38 17.036 4.2%

Microsoft 65.00 106.636 4.0%

Timberland Software 11.80 19.066 1.6%

Intuit 32.63 48.884 9.8%

Great Plains Software 23.88 35.754 9.7%

Inso 12.13 18.004 8.5%

Medical Manager 17.50 24.564 0.4%

MySoftware Co. 2.56 3.563 9.0%

Citrix 48.96 67.633 8.1%

MapInfo 9.25 12.253 2.4%

The Learning Co. 20.00 25.812 9.1%

CE Software 3.84 4.752 3.6%

Network Associates 33.17 40.812 3.1%

7th Level 2.00 2.442 1.9%

Micrografx 8.13 9.001 0.8%

Caere 8.50 9.381 0.3%

Wall Data 16.38 15.00 -8.4%

Platinum Software 10.38 9.38 -9.6%

MathSoft 3.13 2.69 -14.0%

Autodesk 37.00 31.63 -14.5%

Santa Cruz Operation 6.13 5.19 -15.3%

Adobe 47.75 39.13 -18.1%

Artisoft 2.88 2.34 -18.5%

SPSS 22.50 17.50 -22.2%

Bitstream 2.13 1.56 -26.4%

ON Technology 2.63 1.88 -28.6%

Activision 14.63 10.44 -28.6%

Visio 37.19 25.88 -30.4%

Symantec 21.88 15.06 -31.1%

Rogue Wave Software 11.63 8.00 -31.2%

Netscape 32.88 22.56 -31.4%

GT Interactive 9.88 6.50 -34.2%

Diehl Graphsoft 4.63 2.75 -40.5%

Stac Electronics 5.88 3.31 -43.6%

Inprise (Borland) 9.50 5.00 -47.4%

Phoenix Technologies 15.38 6.75 -56.1%

NetManage 3.44 1.50 -56.4%

Insignia Solutions 2.75 1.16 -58.0%

DataWatch 3.50 1.25 -64.3%

IMSI 16.75 5.94 -64.5%

Metrowerks 8.56 2.63 -69.3%

ViaGrafix 13.38 3.50 -73.8%

Touchstone Software 3.75 0.88 -76.7%

MetaCreations 14.50 3.13 -78.4%

Omega Research 8.25 1.63 -80.3%

Expert Software 6.38 1.00 -84.3%

SystemSoft 3.38 0.34 -89.8%

Median -18.3%


Source: 1998 publically-traded Soft*letter 100 companies, excluding acquired companies and companies not actively traded on major exchanges.
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Title Annotation:Industry Trend or Event
Publication:Soft-Letter
Geographic Code:1USA
Date:Oct 31, 1998
Words:1078
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