Editor’s Intro: The purchase of Qualtrics by SAP certainly was big news this week and has immense implications on many levels, but one of the most fundamental is valuation for technology companies in the insights space. Simon Chadwick, who I consider to be one of my mentors and gurus, agreed that a perspective that breaks down the deal pragmatically was needed and volunteered to share his thoughts. While no one is privy to all the thinking that went into this deal, there are a few things we can glean that Simon points out (and he and I have been saying for many years!): data synthesis is the key to unlocking insight-driven impact for brands, scalable technology offerings that help support that vision are in high demand, and the research industry has the opportunity to sit at the nexus of these trends. Time will tell whether the Qualtrics deal was a good financial decision and it’s impact on valuations for similar companies, but it’s certainly hard to debate the possible value of integrating consumer feedback and enterprise data. We’ll let Simon dig into the details in this “can’t miss” post. Enjoy!
SAP, the German software goliath, this week stunned the market research and financial markets by announcing that they were buying Qualtrics for $8 billion in cash. No earnouts, no deferred compensation, no stock. Cash.
This has led a number of industry analysts to scratch their heads and ask “what were they thinking?”. In the first nine months of this year, Qualtrics had revenues of $290 million on which they earned $1.5 million – or 0.5% of revenue. If the firm continues along its current growth path for the year of 87% and maintains its bottom line, the price paid will equate to 20.6 times revenue and 4,145 times net earnings. By comparison, SAP trades right now at a multiple of 26 times earnings and this is forecast to drop to 20x in the next two years. To put it mildly, this deal is massively dilutive to SAP.
Let’s do some basic math. To begin to break even on its investment, SAP would need to see a net present value of $8 billion in future cash flows which is going to take well over ten years even under the rosiest of scenarios. To get Qualtrics to stop being dilutive, it is going to have get to a point where it too is trading at 20 times net income. That would mean the company would have to earn net income of $400 million. Put that figure in the back of your mind for later use.
One of the reasons that Qualtrics earns so little at present is that it has been investing massively in growth, at which it has been very successful. It has received (and invested) over $450 million in venture capital and has invested significantly in both product and business development. Rumor has it that Qualtrics has the largest internal sales force in the industry. A corporate owner such as SAP, eager to end dilution, will want to see net income increase dramatically over a relatively short period of time. Healthy platform solutions such as Qualtrics should be earning 30% at the bottom line.
Let’s put those two figures together – 30% and a net income target of $400 million. That implies revenues of $1.33 billion – or 3.4 times as big as now. Qualtrics’ growth has been super-impressive over the years but it is difficult to foresee it continuing at its present rate ad infinitum, especially if it has to rein in business development expenses to promote greater profitability. Let’s assume that the company can grow 50% next year, 30% the year after that and 20% thereafter. Under that scenario, they could reach the revenue target I posited above and possibly – with really tight management – achieve 30% net income. By that time at least, Qualtrics will cease to be dilutive, but SAP still will not have recouped their investment. But – and it’s a big but – to get to this level of revenue, the firm would have to hold about 65% of the current online data collection market. This assumes that the likes of ResearchNow- SSI will go quietly into the night, which I rather doubt. (By the way, their merger which created a company twice the size of Qualtrics with 50 times the profitability was valued somewhere around $1 billion).
Clearly, these figures, while theoretically doable, will be very hard to achieve. So what does SAP know that we don’t that makes this a deal that is not only worth doing but imperative? Here’s what SAP CEO Bill McDermott had to say: the deal would be transformative because SAP would be able to merge its massive trove of operations data with Qualtrics’ collection of user experience data. But there are two slight problems with this: (1) clients who commission CX data usually believe that they own the data, not the data collector; and (2) in Europe, GDPR makes it very clear that the consumer owns the data. Expect rather serious data protection and/or legal problems if Qualtrics/SAP starts to claim that instead, it owns the data. Obviously, joint clients of the two could see their data merged but that begs the question as to why they weren’t doing so in the first place.
So, the financials are a serious stretch; the market assumptions are a stretch; and there could be serious legal issues if SAP starts to try and mine Qualtrics-collected UX, CX and research data. Which leads us back to the original question: what were they thinking? What does SAP know that we do not? What is so special that a company earning under $2 million a year is worth $8 billion?
One thing is certain: SAP has just thrown the software and market research technology markets the most massive curveball, as owners start to dream about selling their fledglings for massive amounts of money. Pity the poor investment banks and M&A advisors who are going to have to explain that real life is a little bit different.