Technology Business Valuations: Stock Market Bubble Warning Resurfaces
In a letter to investors, Kinsman Oak Capital Partners cautioned against the “very, very expensive” disruptive technology sector, noting for every Google ($GOOG) and Facebook ($FB) that changes the way the world operates, there is an overabundance of others that died trying, SeekingAlpha reports.
Dig a little deeper into the letter, SeekingAlpha notes, and you’ll find this ominous 2002 quote from former Sun Microsystems CEO Scott McNealy (pictured above):
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes which is very hard. And that assumes you pay no taxes on your dividends which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
Why Scott McNealy’s Words Matter
Admittedly, the McNealy quote requires some context for technology entrepreneurs, investors and MSPs that weren’t in the market two decades ago. The back story: During the 1990s Sun Microsystems was a dominant provider of high-end workstations and servers, and the company’s Java computer language was widely popular.
At its peak in 2000 or so, Sun’s market valuation was roughly $200 billion. But Sun’s stock plummeted when the dot-com market bubble popped, and commodity workstations and servers running Windows NT and Linux flooded the market.
When the dust settled, Oracle ultimately acquired Sun for $7.4 billion — or $5.6 billion net of Sun’s cash and debt. Translation: Sun’s valuation fell more than 95 percent from its peak.
2021: Dot-Com Bubble Revisited?
Fast forward to 2021. ChannelE2E recently heard about a small MSP software startup with about $2 million in revenues that was valued at 50 times annual revenues during early stage funding. Moreover, some recent MSP M&A deals involve valuations of 15X to 18X annual EBITDA, private equity sources tell ChannelE2E.
Are those sky-high valuations cause for concern? Perhaps so. Historically speaking, MSPs had been valued around 6X to 8X annual EBITDA — with top performers fetching 10X or maybe 11X or so valuations, according to ChanneE2E’s expansive coverage of M&A deals.
So where do technology market, SaaS & MSP valuations go from here? Instead of looking ahead, perhaps we should all spend more time re-reading that quote from McNealy. And for additional context, check this SaaS valuation analysis from Tanay’s Newsletter.