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OSS/BSS

Why do telco software companies have such lame valuation multiples?

Last month, Amdocs announced the acquisition of BSS/OSS software provider Openet for $180 million, citing its "world-class cloud-native capabilities, network pedigree, and deep 5G charging, policy and data management expertise." The deal placed Openet's value at 2.6 times its reported annual revenues.

Outside of telco, other large, cloud-native, software-as-a-service (SaaS) companies are typically valued at ten times their revenues, with some companies far exceeding that. For example, insurance software provider Guidewire operates in a heavily regulated industry, like telecom. The company is in the midst of transitioning from being a traditional on-premises software provider to becoming a cloud SaaS provider, and it trades at almost 12 times its revenues.

Table 1: BSS/OSS company valuations

Ticker Share price* Market cap ($M)* TTM revenues (mrq) ($M)** Enterprise value ($M) EV/R
Openet N/A N/A $180 $70 $180 2.6
Amdocs DOX $62.45 $8,337 $4,150 $8,187 2
CSG CSGS $44.07 $1,458 $992 $1,766 1.8
Optiva OPT $40.80 $217 $91 $255 2.8
Synchronoss SNCR $3.51 $156 $298 $203 0.7
Source: Companies, Yahoo Finance. Notes: * Marketing cap calculation taken from stock price as of August 10, 2020; ** Revenues, debt, and cash figures taken from Yahoo Finance most recently reported quarter as of August 10, 2020.

However, BSS/OSS software companies, some of which claim cloud-native capabilities, trade in the same range as the Openet valuation: two to three times revenues. So why aren't telecom cloud software companies valued at ten times revenues, like you see in other industries?

Telecom software vendors are services businesses, not SaaS companies
For decades, communications service providers (CSPs) have spent hundreds of millions deploying software applications to provide the best customer experience possible. These CSPs are never content with the product features and functionality delivered out of the box; they instead spend millions more to integrate the applications and customize the software to make it do exactly what they want. They believe the customizations help them to differentiate themselves from their competitors.

All of this work, usually delivered as professional services, drives the software vendors from being product companies into being services companies. Because they have to build their products to support every CSP's whim, it is nearly impossible for the software vendors to provide the universe of capabilities CSPs desire. Typically, software vendors will solve the problem by selling a base "product" and complementing it with (lots of) additional professional services fees that are delivered in a ratio of 1:1 (or more) to license revenues.

The CSP's journey is not a series of product enhancements and upgrades; instead, it's a series of service engagements. Over time, each CSP is on its own version of the product as more customizations are made. On the one hand, the customer has a completely bespoke system that does exactly what it wants. On the other hand, all modifications to the software are funded by the customer and it becomes increasingly difficult to participate in the economies of scale of any R&D investments made by the "software" company.

In contrast, let's look at a software company that's run like a product company, such as Salesforce. This is a product that has standard features and allows its customers to integrate to a predefined set of applications. New features are created for all customers and delivered silently while they sleep. There is the ability to configure the product, to an extent. Custom code is not built for specific customers, and they are certainly not on their own custom version. Deployments typically take weeks (not months or years) and the professional services associated with implementation represent a tiny fraction of the recurring subscription costs to rent the software.

Just as before, there are pros and cons with this approach. On the plus side, it's usually less expensive for the customer, eliminating end-of-life hardware or software headaches. On the downside, it may need to modify its business processes or desires to fit within what the software can do. Cloud SaaS companies are typically valued at five to ten times revenues, leaving Openet as a far outlier.

Table 2: Cloud SaaS company valuations

Ticker Share price* Market cap ($M)* TTM revenues (mrq) ($M)** Enterprise value ($M) EV/R
Openet N/A N/A $180 $70 $180 2.6
Guidewire GWRE $107.78 $8,965 $707 $8,361 11.8
Salesforce CRM $197.16 $177,641 $18,230 $174,051 9.5
Workday WDAY $181.05 $31,503 $3,820 $31,003 8.1
Zendesk ZEN $87.26 $10,072 $925 $10,225 11.1
Source: Companies, Yahoo Finance. Notes: * Marketing cap calculation taken from stock price as of August 10, 2020; ** Revenues, debt, and cash figures taken from Yahoo Finance most recently reported quarter as of August 10, 2020.

For telecom software providers, the ability to deliver integrations and customizations is "table stakes" to land business, and they happily oblige. Perhaps Amdocs, after the review of Openet, saw the business as a services business, with a great collection of customers deployed on a deeply customized product, and not as a cloud SaaS company.

Table 3: Services companies valuations

Ticker Share price* Market cap ($M)* TTM revenues (mrq) ($M)** Enterprise value ($M) EV/R
Openet N/A N/A $180 $70 $180 2.6
Accenture ACN $230.34 $146,542 $44,550 $143,602 3.2
CGI Group GIB $70.53 $16,248 $12,198 $16,194 1.3
Cognizant CTSH $67.11 $36,390 $16,760 $35,280 2.1
Infosys INFY $12.59 $53,382 $12,770 $50,991 4
Source: Companies, Yahoo Finance. Notes: * Marketing cap calculation taken from stock price as of July 31, 2020; ** Revenues, debt, and cash figures taken from Yahoo Finance most recently reported quarter as of July 31, 2020.

Is it a product or services company?
If you're an investor looking at a cloud software company in the hope it can deliver a ten times revenue valuation, then the key question to ask becomes: are all the customers on the same multi-tenant version, with no customizations, or not? In almost all cases, if the company is selling to Tier 1 CSPs, the answer will be "no."

The problem in the telco industry is that CSPs have not yet realized that in order to benefit from truly cloud-native SaaS software they have to abandon their practice of implementing heavy customizations. This has been one of my biggest learnings as CEO of Optiva – every customer required a custom version of the software. In my previous experience as CEO of other cloud SaaS companies, I was managing one version that all customers used. It was a completely different ballgame.


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What about private cloud, you say? Shouldn’t that be considered cloud software and trade at ten times revenues? Again, I say no. It is easy to get confused with companies that claim they have cloud-native software yet are deploying installations into an on-premises private cloud. Investors should look at private cloud deployments as if the company is running a multi-tenant software system on-premises for each individual customer (imagine a private Salesforce installation for each customer – insanity!).

So when you see telco software companies making announcements of cloud deals that are actually private cloud installations, you should assume the company is not going to trade at ten times revenues. If they were going to trade at ten times revenues, you'd see a lot more private equity firms scooping up all these telco cloud software companies for their huge potential returns. Instead, you should expect that it will trade in the more traditional range of two to three times revenues.

In order for telco software companies to pivot and become cloud SaaS companies, they are going to have to deploy their software on public cloud, as multi-tenant. They'll have to dramatically reduce customizations and integrations to get the economies of scale you see with product cloud SaaS companies. And convincing the telcos to give up their customizations may be the disruption both parties will need to make, for the better.

— Danielle Royston, independent consultant

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