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Over the past few months we have placed increased emphasis on software as a service ("SaaS") companies due to the increasing amount of acquisition activity taking place within the industry. You can reference two of our past articles on companies in the same space, Selectica (SLTC), ExactTarget (ET) and E2open (EOPN):

  • December 24, 2012 article on SLTC: Is Revamped SaaS Company Selectica Ripe for Takeover?
  • January 15, 2013 article ET & EOPN: ExactTarget and E2Open: Two Intriguing SaaS Plays

In light of our ongoing coverage of SaaS companies, we have now widened our focus to include Responsys Inc. (MKTG). A clue which leads us to believe that MKTG may be telegraphing itself as an acquisition target exists in information disclosed in a January 11, 2013 8-K (a related press release has not been issued). We mentioned this fact in our January 16, 2013 Seeking Alpha article and disclosed that we went long MKTG shares to our premium members on January 14, 2013 (see January 22, 2013 research note on GeoInvesting for more details). Furthermore, shares trade at an enterprise value ("EV") to sales multiple well below other SaaS companies that have been acquired as well as comparable publicly traded firms. The overall SaaS sector received a lift from the December 2012 acquisition of Eloqua (ELOQ) by Oracle Corporation (ORCL) at an EV to sales multiple of 7.9. This development helped put a floor in shares of many SaaS stocks that had been struggling or dormant.

MKTG is directly comparable to ELOQ, yet is selling well below ELOQ's take-out multiple. Both of the companies provide a SaaS platform to enable customers to automate complex marketing campaigns via multiple channels such as email, social networking and the World Wide Web. Their customers exist in a diverse set of industries including retail, financial service, and technology. These services can help customers deliver targeted content at a lower cost to their current and potential clients.

The Big Clues That Make MKTG an Acquisition Target

The Street Speculates That MKTG Is an Acquisition Target

On November 5, 2012 after market, Responsys reported its 2012 third quarter report. Revenues reached $40.5 million, representing a 20% increase in sales compared to Q3 2011, but missed analyst estimates of $41.2 million. Investor sentiment towards SaaS companies is very sensitive to revenue performance. Shares of MKTG decreased approximately 30% to $5.85.

However, a silver lining quickly emerged. The following comment we stumbled upon from a November 6, 2012 note at wallstcheatsheet.com is worth mentioning:

"After the company reported a lower than expected third quarter revenue, JMP Securities reduced their target on Responsys Inc. However, the firm believes that the company could become an acquisition target and they find the stock's valuation compelling at current levels. The firm maintains an Outperform rating."

Well, the stock now trades around $8.00. Additionally, the company just reported 2012 fourth quarter numbers that beat analyst estimates and issued bullish 2013 revenue guidance of $188 to $192 million, ahead of analyst estimates of $185.8 million. So the "disappointing" 2012 third quarter results are in the rear-view mirror.

Change of Control Severance Agreement

We believe that MKTG's management has recognized the valuation discrepancy between its shares and those of other SaaS companies, especially after the possible market overreaction to its 2012 third quarter financials.

On January 11, 2013 MKTG filed a Poison Pill document to prevent a hostile takeover by other companies. Interestingly enough, management had never undertaken this action, and it came on the heels of the ELOQ/ORCL news. This may be an indication that:

  • The management of the company thinks that their company is trading at fairly low valuation multiples, which may attract existing and potential investors to purchase their shares to the extent that they might lose control over the company.
  • Management sees an imminent threat to its control of the company.

Valuation Multiple Comparison

The following table compares the valuation multiples between MKTG and other SaaS companies. ELOQ and ET are good comparables to MKTG.

EV to Trailing Sales1,2

Gross Margin1,2

Profitable (non-GAAP)?1,3

Annual Revenue,1,3

Revenue Growth rate1,3

Booking (deferred revenue) Growth Run-rate1,2

Cash flow positive1,2,3

MKTG

1.8

0.54

Yes

$190M

17%

10%

Yes

EOPN (public)

5.7

0.69

Yes, per 2013 analyst estimates

$89M

22%

30 to 35%

No

ET (public)

5.4

0.64

Forecast to lose money in 2013

$370M

27%

46%

Yes, per 2013 analyst estimates

ELOQ

8.2

0.72

Forecast to lose money in 2013

$114M

22%

13%

Yes, per 2013 analyst estimates

Rightnow (Acquired)

6.39

0.68

Yes

$222M

19%

5%

Yes

Successfactors (Acquired)

9.9

0.66

Yes

$327M

59%

26%

Yes

Aprimo (Acquired)

6.3

0.65

Yes

$80M

n/a

n/a

Yes

Unica (Acquired)

4

0.72

Yes

$115M

14%

39%

Yes

Footnotes

1 For Rightnow, Successfactors, Aprimo and Unica we referenced trailing revenue, gross margins, annual revenue, revenue growth rate, bookings, cash flow and profitability at the time they were acquired.

2 For MKTG, EOPN, ET and ELOQ we referenced the most recent publicly available filings.

3 Based on analyst estimates/company guidance for MKTG, EOPN, ET, and ELOQ.

From this comparison it is clear that MKTG trades at a lower EV/S than the other SaaS firms. In particular, MKTG is selling below the multiples of ET and ELOQ. (ELOQ EV/Sales pre-acquisition was 6).

We surmise that the reason for the discrepancy may be the result of the following factors:

  • MKTG is expected to grow 2013 revenues at 17% vs. 20%+ of ELOQ and ET.
  • Up until the 2012 fourth quarter, booking growth of MKTG was flat (now it is 9.97% based on the 2012 year end numbers) compared to ELOQ and ET.
  • Gross margins are lower than ELOQ and ET.

However, MKTG is solidly profitable and cash flow positive compared to that of ELOQ, which is losing money and not cash flow positive. Furthermore, MKTG's revenues for the last three years have grown 20%, 43% and 132%, respectively. These growth rates are similar to those exhibited by ELOQ when it was MKTG's current size.

Still, even if we punish MKTG for its lower revenue growth and gross margin we think it is plausible to conclude that assigning a higher EV to sales is not unreasonable. A meager EV/S of 2 would translate into a price target around $9.00.

Upside to Valuation Assumption Is Reasonable

If MKTG were to fetch an EV/sales multiple of other publicly traded companies we have analyzed we would need to consider EV/S multiples of anywhere between 4 and 6. As a matter of fact, before ELOQ was acquired by Oracle, it traded at EV/S of 6. Based on these more aggressive assumptions MKTG is worth between $15.50 and $22.17.

We also think that room for upside to management's 2013 revenue guidance exists based on a February 7, 2013 press release where management stated that it had appointed two new management members to drive revenues.

A continued improvement in the booking growth statistic would likely lead to an expansion in MKTG's valuation multiples.

Acquisition Trend Is No Joke

Due to the cost-saving and efficient services provided to their customers, companies within the SaaS industry have grown quickly in the past few years as demand for their services has increased. A SaaS platform often utilizes the "cloud" and requires less upfront cost to a potential customer compared to old software models. More and more, large companies have started to develop and expand their footprints in the SaaS industry. For example, Amazon (AMZN) is providing a variety of web services to its own customers, and the blue giant, IBM Corp. (IBM), has also been establishing its own mark by acquiring companies.

In previous articles we tallied up 5 high profile SaaS acquisitions since 2012 led by big name companies such as Teradata Corp. (TDC), SAP AG (SAP), IBM and ORCL. However, these were merely the tip of the iceberg. IBM alone has acquired at least 16 SaaS companies over the past few years, and 4 since 2012. ORCL also seems to be in a rush to expand its business with its own SaaS product offerings. It has already made 10 acquisitions since 2012, and 17 since 2010.

The pace of acquisition activity in the SaaS space is not expected to slow down anytime soon. A 2010 analysis of the merger and acquisition activity in the SaaS sector showed that, on average, targets in this sector are selling for 3 times more than the companies in other IT sectors and at premium price to sales multiples:

"SaaS Acquisitions Sold for More Than 7 Times Trailing 12-Month Revenue, Analysis Shows -- IBM, Oracle, SAP buying SaaS companies to gain market position; according to Martinwolf M&A Advisors some of these deals will end up as bargains."

According to a report released by DemandGen regarding the trend of marketing automation, SaaS marketing automation companies have started to integrate their products with CRM (Customer Relation Management). Furthermore, another article from Gartner states that:

"SaaS-based CRM will see the largest global revenue growth of all categories, increasing from $3.9B in 2011 to 7.9B in 2016, achieving a 15.1% CAGR worldwide".

If the trend of marketing automation as noted in the DemandGen report materializes, then the marketing automation SaaS companies such as MKTG, ET and ELOQ could have a good chance of further expansion of their businesses within this industry.

Conclusion

We foresee that the M&A activities in the SaaS industry will continue to grow in the coming months, and that taking a bet in MKTG shares is a compelling gamble. The Poison Pill filing should provide share price support. Even after taking into account MKTG's lower gross margins and estimated sales growth compared to ET and ELOQ, room still exists for an expansion in its valuation multiples.

Caveats:

  • We can't ignore low revenue rate if it continues for a prolonged period of time.
  • SaaS companies are some of the first to correct in weak market environments.
  • We can't rule out the possibility of bad press regarding botched acquisitions in the SaaS space.
  • We have not interviewed management, but plan to in the near future.
Source: Responsys: Filling The Valuation Gap