An important aspect of valuing a company is determining how efficiently profit is extracted from revenue. I use free cash flow as a percentage of revenue to quantify this efficiency. Here are three tech companies which turn over 35% of revenue into free cash flow.
1) VMWare (VMW): VMWare is the largest provider of virtualization software in the world and a leader in cloud infrastructure solutions. In 2011 VMWare generated $1.57 billion in free cash flow from $3.77 billion of revenue, putting the FCF/R ratio at 41.6%.
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2) ARM Holdings (ARMH): ARM is a semiconductor and software design company which licenses its designs, generating 75% of revenue from licensing fees and royalty income. ARM processors are found in many mobile devices, enjoying a 95% market share in smartphones. ARM chipmakers include companies like Nvidia (NVDA) and Qualcomm (QCOM). ARM faces increased competition from Intel (INTC) as the company pushes into the mobile processor space. In 2011, ARM generated 181 million GBP of free cash flow compared to 492 million GBP in revenue, putting the FCF/R ratio at 36.8%.
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3) Microsoft (MSFT): Microsoft develops the Windows operating system, the Microsoft Office suite of productivity software, and Windows Server. The company also developed the Xbox line of gaming consoles and recently announced an in-house tablet, the Microsoft Surface. Windows 8 will launch later this year, providing one operating system for both PC's and mobile devices like tablets. In 2011 Microsoft generated $24.6 billion of free cash flow compared to $69.9 billion of revenue, putting the FCF/R ratio at 35.2%.
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Conclusion
There are many aspects to choosing companies to invest in, and FCF margin is a good measure of the efficiency of the company. These three companies have extremely high FCF margins, consistent with the dominating positions they hold in their respective industry.
