Opportunities for investors in the transition to SaaS

By Phillip Morse, a TMT Strategy Director for EY-Parthenon

The transition from traditional on-premise to software-as-a-service (SaaS) is creating exciting opportunities for investors. 

SaaS typically has six key characteristics: subscription-based payment, cloud-based, web delivery, multi-tenant, standardised (configurable rather than customised) and self-service. On-premise software companies are in various stages of transitioning their operations and native SaaS providers are disrupting the market.

A strong growth story

The market for traditional on-premise based enterprise software is growing, but by little more than inflation. SaaS, on the other hand, is growing fast as it captures value from hosting services, and creates new market demand. For example, by enabling smaller companies to use tailored software for tasks that may have previously been undertaken manually such as adopting HR SaaS software versus using spreadsheets.

Investors are attracted by this growth and by the recurring and predictable revenues generated through the SaaS subscription model (typically per user per module per month fees) versus the more ‘lumpy’ perpetual licence model.

Measuring the valuation gap

SaaS businesses are generally valued at much higher multiples than traditional on-premise software businesses. Our research shows that the average EV/EBITDA multiple for on-premise software companies was just c.5x in 2017 vs c28x for SaaS businesses. 

The UK is also a particularly attractive market compared to the US, due to valuations being comparatively lower and the opportunity for maximising value through the SaaS transition is better progressed. 

Identifying the opportunities

There is a role for investors in helping traditional business in transitioning to SaaS, as this shift often requires new investment, technology skills and management expertise while retaining value from legacy products. 

There are a wide range of investment opportunities for investors, given the fragmented nature of the software market, but there is a need to move quickly to seize the best opportunities during the ‘land-grab’. 

Our analysis of potential opportunities evaluates each market segment and sub-segment, based on how suitable it is for SaaS and how viable it is for investment. The results show that there is a large variance in the pace at which the SaaS transition will occur and how attractive the investment opportunities may be.