Tuesday, June 28, 2011

Thoughts on Software from Brent Thill at UBS

There's been lots of talk in the press about a new tech bubble, especially in the software area.

Much of this chatter relates to the huge valuations attached to companies like LinkedIn and Pandora Media when they have been brought public in recent weeks. Private estimates now value Facebook at around $100 billion even though Facebook's revenues in 2010 were just over $2 billion.

When Google tried to buy Groupon for $8 billion a few months ago, Groupon turned it down flat. Many tech observers thought that company management was crazy, but now it appears that the private market value for Groupon is twice Google's offer.

This is concerning, especially for a group that is producing prodigious top line growth but very little in the way of profits.

I just heard UBS software analyst Brent Thill today at lunch. Brent is a first-rate analyst, in my opinion, and has been following the group for more than a decade.

Brent said that the IPO pipeline for software companies is a robust as he's seen it in 10 years. Small tech companies, it seems, are rushing to the public market while prices are generous, and investor demand for new concepts in social media and cloud computing appears insatiable.

All this makes Brent uneasy. It gives Brent pause when industry leaders like Larry Ellison of Oracle say that their deal activity has slowed due to excessive valuations.

Brent noted that in the past, Oracle has paid anywhere from 0.5x to 4.0x Enterprise Value/Revenues for acquisitions. But when I glanced down the list of the stocks that Brent covers, exactly one of them (Microsoft) trades below 4x EV/Rev.

More typical is VMWare, which now trades at a cool 50x P/E, or 10.5x EV/Revenues. Virtualization is a crucial part of today's tech world, but this is a very full valuation for VMW.

Brent still sees some upside for the group - there's too much cash chasing too few names - but it seems that we are in the late innings for stock performance for the group, especially for the newer "concept" stocks.