Friday, July 14, 2006

The golden rule (the guy with the gold makes the rules)

Surfcontrol,(SRF.LN) an Internet content hygiene company based in the UK, has just put down £20m for BlackSpider, one of a number of companies offering Email scanning services such as protection from Spam and Viruses. The spiders are also based in the UK, privately held and venture funded. Their business received £5.7m (£4.6m from VC) of investment in 2004.

Valuation of companies has always been more art than science, and has given rise to a myriad of methods for answering the question, "What's this thing actually worth?". Somewhere between DCF, revenue multiple, and book value, a deal is done and the speculation ends.

It is because valuations are so subjective that analysts are so very interested in recent transactions, benchmarking potential deals against what sold recently. Here is how the UK market shares break-down for BlackSpider and their competitors.

Given the hype levels surrounding managed services of this kind, it is interesting to note the level of penetration of the UK market. BlackSpider and their peers are only 10% into this market.

Secondly, when we look at those who make-up that 10%, not all is as one might expect.

(*) UK business market is comprised of the 80000 largest companies or organisations in the UK.

Messagelabs have capitalised on being the first into their home market, as you would expect they occupy the top spot with an overwhelming majority. However it will come as a surprise to many that BT's very own in-house service takes second place, with BlackSpider a distant 3rd. BT's customers are smaller in size than the others on this chart, but still their sheer number is impressive. Seeing this reminds me of report that crossed my desk from Goldman Sachs Investment Research (Rick G. Sherlund & friends) in January. Their report credited ISPs with the power to impact pricing of pure-play security service providers, by bundling similar services with Dedicated Access or making them easy "+1" sales at point of order. If you can find it, read it. Looking further down the list, the sleeping giant at the moment must be Frontbridge, now owned by Microsoft. The company has been pretty quiet in the UK, how much longer will that last?

Given BlackSpider's valuation of £20m and declared revenues of £1.8m, what can we say about the relative value of the UK business of the other players in this market? Or the whole UK market in total?

Using the BlackSpider transaction as a guide, Messagelabs UK business is worth £112m today (6x the UK customers of BlackSpider, 6x the acquisition price) and Frontbridge UK £8m. This valuation is based purely upon customer numbers.

BlackSpiders revenues were £1.8m, and it was acquired for 11x that. Our table has Messagelabs UK at about £10m in revenues, their annual report doesn't clearly break out UK numbers for just the message scanning business, but a figure of £40m revenue worldwide looks possible, meaning the home market is still responsible for 25% of revenues. A figure of £40m worldwide revenues would suggest a valuation of £440m (11x revenues) for the whole operation ignoring non message-scanning business units. Given the relative ease with which customers can churn from one service to another, does anyone really believe this multiple? Perhaps there was still a lot of cash on hand or assets of value in the £20m BlackSpider price. Figuring £5m of assets leaves us with an 8x ratio of price to revenues.

With any valuation model must come assumptions, and here we've a boatload of them. We assume that a BlackSpider customer has roughly the same value as any other customer in this market, we already know this is not the case for BT with its large number of tiny accounts. We assume that the overseas operations of BlackSpider did not significantly contribute to its valuation. As it happens, the company has no customers among the S&P500 or the ASX200 so this may not be such as bad assumption after all. As stated above we also ignore whatever portion of the £20m acquisition price was for assets and cash.

At the end of the day, something is worth what someone will pay for it.

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