As technology investors scrutinize their portfolios for signs of defensiveness in a downturn, recurring revenues is one key metric they might look for. But how much do these kinds of sales really insulate them from ?
Several software and IT services providers, including Telecity, SSP, Fidessa, Micro Focus and Innovation Group, claim two-thirds and upwards of their sales are recurring. The predictability and dependability this is supposed to demonstrate did much to lure investors back to technology after the dotcom crash.
But analysts are warning investors to be careful about taking the term on trust. "As you start to navigate a more difficult [investing] environment, it’s right investors focus on contracted recurring revenue," says Milan Radia, analyst at Jefferies. He contrasts the guaranteed income of support contracts with "extrapolated recurring revenue", which takes a previous run rate of new sales to existing clients or incremental product upgrades, for example, and uses it as a guide to future performance.
Few companies make the distinction clear in their accounts. Roger Phillips, analyst at Evolution Securities, admits that a predictable revenue stream such as ’s usage-based pricing is more defensive than one more reliant on new licence sales, but warns City layoffs could quickly eat into its recurring revenue stream.
is particularly reliant on new deals from existing customers, while Mr Radia notes Micro Focus' self-imposed target of double-digit organic growth means the small proportion of sales from new licences is critical.
"The only thing that's rock solid in a software company is maintenance revenue," says Mr Phillips, "and I can't think of a [large] software company where maintenance covers costs."
The evolution of SaaS
The debate is evolving as more software companies look to deliver their applications over the internet. The subscription payments of the hosted software model provide a more predictable income than licence fees. "However, the early stages of a SaaS [software as a service] business are hard, and so is transitioning to the SaaS model from an initial licence model," warns George O'Connor, analyst at Panmure Gordon.
While revenue recognition and cash collection is spread throughout the life of a contract, research, development and marketing costs are little different to existing models. So established software companies moving into this model "treat their investors to deteriorating revenue and cash", explaining the "softly-softly" approach employed by Sage and Misys to SaaS.
Abandoning the licence-fee model removes the operational gearing that has sustained the high ratings - and, in a better market, strong share price performance - at Autonomy and Aveva. In technology, as in any investment, with greater risk comes greater reward.
