TMT sectors rely on digital advancements and innovation in M&A.
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Key takeaways
Accurate revenue recognition is crucial for capturing true revenue performance.
Retention trends reveal recurring revenue strength and growth potential.
This article was originally published on July 18, 2020, and has been updated.
In the fast-evolving technology, media and telecommunications (TMT) industry, financial due diligence goes beyond the traditional “quality of earnings” analysis to assess recurring earnings. Investors need a deeper analysis to uncover the value drivers and potential risks within this competitive, dynamic industry. A focused evaluation can offer a clearer view of a company’s true potential—an especially crucial perspective in today’s unpredictable economic environment.
Here are 10 critical steps to help investors gain a comprehensive understanding of the value drivers in TMT businesses, identifying both opportunities and risks in potential transactions.
Revenue analyses: Optimizing financial performance
- Revenue recognition: Beyond cash flow, earnings under U.S. generally accepted accounting principles (GAAP) and Topic 606 of the Accounting Standards Codification (the updated revenue recognition standard) should be reviewed to accurately capture revenue performance, critical in transactions where revenue patterns may affect valuation.
- Customer retention: Understanding retention trends offers insight into recurring revenue strength, growth potential and customer loyalty. Metrics include annual recurring revenue, total contract value and customer/user count, which serve as indicators of a company’s stability in subscription-based models.
- Contracted backlog and estimated pipeline: Reviewing contracted backlog and pipeline data helps forecast future revenue, especially when combined with retention metrics, for more precise financial modeling.
- Customer concentration: Analyzing the diversity of revenue sources highlights risks from high dependency on major customers, while also identifying opportunities for targeted upsells and customer diversification.
- Lifetime value: Estimating customer lifetime value based on historical revenue patterns helps gauge potential revenue from customer relationships, offering guidance for strategic decisions of growth-focused TMT firms.
Cost analyses: Enhancing profitability and efficiency
- Gross profit analyses: Gross profit—revenue minus cost of services—must be accurately calculated to reflect profitability. Correct cost allocations are essential for a transparent view of gross margins.
- Utilization rates: Analyzing employee utilization rates—time spent on billable versus available hours—helps assess efficiency and management of personnel costs, which directly affects profitability.
- Customer acquisition costs (CAC): By analyzing CAC, investors gain a clearer picture of pricing strategies and scalability. Earnings per customer should ideally exceed CAC to ensure long-term growth.
- Software development costs: TMT companies must distinguish between expenses and capitalized costs for software development, which affect asset valuation and financial reporting, especially in firms with software as a service (SaaS) or on-premises offerings.
- SaaS rule of 40: The “rule of 40,” calculated by adding the revenue growth rate to the EBITDA (earnings before interest, taxes, depreciation and amortization) percentage, is a benchmark for SaaS businesses. Companies hitting or exceeding 40% demonstrate a robust balance between growth and profitability.
Enhancing strategic value
To further optimize transaction value, TMT investors should also consider:
- Adaptability and agility: Understanding a company’s adaptability to new technologies and shifting market demands will help mitigate risks and enhances competitive advantage in dynamic TMT landscapes.
- Strategic acquisitions: Pursuing acquisitions that align with long-term growth objectives—such as entering emerging tech markets or strengthening data capabilities—can drive scale, operational efficiency and sustained market relevance.
- Data-driven decision making: Leveraging advanced analytics to assess customer behavior, refine operational efficiencies and make informed investment decisions can improve both valuation and long-term resilience.
The takeaway
These analyses lay a solid foundation, but investors should also assess a company’s cash flow management and financial resilience to fully understand the return on investment in TMT transactions. By implementing these 10 steps, and gaining industry-specific insights, investors can gain a well-rounded perspective to navigate the complexities of the TMT sector and make more informed, value-focused decisions.
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