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What’s a Subscription Software Company Worth?

If you remember Enron, Worldcom and the dot-com 1.0 preference for eyeballs over revenue, you can understand why people are wary about the unfamiliar accounting metrics used to justify big valuations for subscription software companies.

Salesforce.com, Jive Software, Dropbox and Evernote don’t need profits to be worth billions, the thinking goes, because their value is underpinned by a set of numbers different from traditional earnings and revenue metrics. Company executives say it’s more important to focus on annual recurring revenue, margins, customer acquisition cost and the lifetime value of a customer.

With companies placing much more importance on projected revenue than on past performance, it’s no wonder so many cloud executives are optimistic on earnings calls.

But for all the fuss, subscription businesses aren’t new. The alternative metrics used to value them are pretty straightforward. And as more software-as-a-service (SaaS) companies go public, investors will have to understand them to make smart bets.

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During the last few years of unbridled exuberance, investors deemed the whole subscription software category a winner. But Wall Street took a more critical look at the sector during this spring’s selloff. The best performing stocks of the future should be those that give investors all the data they need to correctly analyze their businesses.

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Rod Drury and Dave Goldberg commented on this article.
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While companies estimate the lifetime value of a customer, essentially a measure of churn, that number can fluctuate pretty wildly depending on how sticky the business.