Why is SAP spinning Qualtrics out via an IPO?

What we can learn from Qualtrics' old valuation and new results

Over the weekend, software giant SAP announced that it will take Qualtrics public, with the German software company retaining a majority stake in the Utah-based “experience management” firm after its forthcoming debut.

SAP paid $8 billion in cash for Qualtrics back in 2018, right before the smaller firm was set to go public. Chatting with the CEOs of both companies around the time of the deal, they were pretty pumped about the combination. Since then, SAP has swapped CEOs.


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At the time, the deal not only made waves within the business realm, it also helped put Utah’s startup scene on the map. (An $8 billion deal makes an impact.)

Current commentary on the spin-out idea seems to rotate on the idea of unlocking value: That if SAP can float a good chunk of Qualtrics’ shares, the market may give that equity a good price. Then, the value of Qualtrics that SAP will retain will gain implicit value, perhaps boosting the value of its own shares. Making the point, CNBC quoted analysts from Bernstein Research, which said it believes “many SAP investors do not fully understand Qualtrics,” and that the spin-out might “help at least as it relates to better understanding its value.”

What is Qualtrics worth? If we can understand that, we’ll know if the current commentary regarding the spin-out makes sense. So this morning, let’s remind ourselves how big Qualtrics was heading into its IPO, what it might have been worth, how much it has have grown since and what that might be worth at today’s super-high software valuations.

Did SAP overpay? Did it get a deal? Let’s find out what Qualtrics might look like in 2020.

2018

Before SAP stole it from the public markets, Qualtrics was looking for $18 to $21 per share on the public markets, valuing the company at around $3.9 billion to $4.5 billion. SAP had to pay up for Qualtrics stock, obviously, to get the deal done given how hot the Utah-based firm was at the time.

Qualtrics had growth and profits, two things that combine to create lots and lots of market value. Here are some key Qualtrics numbers from the time:

  • 2018 revenue, through Q3: $289.6 million, up 39.8% from its 2017 result.
  • 2018 net income, through Q3: $1.5 million, up around 50% from the year-ago period.
  • 2018 operating cash flow, through Q3: $52.5 million, up from $36.1 million in the prior year.
  • Q3 2018 revenue growth: 39.3% to $105.4 million in the third quarter of 2018, compared to the third quarter of 2017.

That’s a valuable company. With around 75% recurring software revenue out of its total and 75% blended gross margins, it’s pretty obvious why Qualtrics looked so interesting to SAP.

Now, what has happened since? We know a bit. SAP reported earnings this morning (media coverage, formal release), giving us a window into what Qualtrics has become:

In the second quarter, Qualtrics segment revenue was up 34% to €168 million year-over-year (up 32% at constant currencies).

That squares up with our prior knowledge. From the release on the two firms’ plans:

‘SAP’s acquisition of Qualtrics has been a great success and has outperformed our expectations with 2019 cloud growth in excess of 40 percent, demonstrating very strong performance in the current setup,’ SAP CEO Christian Klein said.

Doing some loose math, Qualtrics wrapped 2018 with around $405 million in revenue. From there, 40% growth is around $560 million. Today’s Q2 number puts the firm on a run rate of around $790 million, which is in the ballpark we’d expect given its recent growth and the differential between trailing results and run rates, which are forward-ish metrics.

Let’s put Qualtrics on an $800 million run rate for the sake of easier maths. It’s Monday, so we can go easy on ourselves. Provided that it kept its blended gross margins merely flat since we last saw its numbers, we now know its size ($800 million), gross margins (75%) and growth rate (34%, year-over-year).

What is that worth? According to metrics from the Bessemer Cloud Index, cloud companies with growth rates of 35.5% and gross margins of 71.3% are worth around 17.3x in enterprise value compared to their annualized revenue.

Given how close Qualtrics is to that averaged set of metrics (slightly slower growth, slightly better gross margins), the 17.3x number is probably not far from what the company can achieve when it does go public. Doing the sums, $800 million times 17.3 is $13.8 billion, far more than what SAP paid for Qualtrics. (For you wonks out there, it’s doubtful that Qualtrics has much debt, though it will have lots of cash post-IPO; expect the company’s enterprise value to be a little under its future market cap.)

So, the markets are valuing cloud companies so highly today that even after SAP had to pay a huge premium to buy Qualtrics ahead of its public offering, the company is still sharply more valuable today after just two years of growth.

If SAP reckons that its worth today does not reflect the full value of its Qualtrics ownership, this spin-out should make it plain that the Qualtrics deal was no boondoggle, but was instead a surprisingly savvy deal that looked expensive at the time, but now appears cheap in retrospect.

Things could go wrong, of course. A major correction in cloud valuations would harm the timing and efficacy of the deal. Or Qualtrics could be in worse shape than we reckoned. But with what we know, it’s clear that the company’s impending debut should list a software firm worth more than $10 billion onto an American exchange. And that’s why SAP is making the move.