Martin Wolf, founder and president of MartinWolf, a global M&A investment adviser focused on services models that has completed more than 115 deals, doesn't sugarcoat the prospect for most VARs trying to last to 2018.
"I think most VARs are going to go away," said Wolf in his characteristic, no-nonsense manner at a breakfast meeting in Natick, Mass.
Bottom line, said Wolf, most of the current crop of solution providers won't be independent businesses in five years. They will have gone through a merger, acquisition or their own metamorphosis become something completely different.
Wolf knows of what he speaks. He has spent the last 15 years working day in and day out advising solution providers on how to raise their valuation -- the price the company will fetch on the open market -- and making deals happen. That makes Wolf a detective of sorts, scouring the balance sheets and innards of solution providers, trying to find the crown jewels that will bring a higher valuation. He knows where the money is and it's not going to be found in any place that calls itself a VAR. "It's a four letter word," said Wolf of the VAR label. "It is low down. VAR is like saying you are a flasher. You don't want that to happen."
DRIVING HIGHER VALUATION
The real money right now, said Wolf, is in the Software-as-a-Service (SaaS) segment.
Wolf recently met with a SaaS company that is worth five to seven times sales and once sold a SaaS company with no earnings for four times its sales. A typical SaaS company with just $7 million in sales would be valued at $35 million to nearly $50 million, said Wolf. That makes a SaaS company about 25 times more valuable for every revenue dollar vs. a midmarket VAR. "SaaS adds more value," Wolf said. "You are not beholden to vendors. You have higher gross margins and higher growth."
Most of those midmarket VARs, said Wolf, are worth only about 20 percent of sales. AdvizeX, No. 113 on the CRN Solution Provider 500 list with $147 million in annual sales last year, fetched just $32 million -- about one-third of sales -- when it was acquired last November by Rolta International, which was represented in the transaction by MartinWolf.
So how does a solution provider get a piece of the SaaS pie and dramatically increase its valuation?
"You need to grow your services business and of your services business, more of it needs to be yours and it needs to be recurring," said Wolf.
Some VARs actually have their own software intellectual property for a specific market that can be moved to a SaaS model, driving a big increase in valuation. So a minor product or tool in a solution provider's portfolio could be worth an amazing five to seven times sales, said Wolf. A solution provider doesn't necessarily have to own the intellectual property but definitely needs some control, like an exclusive regional offering.
The hidden gem, said Wolf, is usually a SaaS offering or a cloud-based proprietary product or tool. "It's a niche product," said Wolf. "Most likely it's a software solution, either modified for the cloud or cloud-based."
The question then becomes where should a solution provider be spending his precious time and resources to drive a higher valuation?
"If you have a chance to generate one dollar of product revenue or one dollar of SaaS revenue and one is worth a five multiple and one is worth 25 times more, where do you want to spend your time?" Wolf asked rhetorically. "I would rather run a $2 million SaaS business than a $50 million VAR business. You have more control and it is worth more. So I would put all my energy, all of my limited investment, into that SaaS business."
The problem is most solution providers "like to do what they are familiar with and what they know," said Wolf.
What solution providers need to do, he said, is take a step back and take a close look at their customer base. "Their core business today is centered around servicing their existing customer base," he said. "That is where they have to start from. So the question is what other services, whether it is SaaS or other intellectual property, can they sell to their existing customer base? That is where they need to direct the business. Their business is servicing and supporting that existing customer base either by geography or size.
"That is first and foremost," said Wolf. "You have to start out with that and you have got to get growth. You have to ask what services can you sell those customers. And when you are looking at a market segment that is growing 45 percent like managed services that you can participate in, why wouldn't you put all of your energy and resources into that?"
Wolf said solution providers need to spend every single bit of their time, resources and investment into managed services and stop worrying once and for all about vendor-driven product-oriented sales. "They can't do anything else," said Wolf of the march to managed services. "Most of these guys do not have enough resources to gamble."
Wolf scoffs at just how many solution providers are still gambling and scrambling, hung up on the car dealer mentality of the latest and greatest product model. "The problem with the channel -- and it's going to get worse -- is it is like being a Ford dealer," said Wolf. "If you are a great [Ford] dealer, you do well in service, you do well in financing, you do well in parts. You service your customer. You manage your investments, but you can't replace the fact that Ford may be hot for a cycle or weak for a cycle. You follow."
For solution providers to make the cut in 2018 they need to lead, said Wolf. They have to move the needle from what is predominantly a product-driven business with 90 percent of sales for most solution providers coming from product and less than 10 percent from services, to a business where 80 percent or more of the business is coming from their own services with unique intellectual property, said Wolf.
PUBLISHED FEB. 11, 2013