finnCap Tech Chat | The party's over

It’s official, COVID must be over: Houseparty, a video group-chat app which gained popularity with the arrival of lockdown 1, has been removed from app stores and will shut down in October. Thank goodness that the reality is now that we can meet in person, scowl smugly at the anti-vaxxers and the unmasked tube passengers, and return to staring at our phones without someone staring back.

What happened to Houseparty though, and why is it interesting? According to Wikipedia, Houseparty was developed over ten months, and launched in February 2016, being sold to Epic games in 2019. Epic used the technology to integrate into Fortnite to provide a comms platform within the game – It’s not that unusual as an approach: in the nineteenth century Joseph Lister developed Listerine as a surgical antiseptic, and it didn’t sell well. He redefined it as floor cleaner, and it still floundered. When it was repackaged as a cure for halitosis (the same product!) it took off, and we still use it today. Although evolved under the same ownership, the original solution did better elsewhere and the first application was jettisoned.

One of the common questions we get for clients making acquisitions is “what multiple did they pay”, but it’s not that simple when M&A has been used as an alternative to R&D. Dotdigital acquired Comapi in 2017 for its CPaaS, or Communication Platform as a Service functionality – Comapi represented an established platform which had been through testing, and deployment, and fine tuning to match customer needs – an acceleration of the roadmap for DOTD, where the original revenue stream, now winding down as discontinued operations, is not the reason for the acquisition. IQGeo’s acquisition of OSPi last December added not only a profitable US operation, but also solutions that allows it to expand its geospatial software into the huge global market of smaller Tier 3 and 4 networks. Ideagen routinely buys “accelerants”, advancing the solution set and sometimes, eventually, subsuming the original software solution albeit behind an unchanged user dashboard; Access Intelligence sprinted forward with the acquisition of Pulsar at an unbelievably low eventual acquisition cost; and Universe marched forward about three years with their Celtech acquisition taking them into the cloud at a gallop.

How do you value the R&D if there is also revenue, or even more unhelpfully than a loss, a bit of profit (which makes the EV/EBITDA multiples look obscene; better in that case to make a loss). We could consider Intercede a good example of the issue: a £50m market cap, world leading, credentials and identity management software business, with clients including multiple US Federal Agencies and global aerospace and defence businesses. Intercede has never capitalised any R&D, putting it at an instant disadvantage to peers which have better EBITDAs but far worse free cash conversion. Management estimate that the current platform is the product of more than £50m, but underplays the fact that that includes over a thousand “person years” of accumulated experience and reputational strength. The group is generating revenue of £11.5mE (FY March 2022) and £2.0mE of EBITDA (probably c£3-3.5m if R&D was 50% capitalised) – is that really a basis for valuation given the significant time and effort any competitor would take to replicate it? Well, it forms a base case, certainly at around the current market cap, with revenue multiples which are reasonable, and capitalisation adjusted EBITDA somewhat light – but totally overlooks the true value to acquirers. In Intercede’s case you get world leading tech adopted by the most demanding users – worth much more than its accumulated cost when seen as a multi-year acceleration for an acquirer.

So before you shed a tear for Houseparty, remember it’s gone to a better place (Fortnite!). If you want to get to the bottom of a really exciting acquisition, always ask what the replacement cost is of the target business’ tech and how many roadmap years the acquirer is advanced – a far more pertinent question as AI gains importance, and data scientists are now as tough to find as hen’s teeth and even more expensive.

Happy Friday