The 40 Fastest-Growing Software Companies
The 40 Fastest-Growing Software Companies
The biggest public software companies are increasingly relying on acquisitions for growth, as they pick off weaker competitors or startup companies that have decided not to go it alone. In addition to their desire to get bigger, those doing the acquiring say they are responding to a move on the part of enterprise customers to reduce the number of vendors with which they do business.
Slide show: The list 1-40
How software's fastest growers got to where they are
The biggest public software companies are increasingly relying on acquisitions for growth, as they pick off weaker competitors or startup companies that have decided not to go it alone.
Most software companies that grew more than 20% last year were helped by an acquisition, a Baseline survey shows. The acquisition trend is putting more control, and power, in the hands of a few relatively well-known companies.
For instance, Oracle has spent well in excess of $20 billion making acquisitions over the last few years, from its $11.1 billion buyout of PeopleSoft to its $6.1 billion pickup of customer relationship management giant Siebel Systems. Oracle has continued its acquisition binge this year, buying Hyperion, a maker of business intelligence software, for more than $3 billion in April.
"You've got some 800-pound gorillas out there that are growing by acquisitions and consolidating their markets," says Mark Lotke, who runs the software investment group at venture capital firm FT Ventures in New York. "It's a natural maturity of the industry."
To some extent, the trend is being dictated by the software industry's customers. Chief information officers are looking to work with fewer software vendors and get more out of them. "Corporate America got indigestion buying best-of-breed point solutions from smaller companies," says Eric Shealy, an investment banker at Innovation Advisors in Boston. "They said, we've got too much stuff. We want to buy from fewer folks, who can put it all together for us."
Baseline's survey which began as an attempt to rank the 40 biggest software companies by revenue growth amounts to a health check on the enterprise software industry. We started by eliminating companies that aren't purely in software. That's why you won't see IBM or Sun here their revenue is too diversified. We also disqualified companies (Google, for instance) that derive most of their revenue from consumer services, since those companies aren't as relevant to Baseline's readers.
Finally, we ruled out any company that didn't have sales of at least $150 million in 2005. That, too, was an attempt to focus attention on the companies most likely to be of interest to an audience of enterprise technology managers. The weeding-out process left us with 49 companies.
As our list shows, most software companies are in pretty good shape. The 49 largest had $110 billion in revenue in 2006, 13% above their 2005 levels. The median company grew 11%. (For simplicity's sake, we used the companies' fiscal years, not their calendar years.)
From a profit perspective, too, the industry looks healthy. Aggregate profit at the 49 biggest software companies last year was $22.4 billion, for a profit margin of 20%. But the profitability was concentrated in the three biggest companies, Microsoft, Oracle and SAP.
Microsoft alone which has typically emphasized organic growth over acquisitions accounted for 40% of the revenue and 56% of the profits among the companies we considered.
Mergers and acquisitions may not be helping Microsoft much, but they were a major source of growth for many of the companies on our list. Nuance Communications and Ansys, No. 1 and No. 2, used M&A to propel them in their respective areas of speech software and simulation software. Nuance paid $357 million for Dictaphone, and Ansys paid some $600 million for Fluent. Adobe (No. 6) added hundreds of millions of dollars in revenue from its late-2005 purchase of Macromedia for $3.5 billion.
No. 8 Symantec has also shown its predilection for acquisitions, especially in what technology vice president Rob Clyde calls "adjacent spaces." In April, the Cupertino, Calif.-based security company bought Altiris, a systems management vendor, for some $800 million, and it is still seeing a benefit from having acquired backup giant Veritas for $13.5 billion two years ago.
Acquisitions are "not the only way" for established software companies to come up with innovative new products, Clyde says. But they're important, alongside internal research and development.
Indeed, some established companies regard their acquisitions as another way of doing R&D of continuing to offer innovative products to a customer base that may be happy to consolidate vendors but doesn't want the pipeline of new ideas to dry up. This is especially true of smaller acquisitions, which often don't add much in the way of revenue or customers but can add a lot in terms of potential.
"There are a lot of venture-backed companies out there that are doing work in all these interesting areas," says Charlie Peters, chief financial officer of Red Hat Software, No. 4 on Baseline's list with a growth rate of 44%. "In many cases, it's easier to do an acquisition than try to start something greenfield."
An established software company hungry for growth may buy a company with scant or nonexistent revenue, thinking it may eventually have the potential to generate tens or even hundreds of millions in business. Or it may buy the small company with the idea of integrating the smaller company's product into an already established suite. While such "tuck-in" acquisitions rarely allow buyers to charge more for their software, over time they can translate into getting a larger share of chief information officers' I.T. budgets.
For their part, when they are working with small companies, CIOs understand the need to proceed with caution. For instance, while Royal Caribbean, the $5 billion cruise company, doesn't shy away from working with startup companies whose products it considers promising, it makes sure the startup company's products aren't too deep in the infrastructure.
"We have on a number of occasions invested in products from small and midsize software firms that did not have large or even positive income," Mike Sutton, CIO of Royal, says in an e-mail. "In almost all cases, they ended up being acquired and assimilated into larger companies such as IBM or Oracle, which managed a fair and timely transition to the more enterprise support model."
For CIOs, there may be some security in knowing that no startup with promise is likely to remain independent for long. But the acquisition trend and the almost complete familiarity of the names on the Baseline list raise the question of whether the window has shut for young enterprise software companies that want to grow and remain independent.
Despite the strength in the stock market, relatively few enterprise software startups are planning to go public. One exception is BladeLogic, a virtualization company that helps CIOs save money by automating the configuration of servers in data centers. BladeLogic doubled its sales to $12 million in its December quarter, according to its prospectus.
But even in hot areas like virtualization, there is as much money being poured into M&A as into new-product development or new-company formation. In December, Citrix, the No. 9 company on our list with growth just below 25%, bought virtualization company Ardence for an undisclosed sum.
Citrix had a secondary reason for buying Ardence the Fort Lauderdale, Fla.-based company wanted to increase its geographic presence in the Boston area, where Ardence is based.
That pragmatic goal bolstering geographic presence also informs the acquisition strategy of Red Hat. Of the five acquisitions that Red Hat made last year, four (in Brazil, Argentina, India and the Czech Republic) were designed to bolster the vendor's geographic presence. A fifth, of middleware maker JBoss, was about new technology. Still, CFO Peters says most of Red Hat's growth remains organic. The company expects its sales to rise another 29% this year, to $515 million.
Along with the companies whose organic growth has slowed, Baseline's research into how quickly big software companies are growing also shed a light on nine that are shrinking. Novell is the worst case, with its revenue dropping 19.2% last year because of a decline in the company's legacy NetWare business. But Novell's two newer businesses, Linux and systems management, are growing, and executives are promising a steady increase in profitability as the 28-year-old company struggles to right itself.
Is it possible for an enterprise software company to turn things around and become a growth story again? Novell chief marketing officer John Dragoon says it is, though probably only for companies that manage to do some thoughtful acquisitions including tuck-ins and divestitures. Novell, he says, starts with a couple of inherent advantages a $1.2 billion war chest and the 52,000 global customers that still use Novell products.
"We do a lot of research on how Novell is perceived in the marketplace," Dragoon says. "Novell is a brand that has a lot of people rooting for it. There are companies that would pay a lot of money to be in that situation."
9 Software Companies That Shrank in 2006
Sources: Yahoo Finance, company reports
How software companies' financials compare
Baseline's ranking of the 40 fastest growing software companies—those with sales of at least $150 million in 2005 — is intended to provide a health check on the enterprise software industry. What you won't find: companies that aren't purely in software such as IBM or Sun. Or for that matter, Google is not included because it derives most of its revenue from consumer services.
Here is the list: