What price recurring subscription revenues?
Everyone involved in B2B information services, from publishers and distributors to technology and service providers , understands that recurring, subscription revenues are valuable to their business. Strong value propositions that deliver high subscription renewal rates are also highly-prized by investors in the sector who understand the attractive quality of earnings and cashflow characteristics that a strong subscription revenue model delivers.
In shaping their strategies information services businesses often face choices between growth initiatives that will result in different levels of recurring revenue and profitability. Sometimes these parameters conflict; a business can choose to increase its recurring revenues, but forgoes some incremental profitability to do so. To choose amongst these options one has to know not just that recurring revenue is a 'good thing' but exactly how much it is worth, how much profitability should be traded for superior revenue visibility.
To advise a client facing exactly this strategic question we analysed a sample of recent B2B information services transactions to estimate the impact of recurring revenue on value. Obviously, this is a small sample of transactions and many other factors may influence valuation. However, this analysis found a strong positive relationship with each percentage point of recurring revenue increasing the valuation multiple (expressed as EV/EBITDA) by 0.11x.
Practically, we used this relationship to calculate the maximum price reduction that could be offered to a particular group of customers in order to incentivise them to move to a long-term subscription.
As illustrated (table, right) until the EBITDA lost to the incentive outweighs the increase in valuation multiple achieved discounting is value-accretive. In our example this occurs at a discount of c.15%.
What this means for the information services entrepreneur is that if they result in a higher proportion of recurring revenue lower unit pricing and therefore lower profitability can actually result in a more valuable business.