A resurgent economy is driving more venture capital (VC) investments into software products, a clear shift from the trend seen in IT services during its heyday leading up to 2008.
VC investments in IT product firms in India formed 30% of overall investments in IT-ITES sector in FY10, up from 16% in FY08, data from private equity research service Venture Intelligence shows. In comparison, investments in IT services firms constituted just 14% last year, down from 21% in FY08.
FY10 saw a total number of 11 software product deals amounting to $77 million. The IT services segment saw just five deals during the year totaling $36 million.
The data points to a disinterest among VCs in outsourcing-related areas. The IT services story in India may have plateaued and even though product firms have longer gestation periods, there is a possibility of hockey-stick growth a sharp increase in earnings following a period of modest growth. This would result in a higher valuation multiplier effect than IT services, experts feel.
All this is because of some structural changes in the way software products may be delivered in the future, somewhat enforced by last year's recession.
" Software as a Service (SaaS) model kon cloud computing being adopted by SMEs has provided a level playing field for early-stage product firms, as they can now sell and service customers across the world without direct sales presence," says TC Meenakshisundaram, founder and MD of IDG Ventures India Advisors.
The SaaS model has gained traction during the recession because it is pay-per-use and saves enterprises expensive licensing money. It also vastly reduces marketing expenses for product firms.
Harshal J Shah, CEO of Reliance Venture Asset Management, says the global recession has made VCs look at IT product companies as they have a lower dependence on US and UK as compared to IT services companies. There is a huge domestic opportunity in segments such as telecom.
"The product sector is extremely promising and according to a recent Nasscom-Zinnov study, the number of new software product start-ups, every year, has been on the rise. In the last three years itself, India has witnessed the addition of more than 250 software product start-ups," he says.
In FY10, Reliance Venture Asset Management invested in Dhama Apparel Innovations, which uses smart fabric technology to create climate-controlled clothing. IDG Ventures invested Rs 15 crore in Bangalore-based business intelligence product firm iCreate. Seven out of 11 portfolio companies of IDG Ventures India are technology product companies. Intel Capital invested $23 million in three Indian technology companies, one of them being July Systems, a firm providing mobile Internet solutions. Inventus Capital Partners says of the six companies in its portfolio built over the last one and half years, only one is a services company. While the changing macro economy is making it easier for VCs to think products, better exit valuations are helping too. Exit valuation for IT service companies with sub-scale revenues -- $100 million annual revenue, is not very rich, Meenakshisundaram says. "Further, IT services has become a play for companies with scale economics due to commoditisation. Fortune 2000 customers will not entertain companies with less than 1,000 resources, unless niche services are provided by early stage companies. On the other hand, IT Product companies provide the non-linearity between resources and results as well as higher exit multiples," he adds.
VCs are looking at investing more in products than before, since unique services start-up stories are harder to find, agrees Raghuveer Mendu, general partner at Ventureast, which has over $300 million under management. "The potential valuation multiplier effect is higher in product companies. Revenue multiples for valuing services companies are lower than products. Also services companies need to achieve larger scale before exits are possible. A differentiated product with solid IP, shows the potential for faster growth and quicker upside, thereby driving higher valuation multiples than services companies. Done right product companies should show higher bottom lines," he says.
Product companies now also offer better exit opportunities because the era of consolidation is back. They could be acquired for geography domination or because they have a niche offering. Early stage investor Ananth Rao, who has funded four IT product firms in the last two years, sees returns of two to three times the money invested in 4-5 years.
Higher investments in IT product firms in FY10 went to peripheral non-ERP type applications focusing on SME markets on SaaS basis, domain focused business intelligence and analytics and enterprise mobility. Clean-tech is likely to see heavy investments in the future.
Source:http://in.biz.yahoo.com
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