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Application Software
Chelsea Stoner, Neeraj Agrawal  |  April 16, 2016
Brightree and the Vertical Cloud Revolution

When most people think of business software, they think of offerings from big companies—Oracle, Microsoft, SAP, even Salesforce—used by companies across industries. A transportation company or a retail outfit could use Oracle’s well-known database software, for instance. And companies in fields as diverse as healthcare and finance today tap Microsoft’s ubiquitous Office suite to write documents and send emails.

But a new class of software is emerging, and it’s narrower in scope—but not necessarily less profitable. It’s industry-specific, or “vertical” software, delivered through the cloud and built from the ground up to serve one particular market, whether it’s banks or insurance companies or restaurants.

Traditionally, some analysts and investors have spurned these companies, saying their markets would never be big enough to matter. We disagree. One data point: The completed acquisition today of Battery portfolio company Brightree*, which makes software for segments of the healthcare industry, by medical-device maker ResMed (NYSE: RMD). ResMed paid $800 million for Brightree, which is based in Atlanta.

Brightree is not a tech company many people in Silicon Valley have ever heard of. But the company’s record of revenue growth and list of 2,500 customers caught the attention of strategic acquirers–and the ResMed acquisition, first announced earlier this year, is the second-biggest M&A transaction since 2008 involving a “software-as-a-service” (SaaS) healthcare-IT company, according to investment bank William Blair.

Why is Brightree so valuable? For one thing, it has an experienced management team that has worked hard to grow revenue (about $113 million today, up from $8 million when we first invested eight years ago) and has embraced emerging healthcare and insurance-reimbursement trends. The company focuses on providing clinical and business-management software for companies in the “post-acute care” business, meaning healthcare provided in the home after someone has left the hospital. This means technology for companies doing things like providing home nursing and rehabilitation care, home medical equipment (oxygen or wheelchairs), prosthetics or even hospice services. These days, health policy has shifted to allow reimbursements for more care out of the hospital, and this has helped fuel Brightree’s business.

More and more software companies like Brightree are succeeding by targeting very specific industry markets, then leveraging their specialized knowledge of these sectors to build better products more people want to use. We are huge fans of vertical cloud-software companies, and we have funded them in industries as diverse as insurance, travel, oil and gas, healthcare, food/restaurants and banking. There are even specialized companies that sell cloud software to prisons and funeral homes. One of our most-admired SaaS companies is Veeva (we were not an investor), which provides cloud software to pharmaceutical companies and others in the life-sciences sector.  Veeva is now public, and we recently interviewed its CEO, Peter Gassner, to learn more about how the company was founded, managed and scaled.

Vertical-software companies are increasingly providing a full set of solutions to their specific markets – we are seeing them offer data specific to the industry being served; specialized payment services; as well as several add-on, managed services.

RealPage*, a Battery investment from several years ago, is a great example. RealPage serves the multi-family housing market, offering software to property managers to manage leases with tenants. But the company also offers rent collection and processing services, as well as Internet listing services to advertise property vacancies on various Internet listing services.  At Battery, we think this “share of wallet” opportunity in specific verticals can create significant value.  And selling more products and services to a company’s existing customer base only helps solidify the moat around the business, making it difficult for competitors to gain market share

Traditionally, Wall Street has not valued these types of niche SaaS companies at rates comparable to “horizontal” SaaS companies (the Microsofts, Oracles and SAPs of the world) that sell products more broadly across many industries—partly because the sizes of these individual markets are relatively small. Today, however, the Street has had a change of heart:  Companies like Guidewire* (a former Battery investment in the property and casualty insurance vertical) trade at multiples similar to software giants like Workday and Salesforce.com. In fact, Wall Street has been valuing vertical SaaS companies more richly than horizontal SaaS companies over the past several months. As of March 27, the average trading multiple of vertical SaaS companies was 4.2 times 2016 revenue–higher than that for horizontal SaaS companies, which were trading at 3.9 times 2016 revenue.

Smaller markets, clearly, can still create value, and also create profitable companies. Brightree, for example, boasted 40% EBITDA margins at the time of its acquisition by ResMed, proving that the SaaS model can scale profitably. This is a question that has dogged many larger public SaaS companies.

Numbers like that make it likely that other strategic acquirers will want to team up with vertical software players to push their own digital transformations. Healthcare is becoming increasingly digital today, relying on electronic medical records and connected devices that can capture and analyze more data from patients, often remotely. But thanks to the ubiquity of Web-connected sensors, the Internet is also upending businesses like cars, home appliances and even industrial sectors served by conglomerates like GE—turning all these businesses into software businesses.

And with only about 15% of the software business in the cloud today—the rest is delivered via the traditional, “on premise” model—there is plenty of room for new, innovative SaaS companies in many industries to develop and grow. And after the announcement of today’s deal, many of them can look at the Brightree story as a potential path to follow. Battery continues to seek out next-generation SaaS leaders, like the Brightree team, and other great entrepreneurs in vertical industries.

*For a full list of all Battery investments and exits, please click here.

 Follow Neeraj Agrawal on Twitter here and Chelsea Stoner here.

 

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