IT service companies develop Web storefronts that are integrated with back-end implementation systems. Only a small number of companies offer such extensive e-business integration. The industry continues to grow because of customer demand. Unlike traditional valuation, companies in the IT services sector are valued based on revenue multiples. Following are two tables that summarize comparable valuation multiples and operating metrics as of November 22, 2005€”a leading Wall Street investment bank, using its own estimates and company data, compiled these tables.

Required:
a. Explain why analysts employ a revenue multiple model when valuing these companies. How do the €œnon-financial€ operating metrics supplement this model?
b. Can you explain why the distribution of revenue multiples appears to have such a wide variance? Billing rates do not appear to be as varied.
c. Most operating metrics are based on headcount. This can be a problem for an industry enjoying such rapid growth. Can you explain how this can be a problem?
d. Explain why the revenue multiples for year 2006 are all lower than the comparable revenue multiples for 2005.
e. With such rapid industry expansion comes consolidation through business combinations. Shortly after the above tables were compiled, Razorfish completed a merger with International Integration (I-Cube), another company in the IT services sector. Razorfish offered I-Cube shareholders 0.875 share of Razorfish for each one I-Cube share. The deal was valued at $24.72 per share, nearly 18% above what I-Cube was trading for prior to the announcement. At the time of the acquisition announcement, I-Cube was trading at a price-to-revenue multiple of seven. What is your assessment of the price that Razorfish paid to acquireI-Cube?

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Valuation Multiples REVENUE ESTIMATES LATEST QUARTER REVENUE MULTIPLE Price at Shares Market Company 11/22/05 (millions Value 2005 2006 Growth Revenue Growth 2005 2006 23.9$1497 25 78.0 38.9 26.0 29.2 22.1 46.5 31.3 64.5 11.7 23.7 89.1 72% 100 134 38% 100 59.9 34.8 48.8 24.4 53.0 22.7 38.3 20.6 27.2 17.6 26.8 16.6 23.1 14.9 14.0 10.1 Breakaway Solutions. Rare Medium Viant.. ._ . . . _ US Interactive. . . . 31.25 129.38 87.00 73.50 41.25 73.50 48.63 37.00 54.00 38.38 42.50 2,438 50100 5,033 95222 2,262 59110 2,146 79 122 45 29 20 912 34 10 3,420 148 230 1,522109 150 2,388 200 370 632 71 102 909 94 149 3,787 506 925 AppNet 30 39 32 11.9 Modem Media Luminant Worldwide . . USWeb/CKS Selected averages Selected medians.._ 6.2 25 138 73% 67% ng % 38% 27.4 15.4 25.0 15.7 Operating Metrics Company Breakaway Solutions... . Gross Margin Revenue/ Headcount Billable Headcount Billing Rates Annual Turnover Average Utilization 73% 70 620% 51.0 53.8 55.0 48.8 44.2 57.8 45.1 44.0 44.7 $214,000 188,000 303,000 324,000 214,000 187,000 197,000 175,000 217,000 209,000 180,000 223,000 $138 200 20% 140 327 484 254 492 212 868 715 1,260 455 Rare Medium . 12 67 79 68 62 149 160 153 115 152 132 24 18 AppNet 30 Modem Media Luminant Worldwide. . 7 . . . . _ USWeb/CKS. 40.0 3,190 155 21 Selected averages. . Selected medians.. 48.8% 48.8% $219,283 $211,500 $150 $152 20% 20% 69 71% 72% . .