T 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.

Valuation Multiples

REVENUE ESTIMATES REVENUE MULTIPLE Price at Shares Market Latest Quarter

Company $11/22/05($millions$)$ Value $20052006$ Growth Revenue Growth $20052006$

Breakaway Solutions....... $ $62\mathrm{.}6323\mathrm{.}9$ $$1,497254372\%738\%59\mathrm{.}934\mathrm{.}8$

Rare Medium $..................31\mathrm{.}2578\mathrm{.}02,43850100100510048\mathrm{.}824\mathrm{.}4$

Scient $.............................129\mathrm{.}3838\mathrm{.}95,03395222134318853\mathrm{.}022\mathrm{.}7$

Viant............................... $87\mathrm{.}0026\mathrm{.}02,2625911086197138\mathrm{.}320\mathrm{.}6$

Proxicom $.........................73\mathrm{.}5029\mathrm{.}22,1467912254244527\mathrm{.}217\mathrm{.}6$

US Interactive $.................41\mathrm{.}2522\mathrm{.}1912345562102926\mathrm{.}816\mathrm{.}6$

Razorfish $........................73\mathrm{.}5046\mathrm{.}53,42014823055412023\mathrm{.}114\mathrm{.}9$

AppNet............................ $48\mathrm{.}6331\mathrm{.}31,52210915038302014\mathrm{.}010\mathrm{.}1$

iXL Enterprises................ $37\mathrm{.}0064\mathrm{.}52,38820037085643911\mathrm{.}96\mathrm{.}5$

Modem Media $.................54\mathrm{.}0011\mathrm{.}7632711024421328\mathrm{.}96\mathrm{.}2$

Luminant Worldwide $.......38\mathrm{.}3823\mathrm{.}79099414958259\mathrm{.}66\mathrm{.}1$

USWeb$/$CKS$.....................42\mathrm{.}5089\mathrm{.}13,78750692583138227\mathrm{.}54\mathrm{.}1$

Selected averages $...........73\%46\%27\mathrm{.}415\mathrm{.}4$

Selected medians............ $67\%38\%25\mathrm{.}015\mathrm{.}7$

COperating Metrics

Gross Revenue$/$ Billable Billing Annual Average

Company Margin Headcount Headcount Rates Turnover Utilization

Breakaway Solutions.................. $52\mathrm{.}4\%$ $$214,000140$ $$13820\%73\%$

Rare Medium $.............................51\mathrm{.}0188,00032720070$

Scient $........................................53\mathrm{.}8303,0004841271$

Viant.......................................... $55\mathrm{.}0324,0002542867$

Proxicom $....................................48\mathrm{.}8214,0004921491779$

US Interactive $............................44\mathrm{.}2187,0002121602468$

Razorfish $...................................57\mathrm{.}8197,0008681531862$

AppNet....................................... $45\mathrm{.}1175,0007151151673$

iXL Enterprises........................... $44\mathrm{.}0217,0001,2601523073$

Modem Media $............................44\mathrm{.}7209,000455132878$

Luminant Worldwide.................. $180,0002473$

USWeb$/$CKS$................................40\mathrm{.}0223,0003,1901552169$

Selected averages...................... $48\mathrm{.}8\%$ $$219,283$ $$15020\%71\%$

Selected medians $......................48\mathrm{.}8\%$ $$211,500$ $$15220\%72\%$

Required:

a$.$ Considering that the IT services sector is still in its infancy, explain why analysts employ a revenue multiple

model when valuing these companies. How do the $$nonfinancial$$ operating metrics supplement this model?

b$.$ Can you explain why the distribution of revenue multiples appears to have such a wide variance? Notice that

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? $($Hint: Average utilization is the percentage of the $2,080$ normal work year that is billed to clients beginning on the day that the employee is hired.$)$

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 $0\mathrm{.}875$ share of Razorfish for each one I$-$Cube

share. The deal was valued at $$24\mathrm{.}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 acquire I$-$Cube