Clouded Judgement 10.20.23 - Hyperscaler Q3 Preview

Every week I’ll provide updates on the latest trends in cloud software companies. Follow along to stay up to date!

10Y Keeps Climbing

The 10Y hit 5% this week, which sets a new high water mark. In general economic data has continued to come in strong (a data point suggesting inflation could stay sticky, and the economy can absorb rates staying higher for longer). For context on a 10Y at 5% - from 2010 to 2020 the 10Y averaged roughly ~2.5%. Said another way, the 10Y today is double what it averaged from 2010 to 2020.

Hyperscaler Preview

Next week Amazon, Microsoft and Google report earnings and we’ll see Q3 data for AWS, Azure and Google Cloud. These are thought to be the early AI winners, largely due to all of the compute they’re selling to power GenAI applications. However, it’s important to keep in mind that while hype and expectations are quite high around AI, true enterprise buying cycles typically lag. Office 365 Copilot, for example, doesn’t go live until November and we most likely won’t see meaningful revenue from it until next year. And while we’re definitely in the early stages on an important technology transformation and supercycle, headwinds around cloud optimizations might not have abated as much as anticipated by now.

Azure: Grew 27% last quarter, and consensus expectations are for 26-27% growth this quarter

AWS grew 12% last quarter, and consensus expectations are for 12-13% growth this quarter

Google Cloud grew 28% last quarter, and consensus expectations are for 26% growth this quarter.

As you can see, expectations are for growth to stop decelerating this quarter. You can see the last few years of quarterly growth in the charts below:

Top 10 EV / NTM Revenue Multiples

Top 10 Weekly Share Price Movement

Update on Multiples

SaaS businesses are generally valued on a multiple of their revenue - in most cases the projected revenue for the next 12 months. Revenue multiples are a shorthand valuation framework. Given most software companies are not profitable, or not generating meaningful FCF, it’s the only metric to compare the entire industry against. Even a DCF is riddled with long term assumptions. The promise of SaaS is that growth in the early years leads to profits in the mature years. Multiples shown below are calculated by taking the Enterprise Value (market cap + debt - cash) / NTM revenue.

Overall Stats:

• Overall Median: 5.7x

• Top 5 Median: 14.3x

• 10Y: 5.0%

Bucketed by Growth. In the buckets below I consider high growth >30% projected NTM growth, mid growth 15%-30% and low growth <15%

• High Growth Median: 11.8x

• Mid Growth Median: 8.2x

• Low Growth Median: 3.6x

EV / NTM Rev / NTM Growth

The below chart shows the EV / NTM revenue multiple divided by NTM consensus growth expectations. So a company trading at 20x NTM revenue that is projected to grow 100% would be trading at 0.2x. The goal of this graph is to show how relatively cheap / expensive each stock is relative to their growth expectations

EV / NTM FCF

The line chart shows the median of all companies with a FCF multiple >0x and <100x. I created this subset to show companies where FCF is a relevant valuation metric.

Companies with negative NTM FCF are not listed on the chart

Scatter Plot of EV / NTM Rev Multiple vs NTM Rev Growth

How correlated is growth to valuation multiple?

Operating Metrics

• Median NTM growth rate: 15%

• Median LTM growth rate: 21%

• Median Gross Margin: 75%

• Median Operating Margin (17%)

• Median FCF Margin: 7%

• Median Net Retention: 114%

• Median CAC Payback: 35 months

• Median S&M % Revenue: 42%

• Median R&D % Revenue: 27%

• Median G&A % Revenue: 16%

Comps Output

Rule of 40 shows rev growth + FCF margin (both LTM and NTM for growth + margins). FCF calculated as Cash Flow from Operations - Capital Expenditures

GM Adjusted Payback is calculated as: (Previous Q S&M) / (Net New ARR in Q x Gross Margin) x 12 . It shows the number of months it takes for a SaaS business to payback their fully burdened CAC on a gross profit basis. Most public companies don’t report net new ARR, so I’m taking an implied ARR metric (quarterly subscription revenue x 4). Net new ARR is simply the ARR of the current quarter, minus the ARR of the previous quarter. Companies that do not disclose subscription rev have been left out of the analysis and are listed as NA.

Sources used in this post include Bloomberg, Pitchbook and company filings

The information presented in this newsletter is the opinion of the author and does not necessarily reflect the view of any other person or entity, including Altimeter Capital Management, LP ("Altimeter").  The information provided is believed to be from reliable sources but no liability is accepted for any inaccuracies.  This is for information purposes and should not be construed as an investment recommendation.  Past performance is no guarantee of future performance.  Altimeter is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. 

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