Clouded Judgement 11.11.22
Every week I’ll provide updates on the latest trends in cloud software companies. Follow along to stay up to date!
Yesterday we got October CPI numbers which provided a big positive catalyst for the market. First, the numbers:
YoY consensus was 7.9% and actual was 7.7%
MoM consensus was 0.6% and actual was 0.4%
Core CPI (Headline ex food and energy):
YoY consensus was 6.5% and actual was 6.3%
MoM consensus was 0.5% and actual was 0.3%
As you can see, inflation came in below expectations, and in particular core CPI started to decelerate MoM (this month it was 0.27% vs last month at 0.58%). The market ripped higher, but in context we really just recovered from the drop over the last week. The WCLD index (after being up >10% on Thursday) is essentially flat over the last week. After the last Fed meeting, the narrative of “higher for longer” was the takeaway (and that caused the big drop over the last week). But how much higher? And for how much longer? The issue was without an upper bound to where rates could go it was hard to create an investing framework (I talked about this in the context of tail risk a few weeks ago). If this months CPI print was the first sign of inflation starting to cool, then some of the tail risk of runaway inflation might start to come down. The 10Y dropped from 4.2% last week to 3.8% today. Net net - while it seems like a big jump up, we’re really just back to where we were before the Fed meeting last week. Definitely not out of the woods.
In my opinion, the biggest bogey right now isn’t rates / inflation, but fundamentals. We’re definitely seeing softness across the board in software performance. The biggest question - is the weakness now just the tip of the iceberg before a broader slowdown / recession next year (meaning forward estimates definitely need to come down more), or is the level of weakness now something we’ll see continue into next year (but nothing much worse).
To put some numbers on the weakness we’re seeing - the median guide for Q4 is currently 0.2% BELOW next quarters consensus. I don’t ever remember a time where guides across the board were this weak. You can argue it’s just conservatism, but the beats for the current quarter tell a different story. The median is beat for Q3 is 2% which is already a historically low figure, and as I talked about last week the consensus estimates for Q3 were based on very weak guidance coming out of Q2. Anyone who is saying there’s no weakness in software hasn’t woken up to the current reality. It’s hard out there for everyone!
Quarterly Reports Summary
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 Median: 5.1x
Top 5 Median: 12.3x
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: 9.1x
Mid Growth Median: 5.3x
Low Growth Median: 2.8x
Scatter Plot of EV / NTM Rev Multiple vs NTM Rev Growth
How correlated is growth to valuation multiple?
Growth Adjusted EV / NTM Rev
The below chart shows the EV / NTM revenue multiple divided by NTM consensus growth expectations. The goal of this graph is to show how relatively cheap / expensive each stock is relative to their growth expectations
Median NTM growth rate: 19%
Median LTM growth rate: 30%
Median Gross Margin: 74%
Median Operating Margin (25%)
Median FCF Margin: 1%
Median Net Retention: 120%
Median CAC Payback: 35 months
Median S&M % Revenue: 48%
Median R&D % Revenue: 28%
Median G&A % Revenue: 20%
Rule of 40 shows LTM growth rate + LTM FCF Margin. 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.
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I noticed in the today's email JFrog's FCF margin jumped from 2% to 10% (it use to be 2% since August). I haven't done annual calculations by for the last quarter (Q3) they reported $3.8M FCF on $72M revenue (~5%). Something does not add up.