Clouded Judgement 12.13.24 - Beat and No Raise?

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

Beat and No Raise?

We’re just about through 2024. It’s always fun to look back at consensus estimates at the start of the year (for full year 2024 estimates) and compare to consensus estimates today for 2024. Did companies under or overperform relative to consensus estimates at the start of the year? You can see the data in the chart below (the grey link chart shows YTD stock performance, blue bar shows change in consensus estimates from beginning of year to now). What you’ll see, is that for the most part companies performed in line with consensus estimates from the start of the year. The median change in estimates is only 0.2%.

Stock prices generally move from multiple expansion or numbers going up. This year, numbers didn’t go up, and we didn’t see much multiple expansion. The median software multiple has risen 6% from Jan 1 to today (6.3x to 6.7x). Meanwhile the median year-to-date stock performance of the software universe is 9%. So roughly in line. That being said, from early November to today we’ve seen the median software multiple expand 20%! From 5.6x to 6.7x. So ALL of the multiple expansion has happened in the last ~6 weeks.

What’s driving this multiple expansion in software? Was it Q3 results? I’ll post a full Q3 recap next week, but the tldr is that Q3 was solid, but nothing exceptional. The median change in full year estimates from pre to post earnings was 0.0%. So full year estimates didn’t really change after Q3 earnings. And we didn’t get guides for 2025. So there wasn’t necessarily data that showed numbers going up.

Instead, I think multiples in software are expanding for a couple reasons.

1. Macro has certainly stabilized, with some greenshoots starting to show up. There’s hope that we will see numbers go up in 2025 (unlike what we saw in 2024 with numbers staying flat) as IT budgets start to grow more

2. There’s an expectation that AI revenue will start to show up in software companies next year, which could provide upside to 2025 numbers (think things like AgentForce from Salesforce).

3. Doesn’t seem like there’s tons of risk to rates going up next year but they certainly could fall.

4. With the Trump election markets willing to move further out on the risk curve, and there’s more hope for stronger corporate earnings with the Trump tax plan (leading to more growth).

Bullets 1/2/4 relate to “numbers going up.” Bullets 3 relate more to broader “rising tide” multiple expansion. I do think today the risk is to the upside, not downside. There are a few dominos that could fall (and really only need 1) to see multiple expansion. If you get multiple, or all, of those points you could certainly see multiple expansion. Simultaneously, there aren’t as many arguments for “what could go wrong.” Certainly inflation has proven more sticky, this could put more pressure on rates, etc, but I do think there are a lot more things that could go right vs things that could go wrong. And the market is handicapping this in.

The market won’t wait for the numbers to start going up, it will move in anticipation of it. We’ll see next year if this recent run up in software was justified! I’m optimistic that we’re about to enter into a golden age of tech.

Final point - I think people tired of the Mag7 trade, and worried about how much juice it has left. That trade is getting long in the tooth, especially with debates around scaling laws and GPU supply constraints hitting max pessimism. Could the software “reversion to the long term median multiple” trade be the next trade?? We’ll see! I personally think the market has overrated too much against the Mag7. I think inference time compute will be game changing for the demand for chips, and the largest tech companies will not only see real revenues from AI next year, but also get the benefit of margin expansion from AI. It’s certainly an exciting time to be investing in tech.

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 Stats:

• Overall Median: 6.7x

• Top 5 Median: 19.2x

• 10Y: 4.3%

Bucketed by Growth. In the buckets below I consider high growth >27% projected NTM growth (I had to update this, as there’s only 1 company projected to grow >30% after this quarter’s earnings), mid growth 15%-27% and low growth <15%

• High Growth Median: 10.0x

• Mid Growth Median: 12.1x

• Low Growth Median: 4.7x

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: 12%

• Median LTM growth rate: 14%

• Median Gross Margin: 76%

• Median Operating Margin (7%)

• Median FCF Margin: 16%

• Median Net Retention: 109%

• Median CAC Payback: 37 months

• Median S&M % Revenue: 40%

• Median R&D % Revenue: 25%

• Median G&A % Revenue: 17%

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

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