Clouded Judgement 12.20.24 - The Fed Bomb
Every week I’ll provide updates on the latest trends in cloud software companies. Follow along to stay up to date!
The Fed Bomb
The markets were enjoying a nice little Santa Claus rally until this Wednesday when the Fed decided to shake things up! The Nasdaq dropped >3.5%, which I believe is the largest drop after a fed meeting going back to the onset of Covid. So what happened? Why was there such a sharp market reaction this week?
2025 Rate Cut Expectations
The Fed’s “Dot Plot” shows where each member expects rates to be each year. The Dot Plot released on Wednesday showed an expectation of 2 rate cuts in 2025. Prior to this meeting, the expectations were for 3-4 rate cuts in 2025. The 10Y jumped from 4.3% to 4.5%
Inflation Concerns / Hawkish Commentary
Powell also had a hawkish tone. He said that the Fed is “significantly closer to neutral” (neutral being the interest rate that neither stimulates or inhibits economic growth), and will be more cautious about further cuts. He also said “today was a closer call but we decided it was the right call” indicating there was a real chance of no cuts (they cut 25bps).
On inflation - the Fed raised their end of 2025 PCE inflation projection to 2.5% (the projection was 2.1% in the September meeting). Core PCE inflation is projected to be 2.5% in 2025 (with the projection being 2.2% in the September meeting)
Economic Projections
The median estimate for GDP growth in 2025 is 2.1%, which is up from the median projection of 2.0% in the September meeting.
In summary, the Fed expects rates to stay higher, inflation to be more of a problem, but economic growth to be more resilient. Market valuations were also starting to get stretched, so the commentary from the Fed around rates certainly spooked the markets.
You can see a chart below from the Fed meeting on certain economic projections:
You can find the table (and others like the dot plot) here
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: 6.2x
Top 5 Median: 18.4x
10Y: 4.5%
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: 10.8x
Low Growth Median: 4.5x
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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