Clouded Judgement 12.21.23 - Are Software Stocks Expensive?

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

Revisiting the “Is Software Expensive” Question

The current median revenue multiple for the software universe is 6.4x, which is ~17% below the long term average multiple of 7.8x. However, when looking at growth adjusted multiples, the current median is 0.48x, which is ~75% above the long term average of 0.28x (you can see this chart later on in this post in the EV / NTM Rev / NTM Growth section)! So on a pure revenue multiple basis the software universe looks “slightly cheap.” But on a growth adjusted basis, the software universe looks “super expensive.” Below is a chart that shows how growth has really trailed off the last few years. During the period where the long term average multiple was 7.8x, the median projected growth rate was 27%. The median projected growth rate today is 14%

The piece left out of the analysis is interest rates, which are obviously higher today than the period of 2010 to 2020. So given where rates are, all else being equal, you’d expect multiples to be below the long term average. On a FCF basis, the median FCF multiple today is 39x, while the long term average is 40x. So on a FCF basis, multiples today are about where they’ve been over the long term.

Wrapping all of this up, it appears that the market is either “pricing in” forward estimates coming up in 2024, or a big drop in rates (or both). It’ll be interesting to see how things shake out in the first half of next year!

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: 6.4x

• Top 5 Median: 16.1x

• 10Y: 3.9%

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: 16.0x

• Mid Growth Median: 9.0x

• Low Growth Median: 4.2x

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: 14%

• Median LTM growth rate: 20%

• Median Gross Margin: 75%

• Median Operating Margin (13%)

• Median FCF Margin: 8%

• Median Net Retention: 112%

• Median CAC Payback: 39 months

• Median S&M % Revenue: 43%

• Median R&D % Revenue: 26%

• 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

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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