Clouded Judgement 12.6.24 - Is Software Cheap or Expensive?
Every week I’ll provide updates on the latest trends in cloud software companies. Follow along to stay up to date!
Is Software Cheap?
Software has certainly caught a bid recently! Since its lows this summer, the WCLD index is up ~40%! And it’s easy to look at revenue multiples and say “median multiples are still ~20% below their long term average, as rates go down multiples should go up!” However, something has really stood out to me recently when I’m updating all of my multiples charts - growth adjusted revenue multiples are at all time highs (excluding the ZIPR period). The long term average growth adjusted revenue multiple is ~0.28x. Today, the median growth adjusted revenue multiple is 0.56x (chart below).
Said another way, current growth adjusted multiples are ~100% higher than their long term average! So are multiples cheap today or expensive? Looking purely at revenue multiples they look cheap. Looking at growth adjusted multiples they look insanely expensive. One explanation for this delta is looking at business quality. For the public universe of software companies, profitability / FCF has drastically improved over the last few years. When looking at FCF multiples (current median of 32x), that’s about 20% lower than the long term average of 40x. So there is more “FCF support” in the multiples today. That being said, growth has definitely slowed, so maybe the true answer to “is software cheap or expensive” is to look at a FCF growth adjusted multiple (looking at growth in FCF). I’ll save that for a follow up post! But for now, I wanted to call out that revenue growth adjusted multiples are quite expensive.
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: 6.4x
Top 5 Median: 19.2x
10Y: 4.2%
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: 11.6x
Low Growth Median: 4.6x
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: 12%
Median LTM growth rate: 14%
Median Gross Margin: 75%
Median Operating Margin (7%)
Median FCF Margin: 15%
Median Net Retention: 108%
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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