Clouded Judgement 1.27.23
Every week I’ll provide updates on the latest trends in cloud software companies. Follow along to stay up to date!
Azure (Microsoft) Quarter
The week the first of the cloud giants reported - Azure. Their results were quite interesting. Q4 ‘22 (I’m talking about calendar quarters here, not their fiscal quarters), came in at 38% growth YoY in constant currency. This was quite a bit ahead of expectations. Their guide was for 37% growth, but all the commentary they had made since last quarter was quite negative on the optimization environment, so expectations for the quarter were more like 35% growth, and bears were calling for closer to 33%. Needless to say, 38% growth was significantly stronger than anyone expected. The initial report sent Microsoft shares up 5% after hours. However, during the earnings call the CFO painted a different picture. While the overall quarter (October - December) was great, things started to turn in December. She called out an exit growth rate of December as “mid 30’s”, and then said they expect Q1 ‘23 (Calendar Quarter) to decelerate “4-5%” from where they exited December. So call it 30-31% growth in Q1. Given the beat in Q4, a guide of 30-31% growth in Q1 was a big disappointment. Consensus for Q1 prior to this quarter was ~33%. Given the beat in Q4, in a normal environment you’d expect that beat to flow through to Q1. The beat on this quarter coupled with the miss on the guide really points to a tricky demand environment. And if things are tough for Microsoft (a behemoth who benefits from the bundling effect going on given macro), it’s most likely tough for everyone. This quote sums up the quarter: “Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them optimize that spend. Also, organizations are exercising caution given the macro uncertainty.” Wrapping it all up, shares of Microsoft ended down after hours after starting up 5%.
Early Look at 2023 Guides
Given the Azure weakness reported on Tuesday, all software tumbled Wednesday morning with most names down 5-10%. However, as the day progressed everyone slowly climbed back up. The sentiment largely felt like results were better than feared. If we think about the world as a distribution of probabilities, this week (in some ways) raised the floor of how bad things could get (or how bad things are expected to get).
A big reason for that was the guides for the full year 2023 we saw. As I’ve talked about before, a big debate at the moment is “are forward estimates too high.” Or said another way, “has the market appropriately discounted the rocky road ahead, and is this priced in.” The 4 companies to report this week all gave guides for 2023, and we can look at how those guides compare to current consensus estimates to see if estimates (so far) are too high. Here are the results:
Confluent guided full year 1% below consensus
Qualtrics guided full year 2% below consensus
ServiceNow guided in line with consensus
AppFolio guided 1% above consensus
As you can see, everyone to report this week basically said “forward estimates are about right, we don’t expect things to get worse than current expectations / what’s priced in.” On Thursday, we saw the market lift. Whether companies are being too optimistic is another question, but right now what they’re telling us is forward estimates are about right, and don’t need to come down (this would be bullish for the market as it would remove the doomsday / big slowdown scenario). The caveat here is this is only 4 data points so it’s a small sample size, and there’s of course the possibility that these 4 companies are being too optimistic. We’ll get a lot more data points in the coming weeks on how other companies guide for 2023.
Quarterly Reports Summary
Top 10 EV / NTM Revenue Multiples
Top 10 Weekly Share Price Movement
**SumoLogic is rumored to be in acquisition talks with a PE buyer, this sent their stock up this week
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: 5.7x
Top 5 Median: 12.0x
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: 10.6x
Mid Growth Median: 6.1x
Low Growth Median: 3.3x
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: 17%
Median LTM growth rate: 29%
Median Gross Margin: 74%
Median Operating Margin (25%)
Median FCF Margin: 0%
Median Net Retention: 120%
Median CAC Payback: 38 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.
This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and all employers and their affiliated persons assume no liability for this information and no obligation to update the information or analysis contained herein in the future.
Riddle these long-term assumptions implied by Zscaler's current revenue multiple, and put your own odds for these long-term assumptions could change in future years, changing the revenue multiple in future years: https://feed.bulletpoint.network/tiles/1663247300379
Let me know if you'd like to use this SaaS to do that for any other SaaS company on your list, providing more context to all these multiples than the past alone provides.