Clouded Judgement 12.8.23 - Q3 Earnings Preview

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

Q3 ‘23 Earnings Summary Preview

The vast majority of all software companies have now reported Q3. I’ll put together a deeper dive review in a week or two, but wanted to provide a preview here. Overall, I’d describe the tagline of Q3 software performance as “stabilizing trends with some green-shoots starting to show up.” Here’s a summary of the quarter in 5 charts:

Quarterly Growth rates: Still decelerating, but not as quickly

Net Retention: Down from historical averages, but starting to level off. Net retention is more of a lagging indicator, so I expect this downward trend to continue

FCF Margins: Down slightly, but still at that >10% range

CAC Payback Period: Still elevated. Companies have reduced headcount, but new bookings aren’t getting any easier

Quarterly net new ARR growth: Some green-shoots! I posted the same chart last week, but updating it here for the final set of software companies who reported earnings this week. Net new ARR growth is more of a leading indicator, and it has finally ticked positive. Let’s see if this trend continues in Q4, but I think we’re starting to get to the end of the software recession. Andy Jassy doubled down on some of the commentary he’s made in the last few weeks about cloud optimization headwinds starting to abate. On optimizations he said they’ve: “largely attenuated / not nearly at the same rate as before”… “feel good about deal growth in the last few months.” For many companies, seat based contracts have been right sized, consumption based usage has been right sized, and a lot of the software they could bundle into a larger vendor has been bundled. It appears 2024 will be more about building out new functionality vs “getting fit.”

And here is the same chart but only looking at high growth software. As you can see, the rebound has been even stronger!

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: 5.9x

• Top 5 Median: 16.0x

• 10Y: 4.2%

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: 14.6x

• Mid Growth Median: 8.4x

• Low Growth Median: 3.8x

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: 19%

• Median Gross Margin: 75%

• Median Operating Margin (14%)

• Median FCF Margin: 8%

• Median Net Retention: 112%

• Median CAC Payback: 39 months

• Median S&M % Revenue: 42%

• 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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