Clouded Judgement 1.6.23 - Estimate Cuts for Hyperscalers

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

Cloud Downgrades

This week UBS came out with a couple research reports citing concerns in AWS / Azure growth. As I’ve talked about before, the big risk for 2023 are fundamentals - are forward estimates too high? If we rewind back the clock to the start of 2022 the big debate was rates. Inflation was starting to run rampant and we knew rates were going up. We didn’t know when inflation would cool or how high rates would go, but we knew they were going up. Call this a “known unknown.” Today I believe the known unknown are fundamentals. We know software is impacted from macro - but how bad will it get? How far do forward estimates need to come down? It’s very tricky to predict.

This brings me back to AWS / Azure downgrades. This quote captures the crux of their sentiment. They described deteriorating channel checks “around (1) customer efforts to optimize/trim cloud spend, (2) delays in new workload migration to avoid upfront costs, and (3) beyond the cyclical/ macro, a shift into a more mature “phase two” of market development, marked by slower growth of more difficult-to-migrate workloads." On AWS in particular they said: “UBS Software and Internet teams recently talked to ~15 large enterprise customers and partners for the different Cloud providers, which suggest that overall cloud infrastructure demand continues to weaken and Street growth estimates for 2023 are likely too high. Reflecting on our field checks, we conclude: 1. This was the worst tone that we’ve heard in years from large AWS/Azure partners, a group that usually expresses different shades of optimism about AWS/Azure growth.”

This all netted out to UBS reducing their ‘23 growth estimates from Azure from 27% to 25% (constant currency), and their AWS ‘23 forecast growth rate to 19% (current consensus is 22%).

Generally forward estimate revisions take time. They don’t happen overnight. We’re definitely starting to see more and more estimate revisions now. The unknown part is how low do they go, and when does ‘23 estimates become “de-risked.”

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: 4.7x

• Top 5 Median: 10.4x

• 10Y: 3.7%

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: 8.9x

• Mid Growth Median: 5.1x

• Low Growth Median: 2.6x

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

Operating Metrics

• 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: 119%

• Median CAC Payback: 38 months

• Median S&M % Revenue: 48%

• Median R&D % Revenue: 28%

• Median G&A % Revenue: 20%

Comps Output

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.