Clouded Judgement 3.11.22

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

Another week of heavy volatility in cloud software. The feeling in the market is completely “risk off” across the board. I came across a tweet this week (but can’t find it now) that said something along the lines of hedge fund exposures to tech is the lowest it’s been over the last 10-15 years (can’t remember the exact tweet but it was something like that). There are way too many variables at play right now - discerning what was real growth over the last year vs covid pull forward, navigating lasting vs transient inflation and the corresponding impact on rate hikes across 2022, the potential for a recession, and a potential world war (and that impact on inflation) all make it very “risky” to invest in risk assets like growth software. The hardest part is that business performance for most of the cloud sector has been very good. Maybe even historically good. As we get through Q4 and later Q1 earnings season I think the “answer” to the first question (was growth real) will become more apparent for every company. We’re already seeing the 1 time covid beneficiaries get slashed (Zoom, Asana, Monday, etc). The last company will report Q1 earnings in June, and I think by then we’ll have a better sense for what inflation will look like in the back half of the year. The main question being - with no more stimulus checks + tougher comps for inflation in the back half of the year, will inflation come under control in Q3 or Q4? Then there’s the threat we fall deeper into a war which makes everything even more confusing to navigate.

All of this to say - I don’t expect there to really be any catalyst to push cloud software stock meaningfully up over the next 3-4 months. At some point we’ll get back to business performance driving stock performance, but I think we’re at least a quarter or two away from that. And for everyone expecting us to “bounce off the bottom” and see cloud software stocks rebound - it’s important to remember that even though its felt like a crash over the last 2 months - we’re really just back to normal valuation multiples. So there’s a very good chance there’s no bounce, and instead we just grind horizontally for the next quarter or two. The highest multiple software companies still have historically high multiples. A sideways grind would mean their multiple will compress to normal levels. Right now, this feels like the most likely path forward.

In the absence of the war I’d be optimistic about the back half of the year for cloud software. However, it’s impossible to know the resolution there, so for now I’m in wait and see mode.

Quarterly Reports Summary

Top 10 EV / NTM Revenue Multiples

Top 10 Weekly Share Price Movement

Update on Multiples

SaaS businesses are valued on a multiple of their revenue - in most cases the projected revenue for the next 12 months. Multiples shown below are calculated by taking the Enterprise Value (market cap + debt - cash) / NTM revenue.

Overall Stats:

• Overall Median: 8.9x

• Top 5 Median: 28.4x

• 3 Month Trailing Average: 10.7x

• 1 Year Trailing Average: 14.2x

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: 12.1x

• Mid Growth Median: 8.7x

• Low Growth Median: 4.1x

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: 26%

• Median LTM growth rate: 33%

• Median Gross Margin: 74%

• Median Operating Margin (22%)

• Median FCF Margin: 3%

• Median Net Retention: 120%

• Median CAC Payback: 24 months

• Median S&M % Revenue: 45%

• Median R&D % Revenue: 26%

• Median G&A % Revenue: 19%

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.