Clouded Judgement 4.26.24 - Azure Gives Positive Infra Software Preview

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

Azure Report - Cloud Infra Looks Good!

Microsoft kicked off earnings season with a bang! For software, all eyes were on Azure - which grew 31% YoY (ahead of expectations closer to 29%). What was arguably more impressive (and a better indicator of what’s to come for the rest of infrastructure software than overall Azure growth) was the Azure growth excluding AI Services (since Azure uniquely benefits from this). I have to “swag” this a bit. Azure doesn’t disclose exact Azure quarterly revenue (they disclose growth rate in absolute terms and in constant currency), but there are good estimations. So the overall Azure quarterly revenue figure is already not entirely spot on. For Azure AI Services, they just disclose the pts of growth they saw from Azure AI (which you can interpret in multiple ways..). If I take my best guess at pulling out AI Services from overall Azure, I get to the data in the below graph. As you can see, there was a nice rebound in Azure ex AI growth as well as the overall growth:

And if I take a similar swag at the run rate of Azure AI Services, those quarterly figures are below:

On one hand, seeing this business get to a $4b run rate in a year is incredible! On the other hand, the rate of growth clearly slowed in Q1. However, the overall Azure growth rate accelerated! This is good news for the broader infrastructure software universe. I do think the “slow down” in Azure AI Services may be a bit misleading - they did call out being "capacity constrained” on the compute side. The full quote is below:

“We expect capital expenditures to increase materially on a sequential basis driven by cloud and AI infrastructure investments. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure build-outs and the timing of finance leases. We continue to bring capacity online as we scale our AI investments with growing demand. Currently, near-term AI demand is a bit higher than our available capacity.”

My read on this, particularly the bolded sentence at the end, is that if they had more compute (GPUs) then they would have been able to service more AI Services demand. Not surprisingly, Nvidia stock was up after hours yesterday, and bumped up after these comments. If this capacity constraint wasn’t an issue, then the Azure AI Services revenue would almost certainly be higher. It also sounds like they were starting to prioritize compute for their Copilot products.

Net net - I think Azure was a positive signal for the rest of infrastructure software. Not surprisingly, names like Snowflake, Confluent, Mongo were up 4-5% after hours yesterday.

FCF Multiples Hit 10 Year Low

FCF multiples (for companies with FCF) have hit 10 year lows (tied with Covid lows and early 2016 lows). You can see my FCF multiples chart below, but I’ll also re-paste it here. Naturally, we can only look at FCF multiples for companies that generate FCF. So I’m looking at a “higher quality” subset of the overall software universe by looking at median software FCF multiples. The 10Y is higher than it’s been in the last 10 years, so it makes sense multiples are lower. But I did want to call out that multiples for higher quality companies are lower than they’ve been in a long time.

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: 5.8x

• Top 5 Median: 16.8x

• 10Y: 4.7%

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: 8.6x

• Mid Growth Median: 8.4x

• Low Growth Median: 4.2x

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: 13%

• Median LTM growth rate: 17%

• Median Gross Margin: 75%

• Median Operating Margin (11%)

• Median FCF Margin: 11%

• Median Net Retention: 110%

• Median CAC Payback: 39 months

• Median S&M % Revenue: 41%

• Median R&D % Revenue: 25%

• Median G&A % Revenue: 16%

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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