Clouded Judgement 4.29.22

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

Negative GDP Growth?!

Q1 GDP numbers came out yesterday and the headline number was quite surprising. MoM GDP was -1.4% vs consensus estimates of +1.1%. Seeing shrinking GDP can be jarring. Two quarters in a row of shrinking GDP = recession. However, like most macroeconomic signals these days it’s important to dig in beyond the headline figure. Peeling back the onion of the Q1 GDP figure, we still (in my opinion) see an economy that is weaker than most predicted, but it’s not as bad as negative GDP growth would suggest.. First, Q1 GDP is a QoQ comparison. And GDP grew 7% in Q4. This made the MoM comp for Q1 incredibly high. Looking at Q1 GDP YoY we actually saw a +3.6% YoY growth. Second, when we look at the individual components of GDP growth (Consumption, private investment, government spending, net exports), the areas dragging down GDP the most was net trade. Consumption was +2.7% vs expectations of 3.5%. Private investment was +2.3% vs expectations of +4%. So both were weaker than expected, but both still positive and not as bad as shrinking GDP may suggest.

Net net for me - the Fed is in a predicament. The economy is slowing, and faster than expected. Only 5 of 69 analysts predicted a negative GDP print for Q1. Raising rates in a slowing economy is dangerous. We’ll almost undoubtedly get a 50bps hike in the next Fed meeting. But after that? I’m not sure we’ll get an incremental 2 50bps hikes like the market is pricing in. Time will tell!

What Happens to Software in a Recession?

Microsoft (Azure) and ServiceNow both noted very little macro effects on their guide for Q2. It’s important to remember that these companies are already 1 month into Q2 and should have a good idea on how macro factors will impact their businesses. The fact that they both made little to no mention of macro adverse effects to their guide was a strong signal that software is more “immune” to a recession. I put immune in ““ because these are two of the best software companies. Huge platform effects, and very sticky products. If we do go into a recession, I think businesses with these characteristics will preform quite strong.

Software is deflationary in nature. My personal take is that the best software companies will be incredibly resilient in a recession, and we’ll get increasing evidence of that as Q1 earnings season rolls out. I don’t think a recession will be a rising tide for all software. But for the best, most sticky companies, it will only entrench them further as winners.

The market is very rocky right now - but I’ve never been more excited to be a software investor. My favorite Buffett quote I can’t seem to get out of my head right now is “Be greedy when others are fearful.” I’m feeling greedy!

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: 8.2x

• Top 5 Median: 26.0x

• 3 Month Trailing Average: 9.2x

• 1 Year Trailing Average: 13.4x

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: 11.1x

• Mid Growth Median: 8.0x

• Low Growth Median: 3.8x

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: 34%

• Median Gross Margin: 74%

• Median Operating Margin (23%)

• Median FCF Margin: 3%

• Median Net Retention: 120%

• Median CAC Payback: 23 months

• Median S&M % Revenue: 45%

• Median R&D % Revenue: 26%

• 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.