Clouded Judgement 4.7.23 - IT Budget Expectations Improving?

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

State of SaaS

Next week I’m giving a talk at the StartUp Grind conference on the “State of SaaS in 10 Charts.” I had a fun time trying to condense down the “state of SaaS” into 10 charts, and look forward to giving the talk! I wanted to share one chart from the talk here (as well as two charts not in the talk from the latest Morgan Stanley CIO survey).

One of the key questions I’m trying to get insight into at the moment is when will growth decel bottom, and when will we see buying behavior, budget growth, etc rebound? First - some data on the magnitude of the slowdown. If we look at the net new ARR companies added in Q4 ‘22 vs Q4 ‘21 (we just wrapped up Q4 ‘22 earnings season and have that data), it paints a pretty bleak picture. The median software company added nearly 20% LESS net new ARR in Q4 ‘22 vs Q4 ‘21! That’s a big difference, especially when you layer in the growth in headcount from 2021 to 2022. Essentially companies grew headcount significantly to add less ARR. We’re obviously seeing the rightsizing of this now with headcount reductions. For companies that don’t disclose ARR I’m using quarterly subscription revenue x 4 as a proxy for ARR.

The second chart comes from the latest MS CIO survey (below). It shows the percent of IT leaders who expect upward, downward or flat budget revisions. As you can see, there is still a greater percentage of folks who expect downward revisions vs upward revisions. However, it hasn’t gotten worse since the previous survey (it had gotten worse for the preceding 3 quarters). In general we want the green bar to get bigger (it did tick up this Q), and the red bar to get smaller. Once the green bar is greater than the red bar it may signal we’ve past the sentiment bottom.

The below chart, also from the MS CIO survey, shows something similar. The lines to key in on are the bright green line at the far right, and the small light grey line right next to it. The green line decreased for a number of quarters in a row (‘22 expectations). The light grey line (‘23 expectations), so far hasn’t decreased much (an initial sign that things aren’t getting worse). In general, annual IT budget growth is still well below the historical average of ~4% / year

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: 6.0x

• Top 5 Median: 11.1x

• 10Y: 3.3%

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: 8.1x

• Mid Growth Median: 6.3x

• Low Growth Median: 3.4x

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: 16%

• Median LTM growth rate: 26%

• Median Gross Margin: 75%

• Median Operating Margin (21%)

• Median FCF Margin: 2%

• Median Net Retention: 116%

• Median CAC Payback: 30 months

• Median S&M % Revenue: 47%

• Median R&D % Revenue: 28%

• Median G&A % Revenue: 18%

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.