Clouded Judgement 5.13.22

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

Update on Multiples

Another big drawdown in cloud software this week. The current median multiple is 6.2x NTM revenue. This is:

• 44% below pre-Covid levels in Feb ‘20

• 20% below the pre-Covid 5 year average (2015-2019)

• 6% below the Covid lows in March ‘20

The argument that we still have pain ahead of us: rates will continue to rise. 10Y is at 2.8% today, but will rise to 5%+ by end of year. At the same time a global recession will trigger downward rev / eps revisions. Throw all historical valuation precedents out the window because we’re in a new regime. (this is not my base case)

The argument that we’ve overshot the bottom (and this is currently my base case): Inflation is already starting to slow, and the Fed won’t need to raise the fed funds rate above 2.5-3% range by end of year. The key here is that software has preformed quite well even in times where rates were ~3%. Software also generally preforms well in a recession. My takeaway - if rates don’t rise >3%, I think it’s very logical to assume we should be trading at or close to the 5 year pre-Covid average (and we’re currently 20%-30% below those levels). Now, this definitely does not mean we should expect a 20% bounce in this scenario. Most likely it’ll take 1-2 years. Investor confidence has been dismantled in software. For 10 years the software industry was proving that unprofitable models based on growth / market share capture in early days turns into FCF and profitability in the mature days for software companies. And we had turned the corner and proven this out! Obviously not for every software company, but for the highest quality ones it was playing out. Today, investors don’t care about future profitability (or they don’t’ believe it). It’s all about who’s generating FCF now (or in the immediate near term).

When the dust settles, investors will get back to picking (currently most are risk-off waiting for macro factors to play out). And in my opinion the key attribute to filter for when picking is which companies will actually get to 20-30% FCF margins. IF you do believe a business will get to terminal FCF margins of 20-30% you can justify paying a higher revenue multiple today. This is a big if! Many companies will get disrupted before they can ever reach 20-30% FCF margins. But today, there is no future picking. It’s all about the present. It’s why Autodesk, Adobe, Veeva, ServiceNow and Paycom all have a top 20 software multiple. They all have FCF! The median LTM FCF margin of the top 10 highest multiple software companies is 16%.

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: 6.2x

• Top 5 Median: 17.3x

• 3 Month Trailing Average: 8.7x

• 1 Year Trailing Average: 13.1x

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: 7.5x

• Mid Growth Median: 6.1x

• 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: 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.