Clouded Judgement 7.24.26 - The World Isn’t Zero Sum

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The World Isn’t Zero Sum

I debated the title for this article a lot. The other option was “The World Isn’t Binary.” I’m still not exactly sure which title better describes this article, but I’ve found the principal of living with a positive sum mentality more impactful in my life so I went with that title. Anyway..on to the post!

There are no shortage of big debates right now in AI. Open vs closed models. Nvidia vs custom silicon. Will chips have value after 5 years. Will AI kill software. God model vs fleet of specialized models. Are we in an AI capex bubble or not. Model layer vs application layer. Will models commoditize. The list goes on! These were just a few that came to mind…

I won’t address all of these today, but the answer for most is “you’re not thinking big enough.” I’m clearly a hyper-optimistic person, I like to view the world through this lens! But I genuinely think these questions do a disservice to the moment we’re in. I don’t mean to invalidate the questions, they are smart questions, BUT in an early exponential moment I think it’s easy to “reduce” the moment to these simple questions that often seem zero sum in nature. When the size of the prize is expanding this quickly, the answer often turns out to be “everybody won.”

Let’s look at the current open vs closed model debate (or really the “Are Anthropic and OpenAI screwed as low cost open weight models take over” question). The TLDR of my perspective is that there will be both a massive market for closed frontier models AND open weight models. Does one come at the expense of the other? Of course. If open weight models didn’t exist, more dollars would accrue to the frontier labs. BUT - the total spend on models won’t stay static…If it did, sure the mix shift of frontier to open would shift towards more open over time (given the starting point today on frontier closed is such a high relative percentage). But, the topline isn’t static. It’s growing exponentially. So as more tokens start shifting to open weight models, the absolute dollar spend on frontier will still grow significantly (even exponentially). I hate to reduce it down to a cliche, but the size of the pie is growing much faster than mix shift is changing.

Same debate for Nvidia vs challengers or custom silicon. Will we have more custom ASICS, or new chips from upstarts like Etched, Positron, MatX, Fractile, d-Matrix, etc? Of course. Will the mix shift of today look less “Nvidia heavy” in the future? Probably. Nvidia is just such a massive percentage today. But do I think Nvidia will continue to grow meaningfully for a while? I do!

So the answer to both of these questions isn’t one winner one looser, it’s “many winners.” And I think in the early days of an exponential it’s easy to reduce questions down to “who wins and who looses” when the real answer is “both can win.”

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: 3.3x

• Top 5 Median: 29.3x

• 10Y: 4.7%

Bucketed by Growth. In the buckets below I consider high growth >22% projected NTM growth, mid growth 15%-22% and low growth <15%. I had to adjusted the cut off for “high growth.” If 22% feels a bit arbitrary, it’s because it is…I just picked a cutoff where there were ~10 companies that fit into the high growth bucket so the sample size was more statistically significant

• High Growth Median: 18.4x

• Mid Growth Median: 4.9x

• Low Growth Median: 2.7x

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 its 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: 12%

• Median LTM growth rate: 16%

• Median Gross Margin: 75%

• Median Operating Margin 2%

• Median FCF Margin: 21%

• Median Net Retention: 110%

• Median CAC Payback: 48 months

• Median S&M % Revenue: 34%

• Median R&D % Revenue: 23%

• Median G&A % Revenue: 13%

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 pay back its 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

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