Clouded Judgement 8.26.22
Every week I’ll provide updates on the latest trends in cloud software companies. Follow along to stay up to date!
Market Thoughts
The 10Y has been creeping up. Earlier in August if fell to 2.6%, and this week it was back up to 3.1%. The market has been quite volatile when it comes to a “market consensus” on where the 10Y should settle. It fell down to 2.6% after inflation started coming down, and the hope of a “soft landing” became more real (inflation comes down without a rate induced recession). Currently, the market consensuses seems to be worsening to “inflation is in fact coming down, but will end up being sticky in the ~4% range” (implying rates will need to go higher to combat this). The Fed has been pounding the message recently that they plan to keep hiking more than what people expected (when the 10Y dropped to 2.6%). It’s hard to know how this will play out. There are plenty of signals that many components of core inflation have peaked and are coming down. I continue to think we’ll see a 10Y in the ~3.5-4% range to end the year.
At the same time - results so far from cloud software businesses have clearly been impacted by the macro, but we haven’t seen anything that impactful yet. Some slight misses, some weak guides (largely from conservative CFOs), but nothing big. It feels like if a recession is coming, we won’t see it show up in fundamentals of software companies for another 2+ quarters. This leads us to an interesting place where the rest of the year could lull folks into a false sense of security before the real pain comes. But then again, maybe Jerome & co at the Fed might pull off a soft landing without a crushing recession :)
The current median ntm revenue multiple for cloud software companies is 6.3x. This is ~20% below the long term average of 7.8x. In the 10Y preceding Covid I’m using as the long term average, the average 10Y was 2.4% (again, it’s currently 3%). The market is definitely pricing in either higher rates, or further impacts to fundamentals, or both. What’s also interesting is that while the median multiple is 20% below the long term average, the highest multiple software companies, on average, are higher than what we’ve seen historically (you can see this data in the chart later on that shows the top 5 median multiple chart). There haven’t been that many periods where multiple companies were trading ~20x+ NTM revenue. Is this dispersion warranted, or do the highest multiple software companies face the most risk in the face of rising rates + macro impacts to fundamentals? Time will tell. There’s not much margin for error in these high multiple businesses, and any missteps that suggest growth may not be as durable as projected now may result in a real re-rating downward.
Quarterly Reports Summary
This week kicked off July quarter end earnings. Only note in the table above is Snowflake’s guidance is for product revenue (they don’t guide total revenue)
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: 6.3x
Top 5 Median: 19.6x
10Y: 3.0%
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: 11.5x
Mid Growth Median: 6.2x
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: 21%
Median LTM growth rate: 31%
Median Gross Margin: 74%
Median Operating Margin (25%)
Median FCF Margin: 1%
Median Net Retention: 120%
Median CAC Payback: 34 months
Median S&M % Revenue: 47%
Median R&D % Revenue: 28%
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.