Thank you for reading the Meritech Software Pulse. As an investor in later-stage technology companies for over 20 years – and predominantly software companies – we closely follow and monitor the public markets. Moreover, we host Meritech Benchmarking, a free easy-to-use application that tracks and analyzes the public SaaS market. Behind this application are millions of data points and with that we decided to launch the **Meritech Software Pulse**: a recurring update on the state of the almost $2 trillion dollar public SaaS industry. The following dives into the state of valuations, operating metrics and KPIs, profitability and scale, and what it means to be a best-in-class public SaaS company. For more information or to sign up, click here for recurring updates.

## Table of Contents

Chart (s) of the Week

Market Data

Growth and Profitability

Company Rankings

Operating Metrics and KPIs

## 1) Chart(s) of the Week

## Top 5 Companies by Implied ARR, Growth-Adjusted Multiples, and NTM Growth Rates by Year

In our last update, we shared a chart of the average ARR multiples by year. The below chart includes the same data and overlays the average *growth-adjusted* multiple by year as a blue line and shows the average NTM (next-twelve-months) growth rates below in a table. Growth-adjusted revenue multiples are a similar concept to the classic PEG ratio (Price/Earnings-to-Growth), which compares a stock’s price/earnings (P/E ratio) to its earnings growth rate. In our growth-adjusted multiples, we compare an ARR multiple against forward revenue growth rates to understand what the market is willing to pay for a unit of growth. The higher the number, the more “expensive” a company is relative to its growth rate. The lower the number , the more “undervalued” it is. Of course, various quantitative and qualitative factors drive differences in growth-adjusted multiples among companies, including investor's belief in the durability of a company's growth rate and margin profile. Not surprisingly, growth-adjusted multiples have somewhat followed “regular” multiples. A few things stand out in the chart below: The average ARR multiple in 2024 YTD is 11% lower than in 2022, but the average growth-adjusted multiple is up 70%! Investors value growth significantly more than they did in 2022, even though growth rates are down 43% from 48% in 2022 → 27% YTD. There are multiple factors at play, but it’s clear that investors are taking a belief that the revenue growth (and margin structure) of this set of companies is durable and are willing to pay significantly more today for a unit of growth than a couple of years ago. This also has downstream effects on the private markets, as investors are much more likely to pay more for a unit of growth today than in 2022, creating a more attractive fundraising environment in the private markets.

Source: CIQ as of 01-Mar-2024. Note: 60 or more trading days required to be included in a calendar year. Growth adjusted multiple calculated by dividing enterprise value over NTM revenue over NTM revenue growth rate. Implied ARR defined as quarterly total revenue multiplied by four.

## 2) Market Data - *Updated Weekly*

## Top 10 Share Price Performances

The below table shows the top 10 share price increases over various time periods. The top three gainers in the past week were C3.ai, Okta*, and Everbridge.

Source: CIQ as of 01-Mar-2024.

## Enterprise Value / NTM Revenue Multiples | All SaaS, Quartiles

The below chart shows the 25th, 50th, 75th, and 90th percentile NTM revenue multiples. 90th percentile companies have seen the most multiple compression, down 74% from a 2021 high of 52.3x to 13.7x today. The current median multiple is 6.3x, still below the pre-COVID median of 8.0x but down 71% from the 2021 high of 21.3x.

Source: CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate.

## Enterprise Value / NTM Revenue Multiples | Top 10

The following chart shows the same view but only for the 10 companies with the highest multiple on each day. The current top 10 company median is 16.7x, 49% above the pre-COVID median of 11.2x but down 76% from the 2021 high of 69.0x.

Source: CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate.

## Enterprise Value / Implied ARR | All SaaS

The following chart looks at Implied ARR multiples for the SaaS market for the last 8 years. The current median multiple is 6.9x, below the pre-COVID median of 8.8x but down 72% from the 2021 high of 24.6x.

Source: Company Filings and CIQ as of 01-Mar-2024. Note: Implied ARR defined as quarterly total revenue multiplied by four.

## Growth-Adjusted Revenue Multiples | All SaaS

The following chart looks at Growth-Adjusted Revenue multiples for the SaaS market for the last 8 years. The current median multiple is 0.48x, above the pre-COVID median of 0.29x but down 51% from the 2021 high of 0.98x.

Source: CIQ as of 01-Mar-2024. Note: Growth adjusted multiple calculated by dividing enterprise value over NTM revenue over NTM revenue growth rate.

## Median NTM Revenue Growth and Free Cash Flow Margins | All SaaS

Public SaaS companies have rapidly shifted towards efficiency. Forward growth rates have come down dramatically, and free cash flow margins have risen across the board. Put simply, companies are trading growth for profitability in today’s market.

Source: CIQ as of 01-Mar-2024 and Company Filings. Note: NTM defined as next-twelve months consensus estimate. Free cash flow defined as cash flow from operations minus capital expenditures and capitalized software costs. Data represents the 30-day rolling average.

## 3) Growth and Profitability - *Updated Weekly*

## Growth Rate & Profitability Buckets | All SaaS

The below analysis shows median revenue multiples segmented by estimated NTM revenue growth rate and profitability over time, with 2017 being a proxy for pre-COVID times and 2021 being a proxy for the post-COVID boom period. As the other charts show, multiples have come down across the board, and even more so for higher-growth companies that are burning cash. Note that today there are no public SaaS companies that the Street expects to grow faster than 40% (even while burning cash!) over the next 12 months. This grid can be used by mature private companies to understand hypothetical trading multiple ranges based on the market today.

Source: Company Filings and CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate. Free cash flow defined as NTM cash flow from operations minus NTM capital expenditures and capitalized software costs.

## Rule of 40 Buckets | All SaaS

The below chart has a similar layout to the prior chart, but is segmented instead based on Rule of 40. Note that CrowdStrike is the only company currently in the Rule of 60 bucket.

Source: Company Filings and CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate. Rule of 40 defined as NTM revenue growth + NTM free cash flow margin.

## Rule of 40 Composition | All SaaS

Previously we showed multiples segmented by growth rate and profitability. Here is a more nuanced view, breaking down the composition of the Rule of 40 between growth and cash flow margins and showing both the median multiple and the median Rule of 40 of each bucket. Simple regressions comparing multiples against growth or Rule of 40 are valuable, but this analysis shows that the composition of your Rule of 40 can meaningfully impact your valuation. This is highlighted in the red boxes in the tables which, show that companies with similar Rule of 40 but growing faster can trade at a significant premium (12.4x) to companies with lower growth and higher free cash flow margins (7.0x). The bar chart below plots those red boxes and visualizes the inverse correlation between Rule of 40 and multiple for this very reason, a dynamic you could not pick up from looking at a simple regression. Investors pay the highest prices for companies that are growing quickly and have *some* free cash flow. This implies the company has a great market structure, and if growth was slowed, theoretically, free cash flow margins would rise even further. Note blank cell(s) indicate no companies are currently in that bucket.

Source: Company Filings and CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate. Implied ARR defined as quarterly total revenue multiplied by four. Free cash flow defined as cash flow from operations minus capital expenditures and capitalized software costs. Rule of 40 defined as NTM revenue growth + NTM free cash flow margin.

## Relative Importance of Revenue Growth vs. FCF Margin

The chart below is based on a two-factor regression of NTM revenue growth and NTM FCF margin to ARR multiple. It shows that growth is 2.8x as correlated with multiple vs. FCF margin. Said another way, a 1% increase in growth would have the same impact on multiple as a 2.8% increase in FCF margin.

Source: Company Filings. Note: We define relative importance as the ratio of the correlation of NTM revenue growth and NTM FCF Margin to EV / Implied ARR Multiple based on a two-factor linear regression analysis. Represents two-quarter rolling average. Data excludes Zoom.

## Regression Analysis | EV / Implied ARR Multiple vs. *Meritech *Rule of 40

We’ve established that growth has (today and historically) an outsized influence on software company valuations relative to FCF margins. So, rather than plot regressions of growth and Rule of 40 separately, we at Meritech plot multiples against an adjusted Rule of 40 score, where growth receives a disproportionate weighting (in this case, 3x) relative to FCF margins – the **Meritech Rule of 40**. This metric more accurately reflects the valuation environment as shown in the prior chart and results in a higher correlation.

Source: Company Filings and CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate. Implied ARR defined as quarterly total revenue multiplied by three. Meritech Rule of 40 defined as NTM revenue growth multiplied by three + NTM free cash flow margin. Excludes companies with top decile residuals from the line of best fit.

## Trended Regression Analysis | Growth vs. Rule of 40 vs. Meritech Rule of 40

The chart below shows the Meritech Rule of 40 correlation plotted over time alongside standard growth rate and Rule of 40 correlations. Following the market sell-off and multiple compression in early 2022, growth and Rule of 40 correlations converged. Recently, however, growth has returned (for now) as being the dominant factor. The Meritech Rule of 40 shows a consistently higher correlation than growth or traditional Rule of 40.

Source: Company Filings and CIQ as of 01-Mar-2024. Note: NTM defined as next-twelve months consensus estimate. Implied ARR defined as quarterly total revenue multiplied by four. NTM Rule of 40 defined as NTM revenue growth + NTM free cash flow margin. Meritech Rule of 40 defined as NTM revenue growth multiplied by three + NTM free cash flow margin. Meritech Rule of 40 calculation excludes companies with top decile residuals from the line of best fit. Data represents 90 day rolling average.

## Performance by Implied ARR Buckets

Note: See footnote on final chart.

## 4) Company Rankings - *Updated Weekly*

## Top 10 Implied ARR Multiple Companies

Note: See footnote on final chart.

## Top 10 Market Cap Companies

Note: See footnote on final chart.

## Enterprise Value / Implied ARR Multiple by Quartiles | All SaaS

Note: See footnote on final chart.

## Bottom 10 Implied ARR Multiple Companies

Source: Company Filings and CIQ as of 01-Mar-2024. Note: Implied ARR defined as quarterly total revenue multiplied by four. Annualized Gross Profit defined as quarterly gross profit multiplied by four. Free cash flow defined as cash flow from operations minus capital expenditures and capitalized software costs. LTM Rule of 40 defined as Implied ARR Growth + LTM free cash flow margin. Payback period shown in months. Payback period calculated as prior quarter LTM non-GAAP sales and marketing expense divided by current quarter LTM net new implied ARR multiplied by current quarter LTM non-GAAP gross margin multiplied by 12. LTM (last-twelve-months) defined as the last four reported quarters. ACV defined as quarterly implied ARR divided by quarterly customer count. All financial figures are non-GAAP which adjust for items such as stock-based compensation, amortization of intangibles, and other one time and/or extraordinary expenses. Historical data includes over 100 public SaaS companies as defined by Meritech.

## 5) Operating Metrics and KPIs -* Updated Quarterly After Earnings*

## Median Net Dollar Retention | All SaaS

Net dollar retention rates across public SaaS have continued to decline and are at their lowest point in years at a median of 111%. Upsells have decreased and churn and contraction have increased.

Source: Company Filings. Note: Quarters are only shown after all companies report earnings.

## Median Implied ARR per FTE | All SaaS

While companies are raising free cash flow margins, they’re being forced to do more with less given layoffs and slower hiring.

Source: Company Filings. Note: Implied ARR defined as quarterly total revenue multiplied by four. Quarters are only shown after all companies report earnings.

## Median Payback Period in Months | All SaaS

No surprise, payback periods are increasing as new business is slower, expansion is harder to come by, and churn and contraction are increasing.

Source: Company Filings. Note: Payback period shown in months. Payback period calculated as prior quarter LTM non-GAAP sales and marketing expense divided by current quarter LTM net new implied ARR multiplied by current quarter LTM non-GAAP gross margin multiplied by 12. LTM (last-twelve-months) defined as the last four reported quarters. All financial figures are non-GAAP which adjust for items such as stock-based compensation, amortization of intangibles, and other one time and/or extraordinary expenses. Quarters are only shown after all companies report earnings.

## Median % YoY Implied ARR Growth | All SaaS

ARR growth continues to decelerate but at a slower rate.

Source: Company Filings. Note: Implied ARR defined as quarterly total revenue multiplied by four. Quarters are only shown after all companies report earnings.

## Median % YoY Customer Count Growth | All SaaS

Customer growth has decelerated but is showing signs of stabilization.

Source: Company Filings. Quarters are only shown after all companies report earnings.

** Indicates current or former Meritech investment.*