Valuations for public SaaS companies have come back dramatically since the lows brought on by COVID in mid-March. Moreover, over the past few weeks, almost 30 pure-play SaaS/cloud companies (29 in total) have reported their Q1 earnings, all of which have March 31 quarter-ends. Companies with April 30 quarter-ends (which will likely have more COVID impact) have not yet reported. I will update this post when those companies report their Q1s over the next 6-8 weeks. We also track the performance and valuations all of public SaaS companies on our Meritech Enterprise Insights page here.
First, where are we in terms of historical forward revenue multiples? Most high-growth SaaS businesses (public and private) are valued on a multiple of forward revenue (i.e., enterprise value divided by NTM (next-twelve-months) revenue). The chart below shows the equity value weighted average, straight average and median forward revenue multiples for all SaaS companies over the last 5 years as well as a table of average multiples over various lengths of time.
We are now sitting at the all-time peak of public SaaS valuations in the midst of a global pandemic.
Why have SaaS company valuations risen so dramatically in the last few months? The following post shows that generally speaking, the outlooks of these businesses haven't changed that much since February, except for Q1 earnings where, in almost all cases, management waved a yellow caution flag to investors and withdrew or lowered guidance. Despite that, in some ways, the changes in valuations make sense. Due to COVID, digital transformation has rapidly accelerated and the surface area that business software can serve is likely to rise dramatically over the next few years as every industry transforms to become digital-first. Companies will need more software to manage this new normal.
Those are just a few examples of SaaS companies that will be the glue that binds the business world together post-COVID and I believe it's a significant reason for all the dollars flowing into these names over the past few months. Moreover, given the SaaS recurring revenue model and the potential for high cash flows, these companies behave almost like annuities or "cell phone towers". Given today's low interest rate environment, the largest SaaS companies are safe havens for cash that can produce strong yields. For example, ServiceNow, which has almost $4 billion of implied ARR (quarterly subscription revenue * 4), grew subscription revenue 34% YoY and had a 39% free cash flow margin in Q1. ServiceNow serves the largest companies in the world and is likely to become even more mission-critical in a digital-first world. They also have virtually no churn. It's no wonder investors would continue to pour money into such an asset. On a more macro side and also important to note, we've seen unprecedented intervention at the Federal level to keep equities afloat, which is a temporary fix but another factor that's helping bolster the strong performance of the SaaS asset class. Dollars are flowing out of fixed income and into equities and investors are looking for yields and relative safety. The SaaS recurring model fits this mold.
We don't yet know what the steady-state will be. Q1 was mostly, if not all, baked prior to COVID for most of these businesses due to their scale. Take Atlassian for example, in their latest shareholder letter the company notes "our revenue model benefits from the fact that over 90% of our revenue comes from existing customers, and over 85% is recurring in nature." The company could see a significant negative impact to new business results but it wouldn't show up unless they had a string of several bad quarters in a row. Moreover, building customer pipeline in the current environment is challenging and the most telling results will come later this year when we've able to see how companies have transitioned to selling all inside (i.e. over Zoom) from start to finish on a new deal. Many software companies generate pipeline from events, conferences, and other in-person events that are not currently happening. Selling over Zoom removes some of the personal elements of a transaction and the best products (not sales processes) will likely win out. While the current environment is great for SaaS companies, I wouldn't be surprised (and somewhat expect) to see a pullback in prices and multiples later this year when Q2/Q3 earnings are reported, but the long-term trends can't be ignored that moving to digital-first at every enterprise will make the companies behind this transition even more valuable.
Q1 Performance and Outlooks
How did the 29 SaaS companies that reported Q1 earnings perform against consensus sell-side estimates? Note for this analysis, I am using consensus estimates vs. company guidance as consensus estimates are what the companies are valued on with regard to their forward multiples. SaaS companies notoriously guide analysts lower to put up consistent "beat and raise" quarters.
Almost every company in this group beat consensus estimates for Q1 and out of the 29 companies, 22 beat their estimates but also withdrew or lowered their guidance for the full year (even if they beat estimates by a wide margin i.e. Twilio, Datadog* and Bill.com).
How much better (or worse) were the revenue results vs. consensus estimates? The chart below shows each company and the percentage they beat (or missed) consensus revenue estimates. Datadog*, Twilio and Bill.com put up the largest beats on Q1 against consensus revenue estimates. The median beat for this group was 4%. It will be interesting to see this analysis for the SaaS companies that report which have April-30 quarter ends as they might see a larger COVID impact on their quarter.
Changes in Valuation Based on Guidance Outlook
Irrespective of guidance (which most companies withdrew), share prices and multiples were up across the board when looking at the day before earnings --> today, which in some cases has been a few weeks. Public market investors have been piling into high-growth SaaS companies even though some gave tepid and cautious outlooks. The chart below looks at the average increase in share price and multiple for this group of companies, sorted by what type of guidance was given. While companies rose more that raised their guidance, those that lowered or withdrew were still up on share price and multiple. Again, most of the 24 out of the 29 companies that withdrew or lowered guidance were still up. Datadog*, Bill.com, and Fastly where the three companies that raised full-year guidance.
Surprisingly, as a group these 29 companies are trading at a higher median forward revenue multiple than before COVID started. Today the median multiple is 13.3x, up almost 20% from pre-COVID levels despite many withdrawn or lowered guidance figures. For the companies that gave guidance for the following quarter and for the full year, that guidance was ~1% below consensus estimates for the same time period, implying that the Street is more bullish on these businesses (or more likely calling management's bluff on forward guidance). Below are the medians by time period of the 29 companies that have reported Q1 earnings.
So, most of these companies beat Q1 earnings, withdrew, or lowered their guidance, but their share prices and multiples are up. What's happening behind the scenes? I think it's important to take a deeper look at where the dollars are flowing. The following few charts show the % change in 2021 consensus revenue estimates, % change in share prices, and % change in forward multiples from pre-COVID (February 19, 2020) to today. I decided to compare today's figures to pre-COVID figures (and not just pre-Q1 earnings figures) because analyst estimates were changing prior to Q1 earnings and the data that companies provide at the time of earnings is just an input into their overall consensus estimates.
Change in 2021 Revenue Estimates, Share Price and Forward Revenue Multiples (Pre-COVID --> Today)
These charts tell the story of a "flight to quality" of dollars from the most negatively impacted public SaaS companies to the less impacted and positively impacted companies. Naturally, the companies that have seen the most value appreciation are those which the Street believes will be positively impacted long-term due to COVID (some of which I mentioned before, like Fastly and Datadog*). Evidence of this is an increase in the 2021 revenue estimates from pre-COVID to today. More interesting though, is that companies that have seen only a very small increase in 2021 revenue estimates or even a small decline in estimates (like Bill.com or Shopify) have also, in most cases, seen a significant increase in share prices in multiples. This is despite the fact that the majority of these companies withdrew or gave tepid outlooks in their Q1 earnings calls. The point is: investors are flocking to companies that they believe are positioned to benefit from the impact of COVID or are largely insulated from those impacts over the long-term, driving up share prices and multiples.
A few important caveats: First, a few companies (like Wix), withdrew their guidance not because they are worried that full-year performance will be underwhelming, but because the recent tailwinds they are seeing make forecasting their business too hard. Second, making 2021 revenue estimates in a time of unprecedented uncertainty is challenging, even for Wall Street analysts, so these estimates may not yet fully reflect the guidance (or lack thereof) that companies gave on their earnings calls, and maybe never will until after the next few earnings releases when the true impact of COVID on deal pipeline and sales efficiency is reflected in the financials. Lastly, buy-side (i.e., public equity investors like hedge funds and asset managers) estimates are distinct from sell-side estimates and may be higher or lower for a given company, and may potentially correlate more logically to the movement of the share price. With that said, you can't ignore the evidence at this point in time of a "flight to quality" among these 29 public SaaS companies.
The below regression plots the change in share price and change in 2021 consensus revenue estimates; the correlation is very high with the r-squared at 0.71. This makes sense, as the value of a business is determined by its long-term performance.
Taking a deeper look into the specific companies, the next three charts show the individual % change in 2021 consensus revenue estimates, % change in share price and % change in NTM (next-twelve-months) revenue multiples. I sorted each of the following three charts by descending order of change in 2021 consensus revenue (for all three charts, the companies are in the same order). Below shows the % change in 2021 consensus revenue estimates.
Now, look at the following chart which shows the % change in share price. Again, the companies with upward revisions to 2021 revenue estimates are seeing the most increase in share price. Companies with relatively low downward revisions are also seeing increases in share price.
Lastly, take a look at the percentage change in multiples. Multiples are up for the perceived winners, illustrating the "flight to quality" phenomenon.
It's becoming increasingly clear that the companies that will generate the most value are ones with the strongest growth + unit economics and those that are critical parts of the infrastructure stack in this new digital-first world (or at least ones where investors believe that to be the case). Due to the change in selling motions -- the move to all inside-sales, limited-to-no personal interactions with prospects, more focus on current product capabilities vs. vision or roadmap -- we're entering a world where product-first companies that have self-serve and/or inside sales-driven models with less friction are likely to benefit the most. Those with long, protracted enterprise sales cycles could be hurt in the medium-term until they can adapt. We'll see what the next few quarters hold for the outlooks of these businesses, but the data would suggest there's been no better time than now to be a high-growth public SaaS company that is seen as an enabler of the digital-first world.
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Special thanks to my colleague Anthony DeCamillo for his help on this post.
*Meritech is an investor in Datadog. Note multiples over time charts includes the following companies: all high-growth SaaS / cloud IPOs since Salesforce’s IPO in 2004 including those which were subsequently acquired: Alteryx, Anaplan, AppFolio, Appian, Apptio, Atlassian, Avalara, Bill.com, BlackLine, Box, Carbon Black, Cloudera, Cloudflare, Cornerstone OnDemand, Coupa, CrowdStrike, Cvent, Datadog, Demandware, DocuSign, Domo, Dropbox, Dynatrace, Elastic, Eloqua, ExactTarget, Fastly, Five9, Fleetmatics, HubSpot, Instructure, LogMeIn, Marketo, Medallia, Mimecast, Mindbody, MongoDB, MuleSoft, NetSuite, New Relic, Okta, OPOWER, PagerDuty, Paycom, Paylocity, Ping Identity, Pivotal, Pluralsight, Q2, Qualys, Rally, Responsys, RingCentral, Salesforce, SendGrid, ServiceNow, Shopify, Slack, Smartsheet, Splunk, Sprout Social, SuccessFactors, SurveyMonkey, Tableau, Talend, Tenable, Twilio, Veeva, Wix, Workday, Workiva, Yext, Zendesk, Zoom, Zscaler, Zuora.