An analysis of 2023 calendar year revenue and free cash flow estimates for almost 100 public SaaS companies.
As many private SaaS companies approach the calendar year 2023 (or fiscal year 2024) planning process, they are confronted by an increasingly uncertain buying environment. As we all know, average SaaS forward revenue multiples are down almost 80% from their peak in November 2021, with the majority of that compression occurring in the first half of 2022. This was largely the result of Central Bank induced measures meant to alleviate rampant inflation at a time of record high SaaS valuations. Long story short, the cost of capital is now significantly higher for technology companies large and small. As this new reality has set in, would-be software buyers are undergoing cost rationalization, both on headcount in the form of RIFs (reduction in force) and on software spend. Softening demand is the second shoe to drop. Even some of the best public software companies have had very cautious commentary from Q3 earnings calls:
Source: Earnings transcripts
This demand side softness manifests itself in many forms: software sales cycles are extending, more signatures are required to close deals, discounts are increasing in prevalence, payment terms are becoming more flexible (negatively impacting cash collections), and the strengthening dollar is causing FX headwinds for companies selling abroad. Moreover, many stakeholders at software companies have been affected by layoffs, creating even more uncertainty in selling discussions. For software companies with usage-based models, the impacts can be felt immediately as customers will try to ration usage. With less capital at a higher cost available for startups, their survival will depend on their ability to rationalize costs and “do more with less” across the board. Planning and forecasting will become extremely important, particularly for companies that are burning cash (most startups). For many companies, new business is slowing, expansion revenue is lower than expected, and churn and contraction are creeping up. Public market SaaS companies can give some insight into what private companies should expect. The following analysis looks at the change in consensus sell-side (not company guidance) CY23 revenue growth rate estimates from 12/31/2021 – before demand softened – to today.
This first chart shows a staggering figure: out of almost 100 public SaaS companies that Meritech tracks, 83% saw a decline in CY23 revenue growth rate estimates between Dec-21 and today (Dec-22).
Comparison of CY23 Revenue Growth Estimates Between Dec-21 vs. Today (Dec-22)
Source: CIQ as of 1-Dec-2022
The below chart shows company-level CY23 revenue growth rate estimate changes. Among the 83% of companies that saw declines, the average change in CY23 net revenue growth rate estimates is (25)%. The calculation is as follows: for example, suppose a company will generate $100M of revenue in CY22. As of Dec-21, it was expected to grow revenue 50% in CY23 to $150M of revenue. As of today (Dec-22), the company is now expected to grow revenue only 37.5% to $137.5M. That would imply a 25% decrease in the CY23 revenue growth rate (from 50% to 37.5%). This theoretical example assumes the CY22 revenue estimates did not change at all over the course of the year, which is of course not true (many came down as well). That is why this analysis focuses on the revenue growth rate instead of absolute revenue dollars – to isolate the estimated impact of softening demand to next year’s revenue. While 83% saw decreases in their revenue growth rate estimates, some have seen increases. These are few and far between (only 17% of total companies) and among this group of companies, the average increase in revenue growth estimates is 11% vs. a 25% decrease for the companies that saw decreases in revenue growth estimates. Many of these companies that saw growth rate estimates increase are in the infrastructure or cloud security spaces, markets that are more insulated from macro headwinds given the mission-critical nature of the products.
CY23 Revenue Growth Estimates on Dec-21 vs. Today (Dec-22) – By Company
Source: CIQ as of 1-Dec-2022
Beneath these high level numbers is a more nuanced reality for new business or net new ARR targets. Most of these companies have recurring business models with large absolute revenue scale – the median CY22 revenue estimate from this group is $618M. Companies like Atlassian and CrowdStrike have been reported to have 80-90% “revenue visibility” into each subsequent quarter, implying that ~85% of revenue for the next period could come from existing contracts. What does this mean for net new ARR targets? Given revenue recognition policies, companies can miss significantly on net new ARR targets since most of the revenue comes from the base – this is the beauty of the subscription model. And while not disclosed, those misses could be much more dramatic than the ~25% decrease in revenue growth estimates that showed up in our analysis. Also consider that for most private startups, smaller quarterly misses will impact total revenue growth more given they are growing so rapidly off of a smaller base of revenue.
These top-line impacts are also being felt on the bottom line. The following chart looks at the same set of companies and the difference in free cash flow (FCF) margin estimates for the same time period, CY23 (companies are in the same order as the previous chart).
CY23 FCF Margin Estimates on Dec-21 vs. Today (Dec-22) – By Company
Source: CIQ as of 1-Dec-2022
The calculation in this chart is as follows: if a company was expected to have a CY23 FCF margin of 30% as of Dec-21, and is expected to have a 25% margin as of today, then that company would have a (5)% change in CY23 FCF margin estimates. Note that this change is calculated as a percentage point “delta” between the two margins (subtraction), whereas the revenue growth estimate changes are calculated as the percentage change between the two growth rates (division).
While 2021 was one of the best software buying and selling environments in recent memory, 2022 has shown signs of deceleration and 2023 is shaping up to be even worse. With lower new bookings targets (and results), cash flow margins will be impacted and for all companies, hard decisions will have to be made on spend, most notably on hiring. As optimistic as things may look for any given private company, these drops in revenue estimates for public SaaS companies should be incorporated into every private SaaS company’s planning exercises. Moreover, with the public markets now valuing growth and efficiency over growth alone, 2023 will be the best time to “under promise and over deliver” on new bookings and to focus on margins, efficiency, and cash conservation. Most companies don’t have the luxury of burning a lot of cash “pushing a refrigerator up a hill” in what is expected to be a tepid software buying environment in 2023.
*Meritech Capital is a current or former shareholder in Alteryx, Amplitude, Box, Braze, Datadog, Domo, JFrog, Okta, Salesforce, Snowflake, Twilio, and UiPath.
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