PVC SaaS Index™ | Q3 2020: “You Get What You Pay For”

Practical Summary:

  • Our PVC Index of SaaS companies now trades at over 11x EV / LTM revenues
  • More recent IPOs (post 2016) are at 18x
  • This group of 51 companies ($680B market cap) is growing at a median 34% yoy growth rate
  • This may be the first time ever that an entire sector in the public market has seen this kind of sustained growth

EV / LTM multiples for SaaS companies

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This post is an update in a quarterly series of posts that tracks the PVC SaaS Index™, a basket of publicly traded US-listed SaaS companies.

Software as a Service (“SaaS”) has been around longer than the cool new “cloud.” It shares some aspects of cloud computing, but its focus tends to be clearer: SaaS is simply the delivery of software applications over the Internet from a server that’s hosted by the SaaS provider somewhere far away.

The first big SaaS IPO was Salesforce (NASDAQ: CRM) in 2004, and now we have 103 pure-play SaaS/cloud companies in our proprietary PVC SaaS Index™, which includes companies that:

1. Are now trading on either the NASDAQ or the NYSE; and

2. Derive a huge majority of recognized revenues from long-term contractual commitments (12 months or greater), and which recognize those revenues periodically over the life of these contracts.

Q3 Valuation Update

The chart below shows the historical EV / LTM (“enterprise value” to “last twelve months” of revenue) going back to 2015. Since early 2015, the median EV / LTM for this group has generally been between 5x and 8x.

At the end of Q3, the median value in the index popped up to over 11x for the first time, while the mean leaped to over 16x, also an all-time high.

Chart 1: Historical SaaS Valuations

Source: CapitalIQ; PVC analysis

If we look more carefully at just those SaaS companies that went public in 2016 or later, these 51 companies are now trading at about 18x LTM.

(I am excluding ProSight Global (NASDAQ: PROS), a specialty insurance company that went public in July 2019. As a result of the COVID-19 pandemic, PROS has struggled, and they reported declining yoy revenues. Their price / revenue multiple has dipped below 1x.)

This basket is worth about $680 billion in market cap — that would make it one of the five or ten largest public companies in the world, though the average enterprise value of these companies is $13 billion. Imagine a company the size and scale of say, Facebook (NASDAQ: FB) … but growing at 34% yoy and accelerating, instead of Facebook’s 11% yoy growth rate, which has declined sharply this year.

Chart 2 below shows how this group has traded, and how quickly it recovered after the Q1 decline.

Chart 2: Performance of 2016–2020 SaaS IPOs

Source: CapitalIQ; PVC analysis

Comparing This Basket to the “Rule of 40”

Given the historic multiples of revenues that these SaaS companies are commanding, it may be easy to dismiss SaaS as a bubble that won’t end well. But investors pass on these companies at their own risk. The world’s top VCs have been investing in SaaS companies for years at 15–20x revenue multiples, as long as the companies follow an informal rule of thumb which Brad Feld popularized in 2015 called the “SaaS Rule of 40.”[1]

Stated simply, this rule says that the sum of a healthy SaaS company’s growth rate and operating margin should add up to 40%. So, if a company is growing at 20% yoy, it should be generating a profit margin of 20%. Growth at 40% yoy is fantastic and the company should be running at break-even … they should be investing in growth instead of kicking off profits.

Some of the largest and most successful SaaS bets ever have been in these kinds of healthy companies, and they were often made at double-digit multiples of ARR. Recent examples would include: Twilio’s Series C and D rounds in 2012 and 2015 from Bessemer and Redpoint; Bain’s investment in DocuSign’s Series F in 2015; Crowdstrike’s Series E, done at 25x TTM in 2018 by General Catalyst; or Sequoia’s lead into Zoom Video Communications in early 2017 at north of 30x. Maybe the best SaaS investment of all time will end up being Snowflake’s Series C and D rounds (led by Altimeter Capital and Sequoia) at current year revenue multiples of over 50x.

These top VCs understand that if a company is able to grow profitably at compounded annual growth rates of 40% or more, then paying 15–20x sales is justifiable over a 5–7 year investment horizon. For most of history, finding rapidly growing and profitable SaaS unicorns was nearly impossible, and those who could get into those deals were destined to generate top-quartile VC funds.

But now, check out Chart 3 below — these are the 51 SaaS companies that are publicly listed in the US. On a cap-weighted basis, the category is growing at 117% yoy and running at about a 13% operating loss. As a category, this group meets the “SaaS Rule of 40,” with business fundamentals that mirror the elite SaaS unicorns of the past.

The whole basket of stocks has a market cap of $680B, and is growing at a median annualized growth rate of 34% yoy … that’s unheard of in the midst of any recession, much less the worst recession since 1929–1937. Most of the companies are now running at break-even, or projecting it by early FY2021.

About half of these stocks are hitting the “Rule of 40” benchmark or are very close to it. Those companies are called out in the chart below with the actual company logos. (Note that any of the companies above or to the right of the line marked “SaaS Rule of 40” have a sum of growth + profitability above 40.)

Chart 3: Mapping Public SaaS Recent IPOs to the “Rule of 40”

Source: CapitalIQ; company filings; PVC analysis

Conclusion

The past 15 years have seen some great public SaaS companies, and very good returns for investors.

As of the end of Q3, the index hit an all-time high of over 18x EV / LTM for recent SaaS IPOs … on average investors are paying higher multiples today for SaaS companies than at any other time in public SaaS trading history.

Aman Verjee, CFA, is a co-founder and General Partner at Practical Venture Capital, a secondary venture capital firm headquartered in Palo Alto, California.

[1] “The Rule of 40% For a Healthy SaaS Company,” by Brad Feld. Feb 3, 2015.

https://feld.com/archives/2015/02/rule-40-healthy-saas-company.html

Former C-suite at PayPal, Sonos, eBay. Now general partner & founder at Practical VC, a secondary venture capital fund.

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