What can private SaaS businesses learn from public cloud company valuation multiples?
Tom Tunguz wrote a blog post in December 2018 wondering if public SaaS multiples have compressed versus historical levels following the Q4 2018 correction. His analysis found that they hadn’t and were still quite expensive. In my analysis below, I found a similar result and data that suggests the group is trading slightly higher than historical averages. For private cloud companies, this probably means there isn’t much impact to valuation after the market volatility. While it is interesting to look at averages, it does not tell the entire story. I find it useful to look at the valuation spread between the most expensive (highest EV/LTM Sales multiple) and cheapest (lowest EV/LTM Multiple) companies.
We examine the valuation spread because it helps us understand the premium investors are willing to pay for the best performing cloud companies. It also tells us generally if multiples have risen because the entire sector grew or if the highest value companies contributed the most. The results are interesting and suggest that investors are willing to pay a larger premium for the high growth, best quality SaaS companies. The rational explanation for this is that relative value stocks are cheap for a reason: slower growth, earnings or sales miss, smaller moat, or high competition. The behavioral interpretation is that investors over-extrapolate past returns, sentiment drives buying or conversely selling if news flow is negative.
What do the numbers say? On Jan 23, the high value group had a mean sales growth rate of 38% versus the low value group with a 28% growth rate. Investors were willing to pay over 12 multiple turns for 10 extra percentage points of growth. Of course, there are other factors too: higher efficiency score (sales growth % + FCF margin %), better net revenue retention and higher gross margin. For comparison, on Jan 1, 2018, investors were willing to pay less of a premium at roughly 7.5 multiple turns. Going back to what this may say about the private markets and investor behavior, I think venture capital money would be willing to pay expensive multiples, but only for the fastest growing, highest quality companies. It certainly isn’t all bad news for private companies because the lowest valuation SaaS companies are still trading at an average EV/LTM Sales multiple of 5.9x. This is still above the long-term median of 5.2x.
The bar chart below summarizes the companies I used in the analysis.
All analysis and charts were created using the Quantopian hosted research environment, which uses Python’s Jupyter notebook as its backbone. If you are interested in looking at my work, please click on button.