High Peak Financial


This blog is written by Austin Conner and covers a mix of business topics that interest me.

I am currently a contract CFO and have worked with companies in a number of industries.

Cloud/Saas Public Company Valuation Multiples Q1 2019 Update

When I work with private Saas companies, the first three metrics I ask about are: net revenue retention, gross margins and CAC payback period. These three metrics answer the following:

  • Net revenue retention: how much of current customer revenue is the company retaining and growing? It is critical to high growth companies because it provides a non-linear contribution to the growth provided by new bookings

  • Gross margins: high gross margins mean there is more cash generated by each new booking, which means a potentially longer runway and more to allocate to other areas of the business

  • CAC payback period: does the business model work? Can the company scale effectively? How soon might the company reach profitable growth?

For public saas companies, net revenue retention and gross margins continue to be important, but investors often focus on one thing: sales growth. Let’s look at the data for the group of companies. Below is a line chart showing the EV/Est. ARR multiple trend over the previous six-quarters. Since the beginning of 2019, valuations have jumped back to all-time highs.

Source: Quantopian and morningstar data. Est. ARR is calculated by multiplying latest qtr revenue by 4.

Source: Quantopian and morningstar data. Est. ARR is calculated by multiplying latest qtr revenue by 4.

Whenever I see a line chart on how valuation multiples have trended over a certain period of time, I wonder if the change is due to broad sector growth or if it is attributed to a few high fliers (or laggards). The chart below illustrates that most of the Saas companies in this group have seen multiple expansion over the past year. (Only 2, BOX and LOGM, have seen multiple contraction.) What are some reasons for the multiple expansion?

  • It is possible that cloud software stocks can gain even in a softer economy because other companies will rely on cloud software to cut costs, create operating efficiencies, and drive growth

  • Cloud stocks are seen as acquisition targets by larger tech companies or private equity

  • While other sectors have seen growth soften, cloud stocks continue to post relatively strong revenue gains. In addition, while investor expectations are high, over the past year, top cloud companies have beaten revenue growth targets

In the correlation chart below, sales growth does a good job explaining the variation in EV/ARR multiples (R-square of 0.55). If we were to do a multiple linear regression, I would use gross margin, EBIT margin, net revenue retention (if it was disclosed), and market cap size.