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May the 4th (Force) Be With SaaS Investors
5/8 OpenView Capital Markets Roundup
“It’s a trap!” In honor of Star Wars Day, we feel this Admiral Ackbar quote appropriately describes the near all-time high SaaS markets. And they aren’t just a trap just because of the bad economic data (33M / 14.7% jobless) and renewed trade issues (more below). And not even just because nearly every earnings print this week was headlined with “business slows,” “quarter disappoints” or “lower guidance.”
Accounting changes and a lack of understanding are creating a trap. As Barclays noted, “software is unlikely to exhibit a V-shaped recovery…and we are not sure investors fully understand this.”
The rise of the pro forma metric has been well documented and we’re all accustomed to non-GAAP metrics—ARR, retention, CAC payback, etc. They’re incredibly effective compared to GAAP measures for SaaS. But ASC 606, which allows companies to recognize revenue sooner, has limited our ability to use rules of thumb.
Take, for example, Alteryx. For a three year, $300k contract billed annually and upfront on Jan 1, they can recognize $170k in the first year, and ~$120k in the first quarter of the deal alone (35%, or $105k plus one quarter of the $65k ratable annual portion for the year) even though they only collect $100k in cash in the year.
We love to talk about how revenue growth is correlated with valuation, and that revenue is valuable because it is recurring and at scale will generate large predictable cash flows. Software companies are benefiting from heavily footnoted financials that make revenue growth (and the presumed likely future cash flows) appear better than they might ever be, preying on us P&L-focused SaaS investors.
This week Alteryx reported growth will drop from 43% YoY to a mere 12.5% (vs. 30% original estimate) in Q2 because “a slowdown in new deal activity, higher expected churn, and more flexible payment terms—all of which is amplified by the upfront revenue recognition for term licenses under ASC 606” (Goldman Sachs).
ASC 606 is pulling valuation forward and misleading investors—on top of the billings confusion noted by Barclays! A 43% growth business commands the ~14x NTM multiple Alteryx is still trading at. A 12.5% grower should trade for 40% or more less than that. But alas it isn’t just accounting creating a trap. Hubspot reported increased headwinds and worsening churn, so reduced revenue guidance for the year. In response, Goldman raised their 2021 revenue and their stock price targets!
Why? Positioning. Whether through use of technically above bar accounting or good old fashioned selling of a story, positioning matters. Shopify’s Head of IR said “investors live in an entirely different context than management…yours is one of 4,000 publicly traded companies…keep that in mind when talking about messaging and execution, the story…stands out.”
Hubspot may see impact, but incremental revenue from new products (positioning on market size, upsell, runway for growth) keeps the market bullish. As operators, continuously reaffirming value proposition, market size & opportunity, and defensible competitive advantage keeps your company top of mind despite macro headwinds.
As investors, we must not let this trap distract from actual business performance and prospects.
You asked and Blake answered! OpenView Partner Blake Bartlett’s Recession Planning Framework is now available in blog form! We’re excited to share the post, which includes a link to download the template.
Also this week George Roberts shared another article on adapting to recession. George’s 41 years in the software industry include six different recessions and in the spirit of “never allow a good crisis go to waste” (per Rahm Emanuel) George reiterates that adaptability is critical during this time.
Paycheck Protection Program
Per our continuing coverage, the SBA’s PPP FAQs were updated on Monday evening with a new Question 43. Safe harbor for returning funds has been extended to May 14 and the SBA has indicated that they’ll provide additional guidance on how they’ll interpret the “necessity” certification prior to that date.
Capital Market Resources
Data from Credit Suisse provides interesting fodder that rationalizes the SaaS valuation melt-up observed this week. With Treasury yields at record lows, corporate spreads tightening, and equities creeping towards all-time highs there are not many great places to park capital.
If we compare revisions in software earnings vs. those of blue chip stocks and chemical, auto, industrial, and consumer companies—there isn’t much safety left in equities. Buying SaaS—which benefits from long term, non-cyclical trends despite high valuations—is a good place to put capital. If it goes down, hopefully it won’t go down as much as the broader market.
This speculation creates demand that has driven prices up. All key indices closed the week up significantly (SaaS +14.9%, Dow +2.47%, NASDAQ +5.97%, S&P 500 +3.54%).
Prior market sell-offs dating back to mid-2016 followed the same narrative: Investors were worried about the impact of ongoing trade wars (US / China and USMCA), uncertainty over the impact of Brexit, and slowing global growth in key economies. Investors got comfortable with these factors in late-2019 given trade agreements and improved economic data.
But on top of the economic impact of COVID, trade is now dragging on economic growth again. As Dion Rabouin writes in Axios Markets, “Most had long expected that China would be unable to meet the terms of the deal as the novel coronavirus ravaged its economy, causing the worst quarterly economic contraction on record… The nascent stock market rebound also could be threatened by revived tensions between the world’s two largest economies.”
What Else We’re Reading
SaaS valuation multiples were effectively flat week over week, moving from 8.6x to 8.8x 2020E revenues at the median to open the week. Signs of recovery in sales from Hubspot. Dry power in the private markets. The current level of unemployment in context vs. other recessions.