6/12 OpenView Capital Markets Roundup
The path of least resistance
“The path of least resistance is the path of the loser,” according to author H.G. Wells. Yet time and time again we see that humans are all guilty of opting for the easier path. Watching Netflix beats reading; going out to a bar beats exercising; and more recently getting rich quick - gambling on bankrupt Hertz’s equity - beats leveraging a long term investment strategy that spans market cycles a la Warren Buffet (where you master the basics like how debt is senior to equity, even - especially - in bankruptcy). It has been extraordinarily hard to employ any sort of strategy given current uncertainty and all time high stock prices. But to help contemplate doing so let’s revisit a January 1997 article by investor Peter Lynch:
If you had missed the 40 biggest up months on the Standard & Poor’s 500 Stock Index in the past 40 years, your return from stocks would have dropped from 11.4% to 2.7% [annually]. That’s how important it is to be invested in those key moments: 40 months on the sidelines out of 10,000 days of trading, and you’d have been better off keeping your money in a savings account.
While Lynch’s data is a bit… stale… the spirit of the comment holds. It is hard, but you have to be in market for the long term. The last three months have been one of Lynch’s “key moments” but prices have been so volatile that it’s been tempting to choose the easier route: overreact and run for the door, selling everything along the way. But we still believe there is no equity safer than a share of a SaaS business today. To add more supporting logic to this claim from last week we point to a piece by Michael Mauboussin, The Math of Value and Growth, in which he identifies three value drivers - growth, return on incremental invested capital (ROIIC), and the discount rate (opportunity cost of capital). We’ve written before and Mauboussin agrees that the value of a financial asset is the present value of future cash flows - a company creates larger future cash flows (value) when it invests in growth above its cost of capital.
And SaaS scores extremely well on all criteria in Mauboussin’s framework. Most software companies have long runway for growth given the undeniable digital transformation mega-trend. We also know SaaS companies generate very high ROIIC (25-30%+ at the median). Finally, the discount rate (or opportunity cost) for SaaS is in the low single digits given the current interest rate environment and the simple capital structures most have. What does this mean? Well, SaaS companies invest so far above their cost of the capital (ROIIC > cost of capital) chasing huge market opportunities that even if they are unable to sustain current levels and ROIIC falls they will still be creating value for a very long time!
With this we can confidently take the hard path (maximize time in the SaaS market vs. playing the Hertz slot machine) so as to not miss the next 40 portfolio defining moments. Investors and operators need only focus on great fundamentals and the market will do the rest in time. Per Lynch “Stocks are a safe bet, but only if you stay invested long enough to ride out the corrections…what makes them a safe bet: corporate earnings. If earnings on the S&P 500 quadruple over the next 2 decades [as in the past] stock prices should rise at a corresponding rate.”
Financial Resources
OpenView BUILD Podcast
This week Blake Bartlett spoke with Alex Rosemblat, VP of Marketing at former OpenView portfolio company Datadog. Alex explains how Datadog generates over half a billion in revenue annually by going both bottoms up with individual developers, as well as top down with technology executives simultaneously in their go-to-market strategy. Blake and Alex also unpack how to decide which leads get human attention, ownership of success metrics in a PLG model, and cross promoting your products.
Capital Markets Resources
Market Updates
The weight of a second wave was heavy on the markets throughout the week, as well as concerns about retail investors driving prices that are further and further detached from company fundamentals. But the markets climb walls of worry so while corporate earnings will be impacted by a second wave should one come, we’re seeing more positive sentiments echoed across our capital markets contacts vs. just a few weeks ago. On the private side in particular we are hearing that M&A dialogues are starting to heat up with both sellers and buyers equally motivated (financial and strategic). On the public side though, the Wall Street Journal said it best – after several strong weeks the markets realized “we had come too far too fast” and all key indices finished the week down from last Friday’s close (SaaS -0.38%, Dow -6.08%, NASDAQ -1.54%, S&P 500 -5.11%).
Economic Data
This week we learned that the US is officially in an economic recession. The Federal Open Market Committee (FOMC), the monetary policymaking body of the Federal Reserve System, also met and announced they will not raise interest rates through 2022. As key data (spending, consumer sentiment) continue to improve it is seeming more like the economy will see a v-shaped recovery (pending second wave shutdowns, if any come) that will put the US economy back on track with prior GDP growth rate. The Fed’s commentary this week made it clear that they are committed to supporting a rapid and complete “V shaped” recovery, which also gives us more hope should a second wave come.
What Else We’re Reading
SaaS valuation multiples moved up substantially from 11.0x to 12.1x 2020E revenues at the median to open the week. Stop whining, the rally is based on fundamentals (note: we disagree with the conclusion, but contrasting views are always useful). Risk reward in the stock market. If You Want Hertz, Have some Hertz. Marc Benioff’s Secret Weapon.