“Investors flock to the safety of bankrupt Hertz” (seriously). Just days after investors sold the equity and bought the debt in fear that creditors would take over the keys to every rental car in the kingdom, Hertz equity is up 220% since last week.
We rarely need to worry about creditors putting the squeeze on our favorite company in the public SaaS world. Equity has funded a generation of companies that return well above the cost of that equity with fundamentally different cost structures. As a result the median public SaaS company maintains a debt to next twelve months revenue ratio of just 0.5x. Similarly, SaaS isn’t as susceptible to demand driven recession. We can make coffee or cook meals at home but most of us can’t homegrow a CRM in our kitchen. When low leverage meets the recurring revenue model with its highly predictable steady state cash flow margins of 20% or more... risk of bankruptcy from either default or lack of demand is minimal.
That said 80% of public SaaS companies have either lowered or withdrawn their annual guidance since mid-March (according to Jefferies’ research) but over the same period - after multiples troughed at 8.4x NTM revenues on March 18th - SaaS valuations (for companies growing >20%) have nearly doubled to 16.5x NTM revenues. In the face of this obvious uncertainty, and expectations aside, we must ask: what else could be driving the outrageous melt up in SaaS valuations?
One hypothesis: in terms of safe assets - there is no equity safer than a share of a SaaS business today. The government stimulus and Fed (which cut tail risk and continues to buoy asset prices through interest rate reductions and historical quantitative easing) have done wonders, but that doesn’t mean that the equity in other sectors won’t still be impacted as companies like Hertz work out issues. Cyclicals, value, chemicals, industrials, consumer staples… SaaS is just the best of the rest as at least with software equities, your holdings probably won’t go to zero. The melt up is driven by software’s combination of balance sheet strength and predictability that has attracted broader investor demand as folks seek a safe haven store of value.
But in the coming months as recovery continues and the Hertz’s restructure, distressed credit funds deploy mountains of dry power, and market leaders widen their moats we must keep an eye on valuations. SaaS prices are so high and the risk return profile no longer makes quantitative sense. So when equity opportunities with more compelling profiles emerge investors will rotate out of software, and SaaS will have merely acted as a high yield savings account in the bad times, and an easy ATM in the recovery. Beware of expectations but also beware of “SaaS tourist” capital that will eventually disappear. As the froth dissipates, so too will asset prices likely fall.
The House, Senate, and White House passed the Paycheck Protection Program Flexibility Act on Friday. This act modifies provisions related to the Paycheck Protection Program. In addition to extending the application window through the end of 2020, the Act also made changes to the rehiring safe harbor, extended repayment deferral, removed the restriction on payroll tax deferment for employers who receive PPP loan forgiveness, and more updates. Further detail about the Flexibility Act can be found with Lowenstein Sandler here. We view these changes as positive as they will enable “main street” to take advantage of the program with confidence. We only wish these changes and clarity in the program came much sooner - in early April - when the business interruption was most acute.
Capital Markets Resources
The biggest news this week: ZoomInfo went public! The market welcomed the new issue with open arms sending the price surging at open. ZoomInfo closed the week up a whopping 85%. Also this week the US 10-year Treasury yield moved to 90bps, which is up from 65bps a week ago and the highest level since March. As a quick reminder bond yields move inversely to bond prices so when we observe yields moving higher, it implies that investors are turning bullish on equities (the economy) and selling bonds (supply is greater than demand, prices fall) and rotating into riskier assets (everything is riskier than the “risk free” 10-year Treasury notes). All key indices finished the week well above their close from last week (SaaS +3.69%, Dow +6.91%, NASDAQ +2.81%, S&P 500 +4.91%).
Friday’s jobs report was the hot topic to close the week - after dismal March and April numbers most approached May’s release with a glass half empty attitude, but the U.S. economy actually added 2.5M jobs and the unemployment rate fell from 14.7% to 13.3% percent last month. Although this job number is in dispute we’d reinforce that real time data (credit card swipes, etc.) we’re seeing (and we believe investors are likely acting on) suggest that as states reopen, people are spending and jobs are returning.
What Else We’re Reading
We stand in solidarity with the black community - hate, racism, and violence have no place in the world. SaaS valuation multiples moved up slightly from 10.8x to 11.0x 2020E revenues at the median to open the week.