Crickets
10/2 OpenView Capital Markets Roundup
Programming notes:
If this roundup was was forwarded to you, please consider subscribing here!
I’ll be metaphorically “out of office” next week, but literally trying not to respond to emails. No roundup next week - it’ll be back the following, 10/16!
The APM and logs products are both in hyper growth and have significant scale, we're not disclosing the exact scale, but I can tell you that they're growing faster than data suggests and at a similar scale, the infrastructure products initially.
As Olivier Pomel noted on Datadog’s Q4 2019 earnings call (and has reiterated since) - Datadog is a multi-product company and multiple new product SKUs are growing even faster than Datadog’s initial product was at similar scale. Datadog benefits from – among many other things – a management team that has proven it can allocate capital incredibly well. The company actually acquired these two hypergrowth products (Logmatic and MortarData) and then more recently acquired Undefined Labs to inorganically extend platform functionality. A large and rapidly growing component of the business’ revenue is a cross-sold acquired product and acquired technology (MortarData did not translate into one of Datadog’s hypergrowth products - Logmatic did - but Mortar did end up becoming their underlying data platform, which has helped them be a multiproduct company).
In M(oat)&A I suggested that we need to see more strategic software M&A activity. If SaaS valuations are going to be rationalized with 20 or 30 year DCF analysis, I demand to see a path to that many years of value creation - I don’t see it today. Then in The Limit Does Not Exist, after seeing many claim TAM expansion is driving multiple expansion, I did my best Michael Mauboussin impression and instead acknowledged that really what is happening is the annuity-like cash flows of software revenue have simply recalibrated to the new interest rate environment. I’ve also recently made the observation that companies are far too willing to sell extremely expensive equity.
M&A, the cost of capital, and expensive equity. Where am I going with all of this you ask? Well, I’m still hearing lots of crickets when I should be hearing about M&A! Because of that very same interest rate environment financing is cheap. It is easy to spin up a convertible note offering overnight for a de minimis spread over the 5-year (see Slack, Zendesk, Datadog, and likely others since mid-March*). It is even cheaper to just use a bunch of the cash already sitting on the balance sheet (median public software company has $250M of cash and is under-levered). And since most companies have had no problems raising equity, it should be even easier now that that equity is trading at more than twice the price it was in late March and is 50% over February all-time-highs (i.e. is far cheaper for companies already ok with selling it). There is an axiom that suggests when the stock is overvalued, use it as currency and when the stock is undervalued buy it back. Alas, this type of capital allocation rule of thumb seems to be escaping all but Fastly (acquired Signal Sciences with 75% equity).
Expanding addressable market to support a 30 year value creation narrative shouldn’t be de facto organic. Looking at venture backed businesses gone public they don’t necessarily appear - outside looking in - to balance the deploy vs. destroy vs. return & reinvest components of the equity hamster wheel very well. Datadog certainly could have gone and built APM and logs but company did the math on cost (both in cash and opportunity) to build and sell organically vs. buy, integrate, and sell. If companies do that calculation right, I’m betting more often than not organic is not the best option.
When building strategic plans M&A should always be an option that is on the table. Perhaps it is the rapid growth of these software companies that is obscuring poor capital allocation decisions today, perhaps it is ego (the most powerful shareholder value destroying force there is), or maybe something else that keeps companies from feeling they need to execute inorganic strategies. But as software markets mature, I believe M&A will become a more important part of creating generational businesses and every company should start building that muscle as part of normal planning today.
Solving Growth Problems
This week on the BUILD podcast we hear from Chris Miller, the Director of Product Growth at HubSpot. Blake and Chris unpack (1) the differences between growth marketing and growth product, (2) how to use the 3D’s to solve growth problems (discoverability, desirability, doability), and last but not least, (3) exactly how HubSpot uses advanced segmentation to serve a large and heterogeneous pool of prospects.
Once again, you can listen to this and all OpenView BUILD podcasts here.
Paycheck Protection Program
I covered the Paycheck Protection Program in the CARES Act in detail through March / April / May, encouraging all companies to review the program internally and with their corporate counsel to understand if it was right for them. After many fits and starts and conflicting guidance from the government, there were in the end a substantial number of venture-backed companies that were able to participate. Now, it is time to start considering loan forgiveness (which made the program so attractive in the first place). Loans can be fully forgiven if the funds were used for payroll costs, interest on mortgages, rent, and utilities. As interest payments approach for some borrowers, we’d encourage all borrowers to start working with counsel again to understand if forgiveness makes sense. There is more detail on the SBA website here. LinkedIn has also aggregated resources for those contemplating PPP loan forgiveness.
Market Update
I enjoyed the below from Goldman Sachs this week, which summed up software performance and tailwinds into the second half of the year - feel free to let me know if you’d like to read the full report and I’m happy to share it! Otherwise, the key indices all closed up this week (SaaS +1.00%, Dow +1.87%, NASDAQ +0.94%, S&P 500 +1.52%). Also worth noting: a whopping 33% of the ~75 public SaaS companies we track are trading for more than 20x 2020E revenue vs. just 9% at all-time-high in mid-February.
Our main takeaways for the quarter are as follows: 1) CY21 revenue estimates bounced back - +2% in the C2Q, up from a 2% drop in C1Q; 2) software multiples are back at highs, but have leveled off since early Sept, fully reflecting, in our view, a sustained period of low rates and bounce back in demand; 3) the correlation of sales multiples to revenue growth and unit economics both improved sequentially in C2Q, as the market is placing more of a premium on resilient businesses, both in terms of growth and efficiency; 4) average CAC moved higher on slower in-quarter growth, but many SMB-focused vendors showed sequential improvement, which suggests that these vendors should warrant higher multiples than what investors have historically applied due to their resilience throughout COVID.
Economic Data
CNBC highlighted this week’s jobs report as “massively concerning”, noting it could be a sign economic recovery is fading. This sentiment was shared by the head of the Cleveland Fed, who noted the next phase of recovery will be the hardest, adding that “it could take two to three years for the unemployment rate to return to levels seen in February as companies adjust to smaller staffs and workers retrain for new careers.” This in my mind is the topic to watch into Q4 and the election. As Congress remains unable (unwilling) to agree on stimulus, a second wave on folks minds, and winter coming, a v-shaped recovery is far from a sure thing despite what some believe.
What Else We’re Reading
The public SaaS companies we track closed the week trading at 15.1x 2020E revenue at the median. Note this figure doesn’t compare to prior weeks as we’ve added numerous recently IPO’d companies to our index (including high flyers like Snowflake) that have pulled the median up significantly. Recurring Revenue: The Rise of an Asset Class.