Fastly? More like Reversely.

10/16 OpenView Capital Markets Roundup

Fastly moved slowly, or better yet turned into Reversely this week on the company’s announcement of a revenue guidance miss. The stock fell 35% from all time high prices and is now trading at “only” 28x NTM revenue (vs.~50x) and is trading at “only” the levels it was trading 3 weeks ago. The bottom of great expectations, the knifes edge public software companies are walking on, falls out on the slightest miss (in this case, just a few million dollar miss caused by reduced usage from some customers). There are two things this news highlights. The first being the generalization of business model, or what I’m calling the Be Like Mike Effect – while a lot of companies can sustain 35%+ growth for multiple years, predictability and margin profile matters. The second is how binary the market feels today, it is either “the product is so good” or “the valuation doesn’t make any sense today”.

On (1), “Fastly is a CDN infrastructure service, not SaaS and, to a lesser extent, sells value-added software.” It is obvious, looking at the financial profile of the business that it is non-SaaS-like in margin profile at its scale. While I get out over my skis trying to describe the product in a concise way, what I can claim is gone are the days of straightforward application SaaS priced on a per user basis and charged monthly, quarterly, or annually. Here are the days of the API-based, developer-centric products with innovative usage-based pricing models. Fastly not only excludes churned customers from their calculation of net dollar retention, they also calculate it in such a way to obscure monthly changes in usage. If done how I’d prefer, it would be obvious the business simply isn’t as predictable as we expect SaaS to be. And down the income statement, the margin profile, as I already noted, is distinctly non-SaaS. Just like how with Alteryx people saw “software” and deemed it SaaS (overlooking the significant on premise portion requiring more complex revenue recognition) folks continue to generalize everything that is software like will look like SaaS – look like Salesforce (the Be Like Mike Effect).

On (2), “Assumptions to get a 15% return for Snowflake for the next five years: 1% annual dilution, 85% revenue CAGR, 20% net margins, ~73 PE (14-15x sales)…” On the one hand the numbers required to generate these returns will scare folks off. On the other, perma-bulls will claim that Snowflake is the most differentiated player out there, it has a strong value proposition, it is incredibly defensible, its management team is so talented, and the market is so large that Snowflake is a sure thing. It shouldn’t be one or the other. The fact that companies like Zoom have produced venture like returns in less than a year seems to have blinded people from doing their diligence – entry price and the potential exit valuation (incorporating #1 above) always matter. It would be great to have both, and with the froth in the market, the qualitative piece is falling to the side in favor of chasing the hype in SaaS.

Fastly’s stock has still returned 260%+ this year (as have many technology stocks). Digital transformation tailwinds are real, and enterprise technology businesses have proven recession proof. There is nothing more sinister happening. Don’t go update your model thinking that the qualitative thesis is on Fastly is broken, update it to reflect what the business actually is. A big question posed this week was what causes SaaS multiples to fall? Interest rate policy is the obvious one, but guidance misses are the other big thing. Investors realizing that in (2) they skewed way too “this product is so great” and missed some key pieces in (1) about how different businesses can really perform over the short and long term. I don’t know just how much this will matter in the next few years. Software markets have proven to be large enough that growth will sustain – but with the Fastly cracks showing – it is something to watch for.

Paycheck Protection Program – Change of Control Guidance

Have you raised capital since taking a PPP loan? Earlier this month the SBA released new guidance for companies that accepted funds and have since undergone a change in control. This new guidance stipulates exactly what a “change of control” is, and the impacts on PPP borrowers. I’ll continue to share updates like this evolving guidance as well as topics related to loan forgiveness as they arise. As many experienced earlier this year the program was largely a public relations disaster for the government and banks who scrambled to release clear guidelines and an application process. If you took a loan, the headaches should not have ended when the money hit your account. Continue to follow closely to ensure your not missing changes that could impact eligibility (i.e. with change of control, “economic necessity” may change) and create a situation where you can’t pursue forgiveness of the loan or worse.

Elsewhere, bulge bracket banks including Well Fargo and JP Morgan have announced the firing of hundreds of employees over fraud related to the Paycheck Protection Program (inappropriately accepting funds). Like I said, the program was and continues to be a public relations disaster.

Integrating a Freemium Product into a Traditional SaaS Business Model

This week on OpenView’s BUILD podcast we hear from Stella Garber, the Head of Marketing for Trello at Atlassian. Stella built out Trello's marketing team and strategy as their first marketing executive, and led the team through a $425M acquisition by Atlassian. OpenView’s Blake Bartlett and Stella sit down and unpack (1) the role of B2C marketing strategies in today's B2B environment, (2) how to make agile marketing decisions in a product-led world, and (3) Trello’s biggest lessons learned on freemium pricing. As always, this and all episodes from the each of the 9 BUILD seasons are streaming here.

Market Updates

Of course, I can’t go without acknowledging the big strategic M&A that took place last week! Segment was acquired by Twilio in a $3.2B all stock deal expected to close in Twilio’s fiscal Q4. Two weeks ago I wrote about hearing crickets, and I guess Twilio heard me! When the stock is overvalued, use it as currency and when the stock is undervalued buy it back. From where I sit, beyond just seeing this Twilio deal get done, I’m encouraged by the sheer number of companies who are willing to engage the capital markets (the bankers we know are busy) specifically potential strategic acquirers – there is no better time to do it. We’ve seen SaaS largely be recession proof so both strategics and their acquisition targets are performing incredibly well. From an optics standpoint, companies can engage in these dialogues with ease: “we’re performing really well, we’re well capitalized, and we’re excited about the prospects for the business standalone – but we’re always open to chat and share what we’re up to!” Never has there been a better time to attempt to catalyze preemptive offers for your business. Public markets ended the week up (SaaS -0.01%, Dow +0.07%, NASDAQ +1.08%, S&P 500 +0.19%).

Economic Data

With respect to important economic developments, the market remains focused on stimulus discussions. Jerome Powell, Fed Char, expressed concern that the recovery could stumble without additional aid, but stocks bounce up and down on “talks resuming” or “talks stalling”. On the surface, it may appear stimulus is necessary! As CNBC’s headlines this week noted, “Jobless claims jump, hitting highest level since mid-August” – only buried further in the article is the admission that “the level of continuing claims continues to fall at a brisk pace, declining by 1.165 million to just over 10 million. Continuing claims data runs a week behind the headline claims number. The economy has recaptured some 11.4 million positions, or about half those who were sidelined. The unemployment rate has come down to 7.9% but is still more than double its pre-pandemic level.” So, as Stephen Andrew’s at Webster Bank notes (attached): “All true, but the question begs: Do we need more stimulus now? After all, the economy, by most measures, is enjoying a “V” shaped recovery, from consumer spending; to housing; to manufacturing. Travel and entertainment are still lagging, as the reopening remains spotty across the country and millions of small businesses have been shuttered for good. At the same time, over 1.7 million new businesses have emerged from the rubble over the past three months.” Be aware that stimulus will remain a talking point into the election, but data tells another story.

What Else We’re Reading

How to Decide. Business applications are soaring. Make More Money, Be More Valued. Critical Accounting Policies of Public SaaS Companies. Going public becomes cool again, VC valuations rise.