Programming note: Happy Thanksgiving! This week’s roundup is brought to you by one very tired new puppy owner, so no roundup next week so I can recharge over the Thanksgiving holiday. It will return the following week (12/4) through 12/18 to close out this year.
Price is what you pay, value is what you get – Warren Buffet
While Snowflake’s IPO day close price (at more than 100% over the offering price, which was already 40% over the Company’s initial price range) and current stock price are both high on a multiples basis “a stock is worth exactly what someone is willing to pay for it.” And anyway, “the present value of future cash flows, not misleading multiples, are the source of value.” In the case of Snowflake, to get a piece of the value that is Snowflake’s future cash flows folks were and are willing to pay high prices. So then magnitude of the future cash flows to come – according to the investors making that trade – is worth it. These quotes sum up what is both special about SaaS and also rationalizes inflated revenue multiples for high growth companies. And they also raise two interesting topics to unpack today: (1) liquidity is the only reality and (2) finding hidden value in the landscape of public SaaS companies.
On (1), the first quote above from Snowflake’s CEO addresses what I started to write about last week: the future cash flows of a company may be very obviously worth $1, but if Mr. Market wants to offer a price of $3 for them, that’s the price (not quite value, though). “Liquidity is the only reality. Supply & Demand & the value that we ascribe to things is a psychological construct not a ‘fundamental’ one...‘Fundamentals’ only matter to the extent that they create demand & drive ‘liquidity.” If no one wants to own it, the stock will be worth less (and vice versa). Price and value aren’t synonymous.
So taking this new reality of liquidity, let’s explore (2). As I’ve noted before I’m convinced that value investing in software today means finding great public SaaS companies trading at obvious discounts (on a multiples basis) to their peers (those with similar organic growth and rule of 40 profiles) for no obvious reason other than lack of Snowflake-like “liquidity”. Look at companies like Dynatrace, Tenable, PagerDuty, and (maybe) even SurveyMonkey for instance. And let’s take PagerDuty as a representative of the set. If purchased today, and if PD grows at a 20% CAGR for 5 years (assuming no multiple compression / expansion), the stock could return >17% IRR by 2025. If in just the next year PD sees multiple expansion to peers, the stock could return as much as 30% IRR or more. And even with multiple compression back to the historical mean by 2025 it could even still yield a 4-7% IRR (won’t lose investor money).
“Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous…growth only adds value when the company earns a return on its investment that is above its cost of capital…The higher the return, the more sensitive the business is to growth.” The market seems to be forgetting companies that aren’t growing 40%+ per year are still growth assets and that sub-40% growers all have effectively the same cost of capital as their high-growth peers. It can’t be validly argued that value isn’t being created, they’re just not shiny objects.
Now sure, these ugly ducks won’t deliver 100%+ returns like some names. And yes TAM, competitive threats, confidence in management’s ability to execute and other qualitative factors are very real and very valid risks preventing liquidity to date – I’m not ignoring that. But in many cases, like that of PagerDuty, I feel great about a company achieving a 20% CAGR and can’t get past the (1) upside in either multiple expansion or M&A and (2) loss aversion / protection in a multiple compression scenario or again, driven by an M&A event. I feel better about this than I do that Snowflake will keep meeting investors loftier and loftier expectations or won’t suffer a Workday-like outcome. Valuations of ugly duck companies are much more so connected to the fundamentals and risks of the businesses, and while fundamentals only matter to the extent the create demand, they do still hint at value.
Once again: Snowflake investment results buy yachts, but a robust investment decision making framework can be used over a lifetime. Many in the market are chasing yield in fully-valued companies and missing that beyond hot SaaS names there is real value being created despite lack of current liquidity (price giving).
I personally own PagerDuty stock,
This should NOT be considered investment advice. Do your own research.
The Product-Led Organization
To kick of Season 10 of OpenView’s BUILD podcast, OpenView partner Blake Bartlett sat down with Todd Olson, CEO and Co-Founder of Pendo, the leading software platform for product teams. Todd recently wrote a book called, “The Product-Led Organization,” and in this episode he joins Blake to unpack just a few of its key themes including: (1) how org design is different in a product-led business, (2) How automating things in your org can unleash creativity for your team, and (3) what to think about as you pivot towards becoming a product-led organization. The podcast is available to listen here!
Market & Economic Data
The public market indices we track (save for the SaaS index) trended down after a strong early November: SaaS +5.66%, Dow -0.73%, NASDAQ -0.26%, S&P 500 -0.26%. Most of the wobbles came on concerns about the lack of fiscal relief. SaaS again appears to move inversely to the rest of the market… SaaS tourists in a flight to safety?
On the economic side (which as always is related to the markets), US treasury yields (which can be a signal about equity bullishness; higher yields is better for equities) fell (bearish) after jobless claims data and worries of lack of stimulus (sound familiar?).
What We’re Reading
Raising Your Next Funding Round - Here’s What to Know. A Few Things We Learned in 2020 Q3. Hayden Capital Q3 Investor Letter (which also covers real options, per the roundup post several weeks ago). Measuring the Moat (and M(oat)&A).