Public Investors Getting SaaSy with Valuations – A Spanking May be in Order

Any tech investor can all riff through stratospheric SaaS valuation multipes like playing the air-guitar, and we often get asked by SaaS company CEO’s and investors the very reasonable question, “What Revenue multiple applies to the valuation of my company?”Public markets are usually a good place to look for guidance, as there are dozens of public SaaS companies trading.  They all publish their numbers and there are also many research reports to reference.   A quick look at the public markets reveals SaaS companies being valued with large variance, with LTM revenue multiples from under 2.0x to over 30.0x!  Lots of smart transactions, lots of companies, lots of financial data and lots being spent on research – sounds like fertile ground to gain some real insight into valuation!Or maybe not.The wide range of public valuation begs the question – what are the key driving metrics?  As the saying goes, “Success has many fathers”, and common sense tells a business analyst to look at a number of metrics such as TAM, growth rates, retention rates, customer acquisition costs and life, profitability and many more.  Thoughtful followers of the SaaS industry like David Skok and Phillipe Botteri have published very reasonable multivariate calculators to help guide valuations.   We note that their calculators look reasonable to us, and happen to mirror ones that have functioned well in other subscription businesses, like Cable TV, for many years.So, one would expect to be able to fine-tune these multivariate approaches against the reams of public data – but this is not so.  We performed statistical analysis across a wide range of variables and stumbled on a surprising result.  Performing a regression analysis of 2-year growth rates and their impact on valuation of 30 public SaaS companies indicated an R2 (Coefficient of Determination) of 0.65.  For those of you who don’t remember freshman Stats – this means that nearly 70% of the valuation of public SaaS companies is explained by one variable – growth.  As my Stats professor used to say – never mind the R2, just look at the graph – it’s practically a straight line.2 yr cagrThis means that from the public perspective, forget Skokand & Botteri, this is a land grab and growth is all that matters.  Never mind if you are getting your growth by selling dimes for a nickel, if you have prices that will face serious pressure as the market matures, or that your churn may surge when new competition arrives.  (Remember, a benefit of SaaS is lower switching costs for customers.)  Public investors seem ready to ignore these details. Just grow baby, grow.Is the public right?  As usual, they are until they’re not.  So if you are a short-term trader or living for a near term IPO, then the answer to “what Revenue multiple applies to the valuation of my company?” is a SaaS quip “what’s your growth rate?”If you are investing for retirement or planning for the long term – we need to have a serious conversation.

Posted on December 10, 2013 in Insights, Technology Industry