How Are 2019 SaaS IPOs Holding Up in the Downturn

Originally pasted on Medium.

Practical Summary

• 2019 was a banner year for high-growth SaaS companies going public, with 12 companies listing their shares, including Zoom, Slack, Datadog, and CrowdStrike.
• These companies IPO’ed at an average EV / LTM multiple of 15x, and as of April 9 … even with the recent market rout … the 2019 SaaS IPO Class is trading even higher at 18x.
• If you had been able to buy into the latest pre-IPO round of these 12 companies, you would have made a 5x return, with 11 of the 12 companies in the black.

2019 was a great year to be a high-growth SaaS company going public. Twelve of them floated their shares for the first time last year, at a time when the sector was trading at historically high multiples. For the most part, buying shares of these companies at the initial offering was a winning strategy for public market investors: a simple, equally-weighted basket of SaaS IPO from 2019 would have yielded a 41% return.

Even better, if you had somehow been able to invest in the latest pre-IPO round of these companies, you would have made a 5x return on your investment … and 11 of the 12 would have been in the black, even after this historic market rout.

If you throw out the top and bottom outliers — Zoom on the high end (they had a Jan 2017 Sequoia-led round that valued them at $1 billion) and Sprout Social on the low end (who did a 2018 round at $840 million) — this strategy still would have yielded a better than 3x return.

Now, that’s some kind of alpha!

Most high-growth SaaS businesses (public and private) are valued on a multiple of forward revenue with enterprise value over NTM (next-twelve-months) as a primary metric.

What is the right price for a high-growth public SaaS company?

Well, since Salesforce went public in 2004, there are about 75 other SaaS companies that have followed them into the public markets. Salesforce itself is worth $135 billion today, putting it at between 10 and 11 times its projected FY2020 revenues.

Historically, publicly traded SaaS companies have gotten multiples of projected annual revenue of around 8x. (Great kudos to Alex Clayton at Meritech Capital for tracking and publishing this! Alex has written insightfully about SaaS over the years and I’d highly recommend that you check his stuff out.)

Beware, however, that the 8x average masks a wide range of values. The public SaaS average multiple dropped down to 6x or lower in 2008-2009 and again during two episodic “SaaS crashes” in 2014 and 2016. The average also spent much of 2013 and most of 2018-2019 above 12x.

How Do Recent SaaS IPOs Trade?

One might expect the recent IPOs from 2019 to trade at higher multiples than the broader market, because they typically have higher growth rates — and one would be correct.

My analysis shows that the 2019 class had an EV / LTM (last twelve month) multiple of 15x at the time of their IPO. Even with the recent sell-off, those stocks are collectively above the IPO price, and now that cohort trades at almost 18x LTM revenues.

Based on reasonable revenue projections for these companies in a war-torn 2020, this equates to approximately 13x NTM revenue, significantly better than the historical average of about 8X that Alex Clayton observed.

As a group, this cohort has traded down by 16%, slightly better than the broader market. The S&P 500 traded off by 18% between February 19th and the close of the market on April 9th, and the NASDAQ Composite Index is off by 17% over a similar period.

Two of the 12 stocks have traded higher since the market peaked — Zoom Video Communications, Inc (NASDAQ: ZM) and Cloudlflare, Inc. (NYSE: NET). Zoom, of course, has benefited from a nearly 20-fold increase in usage (from 10 million users to over 200 million users) as billions of people across the world have stayed at home after lockdowns were enforced to slow the spread of the coronavirus. More recently, Google banned Zoom, so did the German government and others as well after a drumbeat of security concerns.

Cloudflare has benefited tremendously because it focuses on Internet security with an offering that includes edge computing service, a dev ops platform, a variety of security solutions, and a work-from-home capability.

Growth Matters Much

Growth is perhaps the primary determinant of the valuation of a SaaS company at maturity. The other major variables are 1) retention rate, 2) expansion ARR, and 3) CAC payback period. But if you build your own SaaS model (or just download one) and play around with the inputs, you’ll quickly see that nothing matters quite so much as a growth rate that is compounding above 50% annually.

Empirically, that’s also exactly what the market tells us about the importance of growth.

Source: Yahoo Finance; company guidance; analyst consensus estimates

As the figure above shows, some of the high-growth members of the class are trading even higher at above a 20x multiple — Zoom (54x), Datadog (28x), CrowdStrike (26x), Cloudflare (20x), Bill.com (20x) and Slack (20x). These companies all posted YoY revenue growth rates in the most recent quarter of between 50 and 100%, and all seem to be positioned to manage through the current recession.

What Did It Take to Go Public in 2019?

I thought it would be interesting to see how these companies benchmarked across milestones like revenue, growth, and profitability. The mean and median trailing twelve month revenues were both $275 million, with Sprout Social the outlier at just $96 million. That was also the stock with the weakest post-IPO performance.

All of the companies were growing at 20% or better in the prior 12 months, and the higher the growth, the better the offering. The mean and median growth rates were both 45-50%, so to get public last year you had to have line of sight to $200 million in top-line, with >20% ARR growth and real scale.

The good news was that profitability was not critical. None of the class made money (i.e., a positive net income) in the preceding 12 months before the IPO. Zoom, Ping Identity, and Medallia ran about breakeven, but the others did not. In the fiscal year before their IPO, CrowdStrike and Cloudflare had losses of over 50% of revenues. PagerDuty lost about 30% of revenues. Slack, Fastly, Sprout, and Dynatrace ran negative profit margins of over 20%. Bill.com lost over $7 million on revenues of $108 million, and DataDog ran a slight loss after making money the year before.

It remains to be seen in 2020 whether a successful IPO will require not only growth but a path to profitability. Certainly, after the implosion of WeWork in September, public markets began seeing a separation between recent IPOs that were profitable (e.g., Zoom, Spotify, and Sonos all rallied into the market peak in Q1) and those that were not (Uber, Lyft, Zscalar, Elastic, Pluralsight, Pinterest, SmileDirectClub, Peloton, etc. traded off in Q3 / Q4 last year).

I suspect in the SaaS category, once the window opens again profitability will be a “nice to have,” but growth and customer retention will once again be much more important to investors.