Our PVC SaaS Index™companies trade at 11x EV / LTM revenues, well within the historical range of 7-12x where SaaS has traded for most of the past 10 years.
The median SaaS multiple has compressed by nearly 40% from where it peaked in late 2021, at 18x.
The highest growth, smallest cap, and least profitable companies have been hit the hardest. SaaS IPOs that happened in 2016 or later have seen multiples drop by over 50%.
Public markets frequently go through “corrections” of 10% or more. For the broad US index, 10-20% corrections have happened 29 times (about once every 2.5 years since 1946).
The NASDAQ Composite has “corrected” five times since 2010. Historically, the private markets have re-priced only slightly, and with a 3-6 month delay. We think this time is probably a little different, with a more significant (but ultimately healthy) valuation reset in private markets.
This post is an update in a quarterly series of posts that tracks the PVC SaaS Index™, a basket of publicly traded US-listed SaaS companies.
Software as a Service(“SaaS”) has been around longer than the cool new “cloud.” It shares some aspects of cloud computing, but its focus tends to be clearer: SaaS is simply the delivery of software applications over the Internet from a server hosted by the SaaS provider somewhere far away.
The first big SaaS IPO was Salesforce (NASDAQ: CRM) in 2004, and now we have over 120 pure-play SaaS/cloud companies in our proprietary PVC SaaS Index™. These companies…
trade on the NASDAQ or the NYSE
derive the large majority of recognized revenues from long-term contractual commitments (12 months or greater) and recognize those revenues periodically over the life of these contracts.
2022 Valuation Update
The chart below shows the historical EV / LTM (“enterprise value” to “last twelve months” of revenue) going back to 2017.
While broader cap-weighted large cap equity indexes in the US are down between 8% (in the case of the S&P 500) and 15% from their 52-week highs, “growth stocks” have been hit harder than “value stocks.” For instance, while the Russell 2000 Index of mid-cap companies is down 15% from its 52-week high and the iShares Russell 2000 Growth ETF (NYSE: IWO) is down 22%, the iShares Russell 2000 Value ETF (NYSE: IWN) is down 9%.
As you’d expect of an index full of growth stocks, the PVC SaaS Index reflects the mid-cap growth experience.
The 76 SaaS companies in our index that IPO’ed in 2016 or later had an absolutely lights-out year as far as fundamental performance, registering a blistering +41% YoY revenue growth rate from CY2020 to CY2021. There has been an entire subsector of the public stock market that has registered this kind of top-line growth, in the long history of the stock market. But despite generating revenue growth, the median stock in our index has dropped by 54% from its 52-week high. Three quarters of the stocks are down by over 40%. A handful (12 of the 76) are down by 70% or more.
Among smaller tech stocks, the highest growth names are getting punished the most over the past few months. Figure 2 shows the members of our PVC SaaS Index, grouped into two buckets:
“Highest growth” companies with 50%+ revenue growth over the past year, which have continued to guide to 30% growth rates in ARR or higher for the full year 2022
“Other SaaS companies,” which is everyone else
The highest growth group is now trading at about 25x sales, down sharply from about 50x in the fall of 2021, a decline of about 50%. The rest of the recent IPO PVC SaaS Index is down about a third over the same period.
How Did We Get Here?
To put in context where we are, SaaS companies are now trading at 2018-type levels. Some adjustment from the levels we saw in late 2020 and 2021 was inevitable – and healthy – because asset prices have been distorted by two government actions:
The “fiscal” stimulus, quantified by a federal deficit that came in at 12.5% of GDP in 2020, the largest since WW2
The “monetary” stimulus, characterized by the Fed buying financial securities (Treasury bonds, then mortgage-backed securities), which has now increased traditional measures of the “money supply” by approximately 26% since February 2020 (that’s the largest annual increase since 1943).
Over the past two years, I’ve lost count of how many times I’ve heard the words “unprecedented times” inappropriately applied to the pandemic. In fact, we’ve had many pandemics in the US before – most recently, 1969, 1958, 1918, but also repeated outbreaks of smallpox (which wasn’t wiped out in the US until 1972, thanks to a large vaccination initiative), yellow fever, and cholera.
But what is truly unprecedented is the government response, with the Federal Reserve going on a bond-buying spree and expanding the money supply by 26% in just 24 months.
As the economy went into a recession in March 2020, the Federal Reserve started buying securities in order to stabilize the financial markets, which had gone into a freefall that endangered the balance sheets and reserves of lending institutions. When the Fed purchases securities from nonbanks, which is its normal practice, it gives the seller a check or payment, credited to the seller’s bank deposit account. This increases the money supply, which is basically the currency and coins held by the non-bank public, plus checkable deposits/ travelers’ checks (that is called the “M1”), plus savings deposits and money market accounts (in total, that’s the “M2,” the Fed’s broadest measure of money).
The Fed did the same thing (only to a lesser extent) for the first time ever in 2008. During that financial crisis, the Fed began what it called its “Quantitative Easing” program and expanded its balance sheet. But at the same time, commercial banks were busy shrinking their loan books and writing off losses from mortgage debt and securities. The Fed was really only offsetting the contraction of commercial bank balance sheets. From 2010 to about 2019, the M2 money supply averaged only 5.8% a year.
While money on the Fed’s books grew rapidly, money in the hands of the public grew slowly. Spending and inflation were restrained and the postcrisis recovery was anemic with inflation persistently below the Fed’s target.
This rapid increase in the money supply is driving the US inflation rate to a high not seen since 1982, and Fed Chairman Jerome Powell has signaled the end of this 22-month cycle of quantitative easing (“QE4”), along with between 5 and 7 interest rate hikes in 2022. As interest rates go up, asset prices must come down.
High-growth public stocks are getting hit especially hard.
In theory, the equity prices of these companies are the sum of all of the free cashflows from that company (profits, dividends, and proceeds from stock buybacks), discounted by some discount rate that investors will apply to those cashflows. That discount rate is some risk-free rate plus a risk premium that reflects the risk of that asset. As the risk-free rate jumps up, the value of those distant and prospective free cashflows of growth companies will fall.
Over the past decade, the NASDAQ Composite Index has experienced five corrections, which I have defined as a 10% or greater drop from its prior intraday high. Figure 5 shows round sizes for Series A companies; these round sizes dipped only very slightly (if at all) during the corrections but generally continued climbing. On a quarterly basis, the correlation between the NASDAQ closing value and the median series A round size is 0.93.
Figure 6 shows round sizes for Series D or later companies. It shows clearly that round sizes dipped during these corrections. On a quarterly basis, the correlation between Series D+ round sizes and the NASDAQ closing value is 0.92.
After nearly two years of a government-fueled expansion, public markets have adjusted quickly and tech multiples for SaaS have corrected back to 2018-2019 multiples. The companies are generally performing extremely well, so we see this adjustment as an inevitable and indeed healthy correction in valuations, as the Fed has signaled the start of a normalization process.
We don’t think that this is 2008 (or 2001) by any stretch because the underlying growth rates and profitability of today’s tech companies are much stronger than they were back then. Also, the economy today is growing, not in a recession.
Historically, private markets take 3-6 months to adjust to the new valuations. Contracted multiples mean fewer and smaller IPOs, and startups hoping to go public this year may have to wait for a while. Some that don’t need to raise will simply wait until they grow their revenue to achieve desired valuations and exits. Acquirers benchmark their purchases to the public markets, and with comparable prices down by 30-50%, that’s going to be felt by the private markets, most significantly at the later private equity stages.
But for any investor with a longer-term horizon, this is a better time to buy growth assets than at any time in the prior 18 months.
Aman was the COO of 500 Startups, has been the CFO of Sonos, and led finance at PayPal. Before that, Aman worked at Lehman Brothers and McKinsey, majored in economics at Stanford, and earned a law degree from Harvard, so he is particularly good at dollar signs and clauses and commas.
Aman has more than 15 years of financial and operational experience from both private and public technology companies. He has been a member of the management teams at some of the most successful companies in the world, including PayPal, eBay, and Sonos.
Prior to PVC, Aman was the COOof 500 Startups, which during his tenure was the world’s most active VC firm, measured by the number of investments made. Aman managed 500’s global fundraising team, the seed accelerator team, and the Series A growth programs. He also managed the Investment Committee for the firm’s global funds ($500MAUM).
Aman led the strategy teams at both PayPal and eBay Marketplaces and served as the divisional CFO of eBay’s North American Marketplace business, which generated over $2B in revenues and nearly $1B in operating profit.
As CFO, Aman has guided his companies to over $1B in debt and equity financings from family offices, HNWIs, VC/PE funds, banks, and public markets.
CFA since 2000
Financial Analyst at Lehman Brothers, Associate at McKinsey
Taught Economics at Harvard University
JD, Harvard Law School
BA, Economics and Public Policy, Stanford University
PayPal Mafia: wrote the first draft of PayPal's S-1 in the winter of 2000.
CFO at two different unicorns: Sonos, Inc. (NASDAQ: SONO) and CAN Capital