PVC SaaS Index™ Q3/24 Update: SaaS Multiples Stabilized This Summer

A Practical Summary:

• The PVC SaaS Index™ dipped to 6.0X EV / LTM revenue, below both the 5- and 10-year averages of 8-9X.
• Lower multiples reflect slowing growth for public SaaS companies, mirroring the same in private SaaS companies.
• Expect the Fed Funds rate to lower over the next 6 months, but as of Q3, the slower growth rate has now been priced into SaaS stocks.

Every quarter, we update our PVC SaaS Index™, a basket of publicly traded US-listed SaaS companies. This index provides a useful benchmark for how private companies should be valued when they find exits.

Software as a Service (“SaaS”) has been around longer than the cool new cloud. While the SaaS category shares some aspects of cloud computing, its focus tends to be clearer: SaaS is 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. Almost 20 years later, we now have more than 100 pure-play SaaS/cloud companies in our proprietary PVC SaaS Index™. These companies all trade on the NASDAQ or the NYSE. They derive most of their recognized revenues from long-term contractual commitments (12 months or greater) and recognize those revenues periodically over the life of those contracts.

For this update, we have removed several SaaS companies that recently went below $1B market cap, essentially becoming broken IPOs or “zombies” in the public markets, with low liquidity, high volatility, and uncertain public company prospects: Agora, Bandwidth, CS Disco, Olo, Expensify, and Presto Automation. This report summarizes data across 99 SaaS companies publicly traded in the US.

The historical EV / TTM (“enterprise value” to “trailing twelve months” of revenue) going back to 2014 is shown below.

The 6.0X valuation multiple in Q3/24 is exactly the same as the median SaaS multiple in late 2016. The top quartile of SaaS companies (those with multiples higher than 75% of the group) is now at about 10X, higher than it was back then, when the elite group was around 9X. Multiples of that top tier have fallen by about 65% from their peak, set during the period from Q4/20 to Q2/21.

Growth Slowed in Q2

The period between Q3/20 and Q1/22 can be described as the “Everything, Everywhere – All At Once Bubble.” All prior bubbles in market economies have typically been localized by geography and time (e.g., the United Provinces in 1636-1637, Tokyo in 1985-1989) or to a specific asset (e.g., the South Sea Company in 1720, tulips in Europe in 1637). However, the 2020-2021 bubble is best described as a global phenomenon where almost every financial asset that you can imagine suddenly became precious.

The 2020-2021 bubble was fueled by the combination of 1) easy money and a “zero interest rate policy” (ZIRP) from the major central banks of the United States, Europe, China, the United Kingdom, Canada, and Japan; and 2) fiscal stimulus from national governments, with most of the spending coming from the United States, the United Kingdom, and Canada, then China, France, Germany, and Japan, followed by Australia and New Zealand.

SaaS tech stocks rode that wave, and during the peak of the recent “Everything, Everywhere – All At Once Bubble” fully half the companies in our index were trading at a multiple of 18X or higher. Now, virtually no one is being valued at that level – only Palantir, CrowdStrike, WiseTech, and Fair Isaac are left with those heady multiples. In Q4/20, about 60% of the index components were at 10X or higher, but now only about a quarter are in that club. That tells us that premium SaaS businesses trade at premium multiples, but these cases are shrinking.

SaaS businesses grew in 2024, but at a much slower rate than during the pandemic hypergrowth years. At the same time, churn rates were at an all-time high, reflecting a period of “normalization” post-pandemic due to rising interest rates and enterprises cutting down on their software expenditures.

Uncertainty seems to have picked up – the 10-year bond yield has fallen since the spring, dipping to <4% for the first time since February. However, this decline doesn’t seem to have helped valuations. Back in February, the median SaaS multiple was around 7X; today, it is around 6X. While SaaS multiples and Treasury rates have a long-established inverse correlation, rates are but one factor to consider.

To paraphrase the late great Benjamin Graham, the market in the short run is a voting machine that requires only cash – it does not seek proof of citizenship, intelligence, or emotional stability. But in the long run, the market is a weighing machine that assesses fundamentals and growth. Right now, the markets are weighing the prospects of slowing growth.

In August 2024, the economies of the United States and of Western Europe seemed to slow, contributing to a downturn in sentiment that produced the first NASDAQ correction around August 5 (a 10% drop from peak to trough) in 3 years.

After a very weak employment report in July, where job growth sharply declined and unemployment rose to 4.3% (the highest since October 2021), a few companies posted weak earnings. Wayfair CEO Niraj Shah compared the drop in spend on home goods to the 2008 Great Financial Crisis: “Customers remain cautious in their spending on the home and our credit card data suggests that the category was down by nearly 25% from the peak we saw in the Q4/21. This mirrors the magnitude of the peak to trough correction the home furnishing space experienced during the great financial crisis.”

In the software category, Confluent said this of Q2: “After the stabilization in Q1 and a healthy start in Q2, we saw increased short-term cloud cost controls and focus on driving efficiencies in this customer cohort in the month of June.” More broadly, so far in the SaaS category, 9 of the 16 companies that reported Q2 and guided for Q3 have guided below consensus, a startlingly high proportion that brings to mind what we saw back in Q2/20, when the world was ending, not a growing healthy economy.

Perhaps this is happening now because, based on calculations from the San Francisco Federal Reserve Bank, American households fully spent their build-up pandemic-era “excess savings,” which had given consumers a buffer and some resources to maintain the strong levels of spending that buoyed the economy in 2022 and 2023, to the surprise of many economists.

Excess savings were built up over a period of 18 months, from the onset of the recession in March 2020 until August 2021. The rapid accumulation was largely due to pandemic-related financial support to US households and a steep decline in consumer spending as a result of health-related social distancing and business closures. The level of “excess savings” – the accumulated difference between actual personal savings and the trend implied by data for the 48 months leading up to the first month of the 2020 recession – peaked in August 2021 and has been dropping ever since.

As the economy slows, the US Federal Reserve has started to signal that it will cut rates in September, joining the Bank of Canada (which has already implemented 2 rates cuts on June and July 24) and the European Central Bank (which cut rates on June 6), as well as the Bank of England (which made a single rate cut on August 1).

The Fed has been waiting for inflation to subside and get closer to its target rate of 2%, and it finally appears that the balance of risks for rising unemployment exceed the risks of continued inflation.

Conclusion

Between Q3/20 and Q4/21, the revenue multiples of SaaS companies rocketed to all-time highs, fueled by pandemic-era fiscal and monetary stimulus primarily from the US, ECB, China, Canada, the UK, and Japan, peaking around 18-19X in late 2021. By mid-2022, multiples had dropped to 6-8X EV / TTM revenues. As of Q2/24, they continue to trade at the low end of this range. These multiples are below the 5- and 10-year averages for SaaS multiples, which are around 8-9X.

The Q2 earnings season is now behind us, and a review of the earnings reports of the 99 companies in our PVC SaaS Index suggests that a significant slowdown in revenue growth for these companies is underway. Throughout 2021 and well into 2022, SaaS companies were growing revenues at >30%, but over the past 3 quarters, the median growth rate in our index has been a more modest +16% YoY.

An extraordinarily high percentage of SaaS companies have also guided Q3 revenue to below consensus, resulting in a decline in stock prices in the PVC SaaS Index this quarter.

That slowdown may be in part due to a macro slowdown in the US, as well as in major markets for SaaS companies. Germany, Japan, and the UK all experienced mild recessions in 2023, and Canada narrowly avoided one.

Expect large enterprises to bifurcate their budgets, increasing spend on projects that will drive their AI agenda while scaling back on the rest of their IT spend, such as workflow improvements, cybersecurity, payments, and cloud integrations.