PVC SaaS Index™ | Valuation Update Q2 2020

Originally published on Medium.

Practical Summary:

• Practical Venture Capital has developed a new proprietary index of publicly traded SaaS companies — the PVC SaaS Index™ — that tracks 101 US-listed companies with software-as-a-service (“SaaS”) business models.
• These companies have generally traded at 5-8x enterprise value / trailing revenues (“EV / LTM”) since 2013, with a brief period below (the “SaaS Crash of 2016”) and a recent run above.
• The median EV / LTM multiple in this index dipped to 7.3x as the market teetered in March, but it closed an all-time of almost 11x at the end of Q2.
• Recent SaaS IPOS that went public in 2017 or later are now trading at a median EV / LTM multiple of 18x.

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.

Since the first big SaaS IPO from Salesforce (NASDAQ: CRM) in 2004, I’ve counted about 80 pure-play SaaS/cloud companies that have hit the public markets, and more and more go out each year. I have used them to create the proprietary PVC SaaS Index™, a composite of all of these companies that:

1. Trade on either the NASDAQ or the NYSE; and
2. Derive a significant majority of recognized revenues from long-term contractual commitments (12 months or greater) and recognize those revenues periodically over the life of these contracts.

How Do You Value a SaaS company?

Before we present the index’s multiple, let’s talk about how to value a SaaS company. Most high-growth SaaS businesses (both public and private) trade based on their Enterprise Value over Revenue multiple.

A company’s “Enterprise Value” (“EV”) is best thought of as the total value assigned by investors to a company’s ongoing operations. It is properly defined by adding the total of the market capitalization of a company’s equity securities plus the value of its debt, then subtracting the cash or cash equivalents on hand.

I like to look at the EV to the last twelve months of revenue (“LTM”) as a way to compare valuations. While the ideal measure in theory would be to compare EV to the projected next twelve months of revenue (“NTM”), the reality is that projections for fast-growing SaaS companies are usually volatile and hard to come by. EV / LTM offers a better comparative basis across companies because it eliminates the bias and uncertainty that comes with predicting the future.

PVC SaaS Index™

The figure below shows the historical EV / LTM going back to 2015. Since early 2015, the median EV / LTM for this group has generally been between 5x and 8x.

At the end of Q2, the median value in the index popped to over 10x for the first time, while the “mean average” leaped to over 15x, also an all-time high.

If we look more carefully at just those SaaS companies that went public in 2017 or later, these 34 companies are now trading at over 18x.

This smaller basket is comprised of younger, smaller cap companies (the average enterprise value of these companies is just $12 billion, versus about $50 billion for the entire SaaS index) that are growing quickly. Figure 2 shows how this group has traded and how quickly it recovered after the Q1 decline.

The single best predictor of a SaaS company’s multiple is its expected growth rate.

Growth Matters Much

The single best predictor of a SaaS company’s multiple is its expected growth rate. Investors are, after all, forward-looking creatures: they pay now for (discounted) cash flows later. The figure below maps out the 33 recent SaaS IPOs, with projected revenue growth in 2020 versus the prior year on the x-axis and the EV / 2021 revenue multiple on the y-axis.

All 10 of the companies with projected revenue growth rates of 35% or better are trading at 12x or higher … with one exception: Dropbox.

All 7 of the companies with projected growth of 10% or less are at 8x or lower.

On average, the SaaS category is projecting to grow revenues this year at about 30% YoY and sports a forward multiple of about 12x (i.e., today’s enterprise value over 2021 revenues).

Investors are paying higher multiples today for SaaS companies than at any other time in public SaaS trading history.

Conclusion

The past 15 years have seen some great public SaaS companies and generally very good returns for investors.

As of the end of Q2, the index hit an all-time high of 18x EV / LTM for recent SaaS IPOs. On average, investors are paying higher multiples today for SaaS companies than at any other time in public SaaS trading history.