SaaS IPOs are Outperforming on the Rebound

Originally published on Medium.

Practical Summary:

• Since the public equity markets bottomed out around March 23, high-growth SaaS companies that IPO’ed in 2018 or 2019 have been among the strongest performers.
• That group is now trading above where they were in February, when the broader markets peaked and started their freefall. “Work from home” stocks (like Zoom and DocuSign) and companies that make managing a business remotely (like Bill.com) are leading the pack higher.
• If you had invested equally in the IPO prices of all of the 26 SaaS IPOs from 2018 and 2019, your investment would be up 110% as of the market close on May 7, with 23 of the 26 investments in the black.
• Had you invested in all of their most recent pre-IPO rounds, your investment would now be up about 5x.

In a previous post, “How Are 2019 SaaS IPOs Holding Up in the Downturn?,” I discussed the 2019 SaaS class of IPOs and indicated that 2019 was a great year to go public as a SaaS company.

Twelve of them floated their shares for the first time last year, at a time when the sector was trading at historically high multiples. I pointed out that while these stocks had IPO’ed at an average multiple of 15x their enterprise value to trailing twelve months of revenue (“EV / LTM”), they continued to command a multiple of just over 17x in mid-April.

This is an update to that post, where I now include the 2018 IPOs as well.

Back in late March, SaaS as a class traded off with the rest of the market. Panic selling hit just about every asset class equally and indiscriminately as investors looked for liquidity. But since stocks bottomed around March 23, at a trough that was between 34% (the mega cap S&P 500) and 42% (the S&P SmallCap 600 Index, a market-weighted basket of stocks that have market caps of a total market capitalization of $600 million to $2.4 billion at the time of addition to the index) lower than the peak, the market has begun to pick and choose which categories will outperform during the downturn.

SaaS as a category has been among the leaders helping the market to retrace much of its losses.

Figure 3 shows that both the 2018 and 2019 IPO classes have outperformed the broader indices. These classes are full of high-growth software, web infrastructure, and Internet security companies that are well- positioned to benefit from the stay-at-home, remote workforce, “distance learning” economy.

Zoom, Slack, and DocuSign make working from home easier and more productive. Cloudflare, CrowdStrike, Carbon Black, and Zscaler make remote collaboration safer and more secure. Zuora, Bill.com, Dynatrace, PagerDuty, and Anaplan make it easier to manage businesses remotely. And Pluralsight is an online education company, making distance learning possible for tens of millions of displaced workers and students.

Even though governments are beginning to lift stay-at-home orders and allow businesses to start opening back up again, I think these distancing behaviors by consumers and businesses will continue voluntarily to a significant degree for a long time, and these companies seem to be well-positioned to continue to take share from incumbents.

All of these companies also have the additional benefit of having predominantly recurring and contractually committed revenue streams, which helps to buffer their financials against a downturn in consumer spending or in business confidence.

Finally, Table 1 below demonstrates how an investor would have done if they had participated in all of these companies at the most recent pre-IPO round in all of the venture-backed SaaS IPOs in 2018 and 2019. (I have excluded Ping Identity and Dynatrace from this list because they were not venture-backed deals. Ping was an LBO that spun out from Vista Equity Partners, and Dynatrace came out of Thoma Bravo.)

An investor who got into these deals would have generated a 6.5x return, excluding dilution at the IPO – about 5x after dilution. The median time between this last pre-IPO deal and the IPO was about 461 days, so a typical investment would have become liquid in just under two years.

Fourteen of these 24 companies would have been clear big winners, with net 3x returns or higher. Another eight would have been solid outcomes, 1-3x of the money you put in. The remaining two would have resulted in losses.

Of course, this analysis omits the failure rate associated with buying pre-IPO SaaS companies (i.e., not every venture bet works out), but a 5x return in two years creates a lot of alpha to work with and allows for a high swing-and-miss rate.