This morning’s $250 million round for food-delivery startup DoorDash is a good reminder that the market remains enthralled with tech companies, both private and public.
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It’s not hard to see continued investor enthusiasm in tech companies of all sizes. Venture activity keeps setting new records, late-stage private companies have infinite access to capital, IPOs are finally back to form, and the public markets are frothy and warm, provided that your company is not focused on social media.
Perhaps most notably, investment into modern software is rising again, Crunchbase News recently reported. Present-day software shops, which mostly sell their wares on a subscription basis (known as software-as-a-service, or “SaaS”), have seen some large recent public debuts, including Dropbox’s own. The Dropbox IPO was well-received by the market, quickly pushing the San Francisco unicorn to a higher public valuation than the one it last commanded while private.
Behind SaaS’s resurgence in the private markets, I suspect, are good metrics from public SaaS companies. Today, we’ll unpack that to better understand the current state of SaaS, especially from a valuation perspective.
As we often do we’re leaning today on the data compiled by the Bessemer Cloud Index, which tracks a number of public companies that work in the cloud space. Think Twilio and Box and Tableau and Shopify. SaaS shops.
Today we’re bringing the Index back up as one of its listed metrics has reached a nice, round number. And we humans love those.
Per the dataset, public cloud companies (SaaS unicorns, often) are trading for a 10x trailing enterprise value-revenue multiple. In English, that means that the average company on the Index is worth 10.0 times its 2018 revenue.1That figure falls to 8.2 times when present-day enterprise values are compared to 2019 revenue.
These are rich multiples that the market has been building for some time, as we’ve seen. But the 10x multiple seems pretty ecstatic given the following companion metrics from the company set in question:
- 72 percent mean gross margin (could be higher);
- 22 percent 2018 to 2019 revenue growth (could be higher);
- 11 percent anticipated free cash flow in 2019 (could be higher).
Therefore, the firms that are now averaging a 10x current-year revenue multiple aren’t growing too quickly and aren’t too profitable. Indeed, if we take the Rule of 40 (more on similar metrics here in theory, and here in practice) to mean growth rate added to free cash flow, the average company on the list fails in 2018 and 2019.
If we use a stricter profit metric for the Rule of 40 test, the average company on the list is even further from whole while sporting that same 10x multiple.
Our multiple becomes a bit more conservative if we turn to median numbers, but only some. On a median basis, the middle Cloud Index company has 2018 revenue-enterprise value multiple of 8.6. That’s still quite high, historically. Also growth and free cash flow metrics are roughly flat on a median basis, compared to the mean figures.
So this is where we are in middle-ish 2018: fat multiples for SaaS companies that are only so attractive, on a mean and median basis. How long this stands up depends on the public markets, which, as we noted at the start, are pretty hype today.
Top Image Credit: Li-Anne Dias
Enterprise value and market cap are within a few percentage points of each other on the Index, so we can comfortably use enterprise value in this case as a stand-in for our normal valuation metrics.↩