PVC SaaS Index? | Q2 2024

June 21, 2024

Practical Summary:

• The Q2/24 PVC SaaS Index? (98 companies) trades at 6.3x EV / LTM revenue
• The current multiple is well below 5-year average of 11x, and the 10-year average of 9x
• Q1 earnings were very weak for mid-cap SaaS companies, though they were good for “hyperscalers” (esp Azure)
• The median revenue growth rate for SaaS companies was +18% YoY in Q1/24, down from >30% in 2020-22
• Over half of SaaS companies guided Q2 revenue below consensus — the worst performance since Q2/20 (COVID)
• It appeared that there is a bifurcation of enterprise tech budgets - more for AI, less for the rest

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 that’s hosted by the SaaS provider somewhere far away.

The first big SaaS IPO was?Salesforce?(NASDAQ: CRM) in 2004, and now we have 98 pure-play American SaaS/cloud companies in our proprietary PVC SaaS Index?, which includes:

1. Are now trading on either the NASDAQ or the NYSE: and
2. Derive the large majority of recognized revenues from long-term contractual commitments (12 months or greater), and which recognize those revenues periodically over the life of these contracts.

In this index, we have removed several SaaS companies that have gone below $500M 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.

That leaves us with 98 publicly traded SaaS companies in the US.

The chart below shows the historical EV / TTM (“Enterprise Value” to “Trailing Twelve Months” of revenue) going back to 2015.

Chart 1: Historical SaaS Valuations

Source: CapitalIQ; PVC analysis

The multiple of 6.3x in Q2 2024 is exactly the same as the median SaaS multiple in late 2016.? The top quartile of SaaS companies (those whose multiples are higher than 75% of the group) are now at about 10x, higher than they were back then, when the elite group was around 9x. The multiples of that top tier has fallen by about 65% from its peak, set during the period from Q4 2020 to Q2 2021.

A Look Back at Q1 Earnings

Q1 earnings season for cloud businesses is now behind us, with most reporting earnings between April 24th and June 10th.? I have reviewed the results for over 60 of the stocks in our index, which represents a majority of the SaaS companies in our index.

Mid-large cap SaaS results: Rough Seas in Q1

For mid-cap SaaS companies, the Q1 results were very weak. We saw misses versus guidance that were nearly as bad as the pandemic quarter of Q2 2020, when the world was ending and zombies were at our doorstep.

Perhaps some of this is the result of a broader macro slowdown in the world’s major economies. In the US, real GDP growth in Q1 2024 printed at just 1.3 percent annualized growth from the prior quarter; in 2023, the US economy was humming along at just over 3 percent growth. (Several other major markets also entered into recessions recently, notably Germany, the UK and Japan in 2023, and possibly Canada in early 2024).?

This is also likely as a result of enterprises carefully managing their budgets and focusing on tech / IT spend that will further their AI roadmap, but pulling back on everything else (more mundane things like workflow improvements, accounting and legal operations, payments, and even cybersecurity).? As CFOs have started to rethink their budgets, the pullback in software spending that doesn’t directly drive the AI roadmap has clearly affected the growth rates of our SaaS companies, whose median yoy revenue growth has dipped into the high-teens, down from >30% over the past three years.?

When public companies report earnings, analysts typically look at a few things that will affect the trading price of the stock. These include:

• Revenue growth, and forward guidance;
• Free cashflow generation;
• Profitability, both for the business overall and on a single sale (as measured by things like gross margin and cost of acquiring a customer (“CAC”); and
• Net Revenue Retention, which calculated by taking the annual recurring revenue of a cohort of customers from 1 year ago, and comparing it to the current annual recurring revenue of that same cohort of customers.

Probably the most important of these is the company’s historical revenue growth, followed closely by the prospective growth of the business as determined by the company’s revenue guidance. Chart 2 shows how much revenue growth has decelerated in the past five quarters.

Chart 2: Median Growth Rate YoY in the PVC SaaS Index

When you hear the word “guidance,” this term refers to the outlook for its business that a company provides, typically one quarter ahead. When a company provides guidance that is greater than consensus estimates of the equity analysts who cover the stock, it’s always a good sign because it suggests improving business momentum, and a level of confidence that the business will perform better than previously expected.

Guiding above consensus is what’s known as a “raise.” When you hear the term “beat and raise” the beat refers to beating current quarter’s expectations (what we discussed in the previous section), and the raise is raising guidance for future quarters.

On the other hand, when a company guides below consensus, it suggests a weakening in the business versus what was previously disclosed.?

Chart 3 below tracks the percentage of cloud companies that delivered below consensus revenue guidance, which in Q2 hit a multi-quarter high.

Chart 3: Earnings Look Back

Source: CapitalIQ; PVC analysis?

Hyperscalars: Benefiting from AI?

For the hyperscalars, such as Amazon / AWS, Microsoft / Azure, and Google Cloud the band played on. The charts below show that during the easy money “Everything, Everywhere, All At Once” bubble in late 2020 and 2021, these companies experienced a significant revenue pull-forward as enterprises spent big on digitizing their work processes and on pushing software into the cloud.

As of Q1 2024, Azure appears to be slightly above their prior trend line now growing above 30% annually and taking market share (their growth rate is and fully 10 points ahead of the market) with a run rate approaching that of AWS.

Chart 4: Microsoft Azure Revenue Growth, by quarter

Source: Statista; PVC analysis

AWS had decelerated into the high teens, but that’s still an impressive feat on a revenue run rate of over $100B a year. AWS appears to be just slightly below their trend line prior to the pandemic, despite a Q1 acceleration.

Chart 5: Microsoft Azure revenue, by quarter

Source: Statista; PVC analysis

Chart 6: Change in Amazon Web Services revenue, by quarter

Source: Statista; PVC analysis

(I have omitted Google Cloud Platform data, because Google doesn’t disclose this segment cleanly; they includes GSuite revenues in their segment reporting).

These three cloud Goliaths combined accounted for about 70 percent of the $75 billion global cloud infrastructure services market during the quarter.

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Conclusion

Between Q3 2020 and Q4 2021, the revenue multiples of SaaS companies rocketed to all-time highs, fueled by pandemic-era fiscal and monetary stimulus primarily from the US and the ECB, peaking around 18-19x in late 2021. By mid-2022, multiples had dropped to 6-8x EV / TTM revenues, and as of Q2 2024 continue to trade at the low and of this range. These multiples are below the 5-and-10-year averages for SaaS multiples, which are around 8-9x.

Q1 earnings season is now behind us, and a review of the earnings reports of the 98 companies on 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 three quarters the median growth rate in our index has been around +18% yoy.

An extraordinarily high percentage of SaaS companies also guided Q2 revenue to below consensus, and as a result the stock prices in the PVC SaaS Index are down 13% over the past 3 months even as the NASDAQ and the S&P 500 climb to new heights.

That slowdown may be in part due to a macro slowdown in the US (where GDP growth in Q1 fell to an annualized rate of 1.3%), 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).

It also appears that large enterprises are bifurcating their budgets, increasing spend on projects that will drive their AI agenda hole scaling back on the rest of their IT spend (which includes things like workflow improvements, cybersecurity, payments, and cloud integrations).

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Aman Verjee, CFA, is a co-founder and General Partner at Practical Venture Capital, a secondary venture capital firm headquartered in Palo Alto, California.