As much as I like spotting new trends, it is just as important to get confirmation on previous predictions we made or heard. This week brought us some fodder in that regard, on two sectors that are pretty high on my radar: SaaS and alts. Let’s explore. — Anna
Shrinking SaaS multiples, hard times for IPOs
Alex and I spent quite a bit of time this week diving into Battery Ventures’ “State of the OpenCloud 2022” report. It brought some forward-looking data to our attention — for instance, on cloud adoption — but also confirmed something impossible to ignore: That SaaS multiples — enterprise value compared to revenue projections — are shrinking.
“The median forward multiple for SaaS companies has fallen from about 16x forward revenues to roughly 6x today,” Battery general partner Dharmesh Thakker told us.
Multiples haven’t only shrunk, but they have also range-compressed, with fewer rewards for the fastest-growing companies compared to slower-growing ones. There are many factors at play, but the gist of it is that profitability seems to matter again to the markets.
As a result of that, we’re seeing the revenge of some old rules. “Adjusted for growth,” Thakker said, “companies today that show efficient growth as implied by the Rule of 40 (i.e., companies with a growth rate + free cash flow margin greater than or equal to 40) are trading at a premium to those that are growing without regard to profitability.”
Note that it’s not either growth or profitability: It has to be both, and the bar to please investors seems to be getting higher and higher.
A more demanding market is a worrying picture for the many unicorns waiting to IPO, as well as for their peers who already went public but struggle to maintain their market cap. Let’s also spare a thought for Alex, who may not get his hands on another juicy S-1 before Q2 2023.