2017 was a successful year for Cloud companies. At the same time, the stock market hit historic highs - the Dow increased by 25% and NASDAQ increased by 28%. We noticed some interesting trends regarding which companies benefited the most from market cap valuation increases in 2017. Why did some SaaS companies get an incredible bang for the revenue buck in terms of market valuations - and some didn't? Let's take a look at SaaS valuation trends and what they tell us.
When used properly, multiples are robust tools that can provide useful information about the relative value of a company. When you compare multiples over time, you can spot SaaS valuation trends more easily than if you were simply comparing single figures (like Revenue or Gross Margin by themselves). Multiples help to paint a more clear picture.We segmented companies in the Bessemer Cloud Index into 5 cohorts by their Market Cap to Revenue multiple (MCR) as of the end of FY2016 and again for the end of Q3 2017. We wanted to look at what changed, what went up and what went down. We'll be doing a series of these posts looking at the various operating metrics for these 5 cohorts over the next few weeks. Sign up for our newsletter here.
What’s Driving Market Cap Multiples?
The primary multiple we used was Market Cap to Revenue (MCR). We looked at this multiple for FY2016 and Q3’17 to see firstly, whether the market was valuing revenue at the same multiple for all SaaS companies or just for some. Then we looked at the first of several operating metrics that we’ll be reviewing over the next few weeks in our newsletter - today we are looking at Gross Margins. We’ll be looking at Sales & Marketing expense trends next week. We ranked SaaS companies by MCR multiples and split them into 5 segments (of 20% ranges). Meaning, the 80% - 100% segment represents companies with the highest MCR multiple and the 0% - 20% represents companies with the lowest market cap multiples. Again, we compared data for FY2016 to Q32017.OPEXEngine's Performance Engine for Public Companies was the source of the data, and we just happen to have a peer group, or sector group, already created for the Bessemer Cloud Index. We have another one for recent SaaS IPO companies which we curate regularly, among other SaaS peer groups where you can download the latest financials for these groups.
Market Cap to Revenue
The Market Cap to Revenue multiple shows how a company’s stock compares to their generated Revenue. This multiple is often referred to as the Price-to-Sales ratio and is something investors look to understand the value of the company’s dollars.You can see in the chart below that the companies with the highest MCR multiple benefited the most from the hot stock market in 2017 because their median market cap multiple almost doubled. This is huge because they are being valued at almost double what they were in 2016 for every dollar of revenue they bring in.Companies in the middle ranges weren’t as lucky as they didn’t seem to benefit as much from the stock market. Surprisingly given the hot market, the companies with the lowest Market Cap multiples reduced their multiple by almost half. We’ll be looking further at various operating metrics in our next week's newsletter into what drove the increase for the top companies and the decrease for the bottom 20% of companies.
Source: OPEXEngine
2018 -- Investors Looking Beyond Sales and Marketing Hype
While huge emphasis in the SaaS community through 2017 has been focused on revenue growth and Sales and Marketing, we believe that in 2018, a combination of revenue growth, Sales and Marketing efficiency, improving gross margins and operating metrics that demonstrate an efficient growth model at scale will be valued by investors. In terms of investors, we aren’t just thinking about public market investors and analysts, but should remember that private investors, ie., VCs, are driven by their end game, ie., the big pay-off in an IPO or acquisition by large public companies that are also motivated by the metrics tracked by public investors.
How Important is Gross Margin?
As a first step, we looked at how gross margins compared for SaaS companies segmented by the highest to the lowest revenue to market cap multiples. You can see below that the most highly valued companies showed improved Gross Margins which is part of why these companies were valued so highly - but the SaaS valuation trends were slight.On the other end, you can see that the companies with the lowest Market Caps also increased Gross Margins, also only slightly. With this group, slightly improved median gross margins did not result in higher valuations (warning - remember that this trend analysis here is based on Q3’17 numbers alone and should be revisited once full year numbers are out). In fact, their multiple dropped by half, which shows that Gross Margin increases alone are not strong enough to drive stock prices up - or at least these slight increases didn’t affect much.
Source: Performance Engine for Public CompaniesMore importantly, notice that the top 40% of companies measured by market cap multiples had over 70% gross margins, while the companies with the lowest market cap multiples were in the mid-60% range.Next week, we’ll look at how Sales and Marketing expense and the Magic Number compared for SaaS companies. If you aren’t already on our mailing list, sign up here.
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