Weekly Update: No Recession (For Now) & The Billion-Dollar Questions for SaaS Valuations
Highlights from SaaS & VC from the week of 1/30
Despite a pullback on Friday, the WCLD cloud index had another strong week, moving up 6% to $30.47. The market continues to move towards “risk-on” as economic signals suggest a soft landing is possible and a hard landing unlikely.
Of course, macroeconomics trends are like the movie business: nobody knows anything. In the second half of last year, many pundits loudly predicted that a recession was coming. It turns out those pundits were dead wrong. Bloomberg News reported on Friday:
US Payrolls Surprise With Surge as Jobless Rate Hits 53-Year Low
Seems like we’re not in a recession.
Of course, since nobody knows anything, who knows if this will change any time soon. What if the Fed rates hikes might actually be causing economic growth rather than slowing it? Maybe this isn’t a crazy hypothetical:
How can mortgage rates be dropping when the Fed is hiking? Currently, long-term rates are lower than short-term rates - a textbook case of an inverted yield curve. The bond market is implicitly betting that more the Fed hikes in the short-term, the more they will have to cut in the medium-to-long-term. So even though hiking rates is supposed to cool economic activity, perversely, Fed hikes could actually be stimulating the economy by pushing down rates for long-term borrowing.
In the worst-case scenario, this would mean that inflation would still run hot, so the Fed would have to continue hiking. Eventually, the cooling impact of elevated rates would hit a critical mass and trigger a rapid, painful reversal. A “hard landing.” While I don’t think this is likely, the larger point is that anything can happen in a system as fantastically complex as the US economy.
That said, for the moment, there are some rosy economic signals. But will this matter to the tech industry? To SaaS?
Looking at late Q4 and early Q1, the CEO’s/CFO’s who make up the customer base of the tech industry have not embraced the looser financial conditions. Tomas Tunguz had a great Twitter thread on growth trends among the major cloud platforms. Here’s the summary:
I’d note that part of the cloud platform growth decline is likely a bounce-back from the exuberance of 2021. I wouldn’t expect the trend to continue to decline so precipitously from here. Although it’s a safe bet that the largest cloud platform, AWS, which is a massive $85b in ARR, is never going to grow in the 30’s again. Yet at this scale, growth in the mid-teens is not so bad - it would add 10b+ of ARR in a year!
Despite the slowing growth of major cloud platform, January was a strong month for public SaaS stocks. The median valuation is now back above 6x forward revenue:
Will public cloud companies see a similar growth reduction as the major cloud platforms?
That’s the billion-dollar question facing public SaaS companies. A growth reduction would hurt valuations. Fortunately, there’s not much more room for valuation multiples to contract.
That’s a stark contrast to private SaaS unicorns, which have not yet been forced to confront valuation reality. Many, if not most, of the SaaS unicorns of 2021 are carrying valuation multiples that are 2-4x their public comps. That is, a SaaS unicorn might have a valuation of 30x ARR when a public SaaS company with similar growth and profit has a 10x ARR multiple.
This valuation discrepancy won’t last. How will it be resolved? That’s the billion-dollar question facing private SaaS companies.
Podcast Recommendation of the Week:
The Logan Bartlett Show had a fascinating interview with Elad Gil, the prolific startup investor and serial entrepreneur. When Gil speaks, I listen. The interview has a great discussion of the power of networks in the tech industry. Whether its at Paypal or Google or Palantir or Canva, there’s a massive career benefit to being early at a breakout tech company. The inverse of this is the huge value for a startup that comes from attracting top talent and establishing talent gravity in its early stages.
Gil also has offers an insightful perspective on AI as the next major platform technology. While the benefits of the recent AI breakthroughs are immense, it’s unclear how much value creation will accrue to incumbents or to startups. Gil points out that in the rise of mobile, most of the value accrued to incumbents such as Google, Amazon, and Facebook. Of course, even if startups were only able to take a minority of mobile’s value creation, this was still enough to spawn major winners such as Uber, Snapchat, and Tik-Tok (ByteDance)!
Reading Recommendation of the Week:
A great post from NFX Partner Gigi on the early stages of product-led-growth (PLG). Using their recent investment in Whale(?) as an example, the post walks through a useful 3-part framework for success in PLG: Find the Fast-Moving Water, Validate Idea Promise, Iteration Machine.
I love the metaphor of “find fast-moving water” to highlight how an attractive market should feel to an early-stage startup. A great market has the same unmistakable pull that we feel when dipping a finger or a toe into fast-moving water. For a startup that believes it’s on the cusp of achieving PMF, it’s critical to ask if the target market is like fast-moving water. If it’s not, then it’s likely that the startup’s rosy view of approaching PMF is infused with wishful thinking.
Is the eventual result for private saas companies that they have to either take a hit in valuation at the next round or if they don’t have PMF, just don’t raise again, possibly at the cost of slower growth? Or is it looking more serious, with unicorn/private company bankruptcies in the next 2 years?