Weekly Update: SaaS Stock Up, Costs Coming Down
A few highlights from the week of 10/24
Cloud stocks had another strong week, with the WCLD up 6% to $27.62.
The big tech news of the week was Elon Musk completing his purchase of Twitter. He quickly dispelled a rumor that he was planning on laying off 75% of employees, yet significant layoffs still seem imminent.
I found the 75% rumor stunning - the implication being that Twitter had 4x the employees that it actually needed! It’s mind-boggling that anything close to this level of over-staffing could be possible.
With the clarity of 20/20 hindsight, we can see that lukewarm growth was enough to cover up bloated costs in the past market cycle. This has changed. In SaaS, we can see today’s shifted market priorities in the actions of activist investors such as Starboard:
In its most recent quarter, Salesforce had a mammoth $31b revenue revenue rate and 26% growth, yet a paltry 4% operating cash flow margin - putting its Rule of 40 score at only 30. Their low cash flow might not have drawn much scrutiny when interest rates were near zero. No longer.
In slides 56-57 of a presentation on their investment thesis, Starboard explains:
Salesforce trades at a discount to its peer group…We believe the valuation discount is largely the result of Salesforce’s Subpar Mix of Growth and Profitability
Software businesses are supposed to have massive operating leverage - the fruit of selling bits, not atoms. For example, Atlassian at $3b in revenue run rate and 36% growth has 32% operating cash flow. ServiceNow at $7b in annualized revenue and 21% growth has 18% operating cash flow.
Scaled SaaS businesses with anemic cash flow and low Rule of 40 scores are on notice. We are entering a bull market for activist hedge funds and private equity firms with expertise in cost-cutting.
Podcast Recommendation of the Week:
Another great SaaStr podcast this past week, with Jason Lemkin interviewing venture capitalist & serial SaaS CRO Sam Blond.
They cover a few highly relevant topics such as today’s enhanced focus on revenue quality & gross margins. Remarkably, in the boom days of 2020/2021 all SaaS revenue was generally treated as equal, regardless of gross margin. It’s important for founders to appreciate how much this has changed.
They also discuss the challenges of hiring experienced sales leaders. They make a point that I strongly agree with - sector experience is often overrated. Great sales leaders are very hard to find & are capable of learning a sector’s nuances. Limiting the recruiting scope to industry insiders makes its incredibly hard to find a high-performing sales leader.
Reading Recommendation of the Week:
Tomasz Tunguz had a data-rich post a few weeks ago addressing an important question: how low can SaaS multiples go? (link)
The key takeaway is that if interest rates continue to rise, the data suggests that multiples will continue to contract. On a positive note, this could set the stage for a great bull market rally if/when interests rates begin to subside.
