SaaS has become the preferred model for software companies to deliver their applications. The increasing adoption and sophistication of cloud computing, has been the primary driver for this change. The established software companies such as SAP, Oracle, and IBM have more or less shifted completely to this new model. The increased popularity of SaaS model has helped the SaaS-native companies such as Salesforce, Shopify, and Workday immensely. They have enjoyed significant premium in their valuation as compared to other software companies. But how has the SaaS valuation fared over time?
It seems that SaaS companies had their heyday during early 2015. The median revenue multiple, calculated as Enterprise Value / Revenue – one of the popular methods of valuing SaaS firms, peaked in March 2015 at 9.1x. It enjoyed the high valuation of 8.5-9x for around six months. This is the period when companies were growing at crazy pace, mostly at the cost of profitability. The companies were heavily in investing in sales and marketing and product development to establish themselves in the market. The investors were largely looking at the company’s revenues and current and projected growth rates without bothering much about the profitability, this drove up the market valuations.
This golden period was followed by a sharp correction in the market, which made the SaaS firms fall to a median revenue multiple of 6.0x in May 2016. The investors seemed to look for profitability along with the growth in revenues. Only high projected growth was not enough to attract high valuations. Incidentally, this was also a period of high M&A action in the industry where we saw some of the biggest deals being executed in the market. These included Vista Equity Partners’ buyout of Cvent and Marketo, Oracle’s acquisition of NetSuite and Opower, Thoma Bravo’s buyout of Qlik, and Salesforce’s acquisition of Demandware – at a median revenue multiple of 7.5x.
After that lull period of public valuations, investor sentiment toward SaaS companies increased – the median revenue multiple reached 7.7x in May 2017. SaaS firms are now trying to find the balance between growth and profitability and the market has responded accordingly. The multiples have since then stayed put within a range of 7.0-8.0x. The M&A activity has continued as well, both within the strategic and PE buyout space, albeit with quite a difference in valuations. While strategic acquisitions have been executed at a median revenue multiple of 9.7x, Private Equity players have not been quite generous. The buyouts of Xactly, Intralinks, Barracuda Networks, and Bazaarvoice, have been completed at a median revenue multiple of 3.6x. This suggests that companies that have not been able to balance growth and profitability can become viable targets for Private Equity players at attractive valuations.
The past three years have seen a lot of volatility in SaaS valuations and while the market seems to have been stabilized for now, it will be interesting to see how the year pans out. The investors have become more sophisticated in understanding the SaaS model and their future prospects and would not buy the growth story without proper attention being given to the profitability. Also, the private equity buyers are getting more active in the space – identifying cheap targets that have fallen behind market expectations. Companies such as Tableau, Workday, and Zendesk, which have fallen considerably since their highs of 2015 can become viable targets for some of the large private equity players.