2022 SaaS Crash: Analysis of the change in valuations, case studies of the Great Recession, and what every company should think about in this new world (and a lot of charts!).
The almost 12 year tech bull market is over. The value of public SaaS companies appreciated massively during COVID, peaking in late 2021. The past 6 months have been the largest period of value destruction in the history of public SaaS. The chart below looks at every pure-play SaaS company that has traded publicly (~90 companies today): the cumulative market capitalization reached over $2T in 2021 and is down ~$1T, or around ~50% from the highs (and that's including many new IPOs that have entered the index last year). The average company market cap is down 57% from its 12-month highs. Forward revenue multiples – the primary valuation methodology for public SaaS companies - have fallen on average by 67% from their 12-month highs and for some companies by almost 90%. The fastest-growing companies, which traded at the highest multiples before this sell-off, were hit the hardest.
Cumulative Market Capitalization of all Public SaaS Companies ($ in 000s)
Source: CapitalIQ as of 13-May-2022
A few factors have contributed to this precipitous and unprecedented fall – 1) rising interest rates. The value of a software business is the net present value of its future cash flows. If interest rates rise, the discount rate used in the DCF (discounted cash flow analysis) increases, creating a lower present value. Interest rates on the 10-year treasury are inversely correlated with SaaS valuations. Raising rates is one of the last tools the Fed has to fight inflation. 2) end of the “COVID sugar-high”. SaaS multiples initially crashed during the onset of COVID but came roaring back even as forward estimates came down. There was significant (and valid) exuberance around high-growth SaaS stocks and the potential for a step-function pull-forward of IT budgets and revenue for these companies as every company – regardless of industry – needed more software to serve their end-users and customers. Every earnings announcement tended to drive SaaS stocks further upward and there was nothing that could seemingly stop them. That “sugar high” seems to be ending even as IT budgets are stronger now than they were in 2020 3) inflation and macro-economic risks. Inflation is at the highest point in 40 years and in order to combat rising inflation, interest rates must be raised (hurting valuations in point 1). Moreover, given there is a reasonable risk of a recession, valuations have come down as there has been a flight away from perceived riskier assets i.e. high-growth SaaS companies. 4) Russia / Ukraine war and other geopolitical risks.
Given all of these factors have hit the markets at once, we have seen historic drops in market value for public SaaS companies and they have in many ways reverted back to – and in some cases below – historical forward revenue multiples. This not only has an impact on the current set of public SaaS companies but the ripple effects will be felt globally across private SaaS and the broader tech ecosystem.
This post is divided into three sections: 1) the history of public trading performance and valuations for all public SaaS companies 2) case studies of Salesforce and NetSuite during the Great Recession and 3) a framework for thinking about operating plans, both the top and bottom line, in this new world.
1. History of Trading Performance for Public SaaS Companies
Where is the bottom? We’re not sure, but the following analysis looks at the trading trends of every public SaaS company over the past 20+ years to today (13-May-2022 - or until they were acquired) to get a sense of where companies could trade at a steady-state. Over 80% of companies in this index are now trading below 10x NTM (next twelve months) revenue, once deemed a historical terminal multiple for the best companies. Today, out of roughly 90 companies, only 3 companies are trading above 20x NTM revenue (Cloudflare, Datadog*, and Snowflake*).
The following charts show, for the 25 companies that are currently growing LTM revenue the fastest (around 50% or more), a comparison over the past 12 months of their peak multiples and market caps vs. where they are trading today (and just how far they’ve dropped). These fast-growing businesses saw their value and multiples rise the most during the past 2 years and subsequently saw the highest declines.
NTM Revenue Multiple: LTM High vs Today
The chart below compares the peak NTM revenue multiples over the last twelve months to today. The peak NTM revenue multiple median was 50.8x and that median has dropped 80% to 8.8x today. The companies are sorted by peak NTM revenue multiple.
Source: CapitalIQ as of 13-May-2022
Below you can see the % decline of multiples from peak to today for each company (sorted in order of decline). As mentioned above, the median decline is 80%. This is a good representation of what the ripple effect could look like in the private markets. By any measure, these are all great businesses. Take Snowflake for example, which is currently trading at the highest multiple of any SaaS company at 25x NTM revenue. The company is currently at ~$1.5B of implied ARR (annualized revenue run-rate), growing 102% year-over-year, with net dollar retention of 178%, a magic number of 1.3, almost a 10% LTM free cash flow margin, and a Rule of 40 of 109%. Snowflake is in a massive end market with a great management team. Their multiple is down 73% from its LTM high.
Source: CapitalIQ as of 13-May-2022
Market Cap: LTM High vs Today ($B)
The chart below compares the peak market cap over the last twelve months to today. The peak market cap median of this group was $31.2B. The median has dropped 67% to $7.7B today. The cumulative market cap of this set of companies has dropped almost 70% from $1.1T to $379B. The companies are sorted by peak market cap.
Source: CapitalIQ as of 13-May-2022
Below you can see the % decline of market cap from peak to today for each company (sorted in order of decline). Again, the median decline is 67%.
Source: CapitalIQ as of 13-May-2022
Enterprise Value / NTM Revenue for all Public SaaS Companies
During the past two years, median multiples reached almost 25x for all public SaaS companies (~90 in total). The median today is 7.1x, lower than the 2017-2019 pre-COVID median of 8.5x. This is a profound change as the public markets are now valuing this group of companies below their pre-COVID trading levels. As you can see in the chart below, for SaaS companies growing revenue over 50% LTM (last-twelve-months), the market-cap-weighted median has gone from ~57x to ~15x NTM revenue today, a decline of over 70%.
Source: CapitalIQ as of 13-May-2022
Growth Adjusted Multiples (Enterprise Value / NTM Revenue divided by growth rate)
Here is a view of growth-adjusted multiples, which is the NTM revenue multiple divided by the LTM growth rate. As you can see from the chart, we are now back to the 2017-2019 medians in terms of how the markets are valuing growth. While some might say that stocks are cheaper now on a growth-adjusted basis, they are actually in line with the 2017-2019 median after the recent drop.
Source: CapitalIQ as of 13-May-2022
2. Case Studies from the Great Recession
The rapid decline in value of public SaaS companies over the past 6 months has undoubtedly already had a huge impact on private market valuations. That downward trajectory may continue even if the public markets stay flat at today’s levels. If public market returns cannot fuel venture capital fundraising from their limited partners, the flywheel will slow down. Investors will have fewer dollars to invest, companies will have less cash to hire and invest in growth, and outcomes are likely to be much smaller than previously thought. This reset has been swift and will soon be painful for many businesses that are burning too much money and/or those that will have to slow top-line growth. Moreover, there will be wide-ranging implications for employees and investors not only in the SaaS community but for all private technology markets. And while much of the focus has been on the decline in valuations, there is another huge factor that can’t be overlooked – how could a recession or broader economic slowdown affect your financial profile? This could have an even bigger impact on valuations if the fundamentals of businesses change for the worse. While a large part of the sell-off has consisted of a move away from riskier asset classes in sectors such as high-growth SaaS to cash and value stocks, recent earnings results have been strong and business fundamentals have not changed broadly. But what if you traded at 50x forward revenue and are now trading at 10x, and your associated forward revenue also dips by 30-40-50% from your prior plan? The outcome is not pretty and one we have not yet seen, but could soon if the 2008-2009 Great Recession is any indicator.
The following charts look at Salesforce* and NetSuite*, two publicly traded SaaS companies during the 2008 Great Recession, and what happened to their respective value and financial profiles. Unfortunately, while this is a small sample size, these are the best precedents as almost all other SaaS companies went public after the Great Recession.
Salesforce Implied ARR, %YoY Growth and Non-GAAP Operating Margins ($M)
Salesforce was almost a $1B implied ARR (annualized revenue run-rate) business growing over 50% year-over-year at the start of 2008. During the Great Recession, revenue growth slowed to 20%. Non-GAAP operating margins did hold fairly steady, though.
Source: Company filings
Salesforce Quarterly Full-time Employees (FTEs)
Salesforce had over 3,500 full-time employees at the end of 2008 and was growing headcount ~40% year-over-year before slowing down significantly. They made less than 50 net hires two quarters in a row for a $1B+ implied ARR business and didn’t reach historical net hiring levels until Q2 of 2010. Note that the quarter labels are for the calendar year ending December.
Source: Company filings
NetSuite Implied ARR, %YoY Growth and Non-GAAP Operating Margins ($M)
NetSuite was over $160M in implied ARR growing ~45% YoY at the end of 2008 before slowing dramatically. The company did not grow for 3 quarters in a row before accelerating back to growth. Similar to Salesforce, they also held non-GAAP operating margins constant but slowed investment significantly. It would be hard to imagine a ~$150M ARR business today that’s growing fast grinding to a halt, but this happened for NetSuite. The company also sold to SMBs and the mid-market, a segment that was hit particularly hard during the Great Recession.
Source: Company filings
NetSuite Quarterly Full-time Employees (FTEs)
Not surprisingly given the slowdown in revenue growth, NetSuite’s headcount was flat for almost 7 quarters before they started hiring more, and even then they didn’t resume their net hiring pace from pre-Great Recession until the end of 2012, around 4 years later.
Source: Company filings
Looking back in time, both Salesforce and NetSuite probably shouldn’t have cut investments in growth so dramatically – they were emerging leaders in massive markets and were still profitable on a non-GAAP basis during the worst recession in decades. Both went on to grow very well and become massive successes, but hindsight is 20/20. The following charts show their respective market caps and NTM revenue multiples during the Great Recession. After looking at these charts, it’s hard to argue that they shouldn’t have planned for the worst, and it likely made them better for the future.
Salesforce Market Cap and NTM Revenue Multiple
Between December of 2007 and the start of the Great Recession, Salesforce had a peak market cap of $8.9B and a peak NTM revenue multiple of 7.5x. Their low point during the Great Recession was a $2.7B market cap and 1.5x NTM revenue multiple; drops of 70% and 80%, respectively. It took them 3 years to reach their pre-Great Recession high point. Today, Salesforce is worth over $166B at the time of this post, with their market cap up over 60x from their Great Recession low.
Source: CapitalIQ as of 13-May-2022
NetSuite Market Cap and NTM Revenue Multiple
NetSuite has a similar story. Between December of 2007 and the start of the Great Recession, NetSuite had a peak market cap of $2.4B and a 17.3x NTM revenue multiple. Their low point during the Great Recession was a $383M market cap and 1.4x NTM revenue multiple, representing drops of 84% and 92%, respectively. Post-Great Recession, and similar to Salesforce, the company accelerated dramatically and saw significant value appreciation up until its acquisition by Oracle for $9.3B in 2016, almost 25x above its Great Recession low.
Source: CapitalIQ as of 13-May-2022
For those interested in looking at share price, LTM revenue growth, and NTM revenue multiples for all public SaaS companies, you can toggle each company in the Historical Trading data section at the bottom of the page.
Salesforce and NetSuite saw major impacts to both their valuations and revenue numbers and slowed investment in growth and hiring (or even had headcount reductions). Their drops in NTM multiples – 80% and 92% respectively – are not unlike what we’re seeing today. Every downturn is different. While the SaaS market today is much more mature with many more companies and well-understood business models, it’s also saturated with more competition. We’ve seen a bounce in share prices over the past few days and time will tell if it’s temporary or if investors will have to brace for more volatility. With the current public SaaS universe trading at a median 7.1x NTM revenue multiple, and looking back at the Great Recession lows of companies like NetSuite and Salesforce, which were the best companies at the time, there could be more declines given these businesses were trading at ~1-2x NTM revenue during their lowest points.
3. Framework for the Future
Every SaaS company (and any company with negative free cash flow) should prepare for a scenario in which they trade at 10x NTM revenue steady-state. This might mean that a private company with a high valuation will need to grow its revenue much more than their investors initially anticipated to be “in the money.” Private companies receive well-deserved premiums, but if a company raised money at a $1B valuation and is at $10M of ARR, you likely have to get to $100M of ARR and still be growing quickly to be worth that same amount in today’s world as a public company. Right now, public market investors are not valuing growth at all costs. Growth and efficiency together are the most important determinants of valuation. Public and private SaaS companies alike will have to rethink operating plans to gain leverage and efficiency. While many companies (private too) are planning for potential further reduction in value, what if there is a degradation in the top-line assumptions companies are using for their plans? Did Salesforce and NetSuite slow down because the buying environment stalled and their hand was forced? Or did they cut investment in growth out of fear of the markets? Every company should scenario plan for impacts at the top of the funnel – the goal is to understand not only the cost side of the equation but also the demand due to potential changes in macro factors:
Sales cycles lengthen by 10-15% as the urgency to buy software decreases.
To close deals, companies have to discount 10% or more.
The cost of a marketing qualified lead (MQL) or a sales qualified lead (SQL) increases by 10-15% as there are fewer buyers and they are more reluctant to purchase.
Software budgets freeze or slow down as execs force companies to buy and consolidate their software stacks.
Account executives (the sellers) will end up missing their quotas and quota participation rates (the % of reps hitting quota) will fall leading to lower attainment and more attrition.
The overall cost to acquire a customer rises and the associated revenue could be lower.
An increase in stock-based compensation, both for retention and motivation of existing employees who see less value in their equity and for hiring new employees, will result in lower profitability for public companies. For private companies, option pools will run out faster leading to higher dilution.
Inflation requiring increases in salaries and furthering the need to increase pricing.
Each one of these scenarios is not ideal on its own, but together, the impact can be dramatic on cash consumption. Company morale and culture can also degrade as layoffs could occur. This post is not suggesting companies should just blindly slow or halt investment due to market conditions as there are many considerations of when and how much to slow growth, but every team should go through some version of the exercise above and also understand what they’re getting for an extra 20% or 30% or 40% of YoY growth, regardless of the stage of business. How much incremental cash does that extra growth cost and where do the lines cross on a sufficient growth rate and rate of investment i.e. burn. Salesforce and NetSuite slowed revenue growth dramatically but held non-GAAP operating margins flat, and most companies don’t have the luxury to operate profitably as they did. The counterargument could be that Salesforce and NetSuite should *not* have slowed investment in growth during the Great Recession as they saw incredible value creation from those low points and missed opportunities to grow even faster. But they did survive to achieve that eventual increase in value. It’s hard to quantify how many companies didn’t make it through the Great Recession that didn’t plan for a reduction in demand. Given the historic decline in value over the past 6 months, there is likely to be a massive shakeout in the value and growth of private SaaS companies. While the market opportunity is bigger than ever before – any way you cut the data we’re still in the early innings of cloud penetration and there are still trillions of value to be created – we are hitting some serious turbulence at the moment.
At Meritech, we’ve been investing in SaaS companies and other tech sectors during the highs and lows over the past 23 years (Salesforce and NetSuite included), and many of the most successful companies – SaaS and others –were born during the last Great Recession. We fully believe the best days for SaaS and the broader tech market are ahead and are investing in that opportunity. Moreover, unlike in prior downturns, companies now have the ability to hire employees globally (theoretically increasing quality and reducing costs). This will not be an easy period, but the best companies pull ahead in down markets. The most promising companies going forward will be those that not only have great end markets, products, teams, metrics (unit economics / free cash flow!), and emerging leadership positions but those that can adapt to the current market conditions and survive the turbulence.
*Meritech Capital is a shareholder in Amplitude, Braze, Datadog, Okta, Snowflake, Twilio and UiPath. Meritech was a former investor in NetSuite and Salesforce.
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Special thanks to Anthony DeCamillo and Dan Knight for their help on this post.