Durable Growth and the Compounding Returns of Public SaaS Companies: An analysis of trading and financial data of public Software-as-a-service (SaaS) companies to determine the leading contributing factors to shareholder returns.
The SaaS market has reset. We've transitioned from a "Capital is cheap, grow at all costs" era to one where every board room is asking "How should we think about top-line growth if we want to conserve cash and prioritize efficiency but still create value?". When we are asked (and ask ourselves) this same question, we return to first principles. How have the most "successful" SaaS companies (based on shareholder returns) created value? What factors correlate to an increase in share price over long periods of time? In this post, our attempts to answer those questions have led us to a clear conclusion: durable growth, i.e. the persistence of revenue growth over time, matters more than the absolute pace of revenue growth or changes in valuation due to market conditions. This holds true even with the recent massive pullback in public SaaS stocks. This post is organized into five parts: 1) summary of public SaaS company returns 2) components of value creation examples 3) regression analyses on value creation 4) select case studies and 5) closing thoughts. All the market data in this post is updated as of Aug-15-2022.
The takeaways are as follows:
Durable long-term revenue growth is the most important factor in returns, defined as the increase in share price from IPO (or multiple of invested capital / MOIC).
It’s about time in market, not market timing: If you stay public for a long period of time and can compound revenue growth, regardless of market movements that can affect valuation multiple in the short to medium term, you will create a ton of value as a public SaaS company.
The pace of revenue growth, defined in this analysis as revenue CAGR (compound annual growth rate) since IPO, has little relationship to share price returns.
The size of a company’s LTM (last-twelve-months) revenue at IPO has no relationship to returns.There are examples of businesses that grew at high rates, i.e. triple-digit year-over-year (YoY) growth rates, and examples that never grew above 45%. Both still achieved spectacular returns.
There is a level of efficiency required to stay public and generate strong returns; companies cannot burn a lot of money to grow in the public markets. They will be forced to slow growth dramatically and eventually fall out of the index by acquisition (or insolvency). As a result, these companies tend to generate lower public market returns, supporting our conclusions above. That said, our analysis includes only current public companies, not those that have been acquired. This means there is some survivorship bias in our sample set.
(1) Summary of Public SaaS Company Returns
Even with the recent massive SaaS correction, the returns of public SaaS companies over the past almost 20 years, starting with the Salesforce IPO in June 2004, have been staggering.
Top 25 MOIC Public SaaS Companies
The following chart looks at the MOIC from IPO price through today of the top 25 MOIC companies – the average is 13.7x and the median is 9.4x. The average for all SaaS companies in our comparable set (almost 100) is 5.3x and the median of 1.8x. So if you put $1.00 in the IPO of every SaaS company you’d have $5.30 today (which even includes recent IPOs and companies trading at significant discounts to their IPO price). Here is a link to all companies’ returns.
Source: CIQ as of 15-Aug-2022
IRR for Top 25 MOIC Public SaaS Companies
Below is a chart of those same companies from above (still sorted by MOIC). The IRRs (internal rate of return) are impressive with an average of 46% and a median of 39%. The IRRs are different from the returns chart above since it accounts for the time the company has been public.
Source: CIQ as of 15-Aug-2022
(2) Components of Value Creation Examples
Our analysis takes the simplified view that a public SaaS company’s share price is essentially driven by three components: its revenue, how the market values that revenue, and dilution. We define value creation as the increase in share price from IPO to today (i.e., MOIC). How much of that value creation is from revenue growth is simple to imply by calculating the increase in LTM revenue from IPO to today. The difference between the increase in share price and the increase in revenue is what we attribute broadly to “multiple change and dilution”. When multiples expand, revenue growth and multiple expansion are both positive effects responsible for the net value created in a company’s share price. Conversely, when multiples compress, revenue growth is still a positive effect creating gross value and multiple compression is a negative effect, destroying gross value. As such, revenue growth’s gross value can be greater than the net value created (as we will see in the ServiceNow example below). Dilution occurs as shares are issued over time (for primary capital raises, employee stock options, or M&A) and, all else equal, detracts value per share by increasing the denominator which equity value is divided by to calculate share price. If a free cash flow generating company performs share buybacks, however, it can also, all else equal, create value per share. We opted not to separate dilution from multiple change because the focus of our analysis is not capital allocation, but rather on top-line growth rates and market movements and dilution tended to be a smaller component of the net change. This section starts with two examples to illustrate this calculation: Atlassian and ServiceNow.
Atlassian (NasdaqGS:TEAM) Share Price Value Creation Components
Atlassian went public at $21/share in late 2015 and is trading at $288/share today. Atlassian is one of the rare companies whose NTM revenue multiple (net of dilution) expanded significantly over time. In summary:
Atlassian went public at $21/share in December of 2015.
Its share price is at $288 today, up 13.7x from IPO, an increase of ~1,270%.
LTM revenue at IPO was $353M and was $2.8B last quarter, a CAGR of 36% since IPO.
During Atlassian’s first 30 days of trading, they traded on average at an 11.6x NTM revenue multiple vs. 20.3x today, an increase of ~75%. Note, we do not use these figures in our calculation, but rather imply the multiple and dilution impact based on the difference between the change in share price and change in revenue. The results would be similar either way.
Atlassian shareholders have been diluted on average 3% annually since IPO.
As a result, revenue growth accounted for 54% of the increase in share price and the implied multiple change (net of dilution) accounted for 46% of the increase in share price.
Atlassian MOIC Bridge
Source: CIQ as of 15-Aug-2022. *Takes the average of the first 30 trading days
Here is another view that decouples the 13.7x return by share price gains from IPO price to today to help visualize the share price gains.
Atlassian Share Price Bridge
Source: CIQ as of 15-Aug-2022. *Takes the average of the first 30 trading days
ServiceNow (NYSE:NOW) Share Price Value Creation Components
ServiceNow went public at $18/share in mid-2012 and is trading at $504/share today. ServiceNow, like many companies, saw its NTM revenue multiple decrease from when it first started trading in 2012. In summary:
ServiceNow went public at $18/share in June of 2012.
Its share price is at $504 today, up 28.0x from IPO price, an increase of ~2,700%.
LTM revenue at IPO was $150M and was $6.6B last quarter, a CAGR of 45% since IPO.
During ServiceNow’s first 30 days of trading, they traded on average at a 15.4x NTM revenue multiple vs. 12.3x today, a decrease of 20%.
ServiceNow shareholders have been diluted on average 6% annually since IPO.As a result, revenue growth accounted for 159% of the increase in share price and the implied multiple change (net of dilution) accounted for (59%) of the decrease in share price.
ServiceNow MOIC Bridge
Source: CIQ as of 15-Aug-2022. *Takes the average of the first 30 trading days
Here is another view that decouples the 28.0x return by share price gains from IPO price to today to help visualize the share price gains.
ServiceNow Share Price Bridge
Source: CIQ as of 15-Aug-2022
Implied Value Creation Components for the Top 25 MOIC SaaS Companies
Atlassian and ServiceNow are just two illustrative examples. The following analysis looks at the top 25 MOIC SaaS companies and charts their value creation components in the same methodology as above – the net effects of revenue growth, valuation multiple changes, and dilution. The blue represents the portion of value created by revenue growth and the red is value created or destroyed by changes in multiple and dilution. In this list of high-performing companies, on a median-basis 105% of the value creation comes from revenue growth and not increases in valuation multiple (there is a lot of blue!). This chart reinforces the point made earlier: durable revenue growth – regardless of market environment – is the most important driver of returns for the highest-returning public SaaS companies today, even in the face of market turbulence. The average return for this set of companies is 13.7x from IPO price.
Source: CIQ as of 15-Aug-2022
(3) Regression Analyses on Value Creation
While the data above has shown that revenue growth is the most important lever in long-term returns vs. changes in valuation multiple, an important question remains: what pace of revenue growth rate do high returns require? We did regression analyses against many metrics to identify the most highly correlated variables to returns of almost 100 public SaaS companies. We removed a few outliers given exceptional circumstances (e.g. Salesforce which has been public for almost 20 years).
Share Price MOIC vs. LTM (Last-twelve-months) Revenue at IPO Quarter
One question we had was does the revenue scale of a company at IPO impact returns? No; there is no relationship between the LTM revenue at IPO and returns. Companies should generally IPO when it makes sense for the business vs. at a specific size of the business.
Source: CIQ as of 15-Aug-2022
Share Price MOIC vs. Revenue Increase
As we’ve established, the following is the most important driver of MOIC: how much LTM revenue today has actually grown from the LTM revenue base at IPO. So while it doesn’t matter where you start, what really matters is how much you have grown revenue since IPO. It’s quite intuitive, but this is the highest-correlated factor to MOIC in the data set at an r-squared of 0.57. If we include Salesforce in this analysis, the r-squared is 0.76. Note the cluster of companies in the chart are mostly recent IPOs.
Source: CIQ as of 15-Aug-2022
Share Price MOIC vs. Revenue CAGR
While the above chart might be intuitive, the following was quite interesting. When looking at MOIC against the revenue CAGR or % revenue growth rate from IPO to today, there is essentially zero correlation to returns. Meaning, that the absolute growth rate is irrelevant over the long-term for returns for this set of companies, and what matters is just how much companies grow from their revenue scale at IPO.
Source: CIQ as of 15-Aug-2022
Share Price CAGR vs. Revenue CAGR
We even looked at share price CAGR vs. revenue CAGR to see if the pace of share price growth is impacted by the pace of revenue growth. Again, the answer was no.
Source: CIQ as of 15-Aug-2022
Share Price MOIC vs. Time Public (Years)
Growing revenue by many multiples from IPO takes time. This regression looks at share price MOIC vs. time public, expressed as years. Naturally, this was the second highest correlated set of data (behind revenue increase) and shows that just staying public has a huge impact on returns. The point is – if you can stay in this data set, which implies you are growing revenue – it means you are likely to create significant value. Of course, there is survivorship bias in all of this data, but that’s the point. To be successful and stay public, you have to grow at a certain rate, and if you do, you’ll create a lot of value along the way.
Source: CIQ as of 15-Aug-2022
Share Price MOIC vs. Share Price at IPO
This was a “fun” chart, as many companies spend time wondering if they should do a share split (or which split factor they should use) before an IPO so they can go public at a “lower” absolute share price. The results show that it actually doesn’t matter what price you start with.
Source: CIQ as of 15-Aug-2022
That said, most companies try to avoid going out at super high absolute share prices to allow for “more” retail participation. Still, the data shows that the actual number doesn’t impact long-term returns. The range of share prices at the time of IPO here was $7 (FIVN) to $155 (MNDY).
In summary:
It doesn’t matter how big (revenue scale) you are when you go public: r-squared of .07
The most important factor is how much you actually grow your revenue from IPO: r-squared of .57 (and .76 including Salesforce)
The absolute revenue growth rate has no impact on share price MOIC or share price CAGR: r-squared of .002 and .004
Staying public is very important. The longer you are public, the more returns you’ll likely generate: r-squared of .52
Absolute share price at IPO is not important to returns: r-squared of .099
(4) Select Case Studies
The following section takes a deeper look at a few companies as case studies and charts their implied ARR (total quarterly revenue * 4), implied ARR year-over-year growth rate, share price, and valuation multiples from their first quarter of disclosure through today.
Salesforce Implied ARR and Growth ($M)
Salesforce (NYSE:CRM) is the best example, and while it was removed from the regression analyses above since it was such an outlier, the company has grown its implied ARR almost 800x from $37M in Apr-2002 to $29.6B over the past 20+ years. That represents an implied ARR CAGR of 40% since their first quarter of disclosure. The company has also made many acquisitions to support this growth.
Source: CIQ as of 15-Aug-2022
Salesforce Share Price and NTM Revenue Multiple
The following chart shows Salesforce’s stock price, NTM revenue multiple, and average NTM revenue multiple since its IPO in 2004. While the company has traded from 1.5x NTM revenue to almost 12x NTM revenue, for the most part, it has traded from 5-8x NTM revenue (6.6x average). With a relatively stable multiple, durable revenue growth has resulted in significant share price appreciation, up 69.5x from IPO.
Source: CIQ as of 15-Aug-2022
ServiceNow Implied ARR and Growth ($M)
ServiceNow (NYSE:NOW) is another strong example. The company has grown its implied ARR almost 106x from $66M in Sep-2010 to over $7B today, representing an implied ARR CAGR of 49% since their first quarter of disclosure.
Source: CIQ as of 15-Aug-2022
ServiceNow Share Price and NTM Revenue Multiple
The following chart shows ServiceNow’s stock price, NTM revenue multiple, and average NTM revenue multiple since its IPO in 2012. ServiceNow has traded between 5.5x and 21.5x (average of 12.9x) and its share price is up 28x from IPO. ServiceNow’s NTM revenue multiple has come down since their early days as a public company, but durable revenue growth (and strong free cash flow margins) have driven significant gains.
Source: CIQ as of 15-Aug-2022
Five9 Implied ARR and Growth ($M)
Five9 (NasdaqGM:FIVN) is a unique example. The company has grown its implied ARR by over 13x from $57M in Mar-2012 to almost $760M in almost 11 years, representing an implied ARR CAGR of 29% since its first quarter of disclosure. While COVID accelerated its revenue growth, unlike the other two examples that grew very fast at a smaller scale, Five9 was growing at 23% YoY when they crossed $100M of implied ARR but kept that growth rate for a long period of time. Companies create value on their own trajectory and the Five9 example shows that you don’t need to grow at a super high rate (even at a smaller scale) to create significant value, but that your growth rate must be durable.
Source: CIQ as of 15-Aug-2022
Five9 Share Price and NTM Revenue Multiple
Five9’s top-line growth rate has been consistent, but it has seen multiple expansion as a public company. For the first 3 years as a public company it traded <5x NTM revenue and while it had a bump during COVID (as did most public SaaS companies) and when they were under LOI to be acquired by Zoom, the company has retreated back to <10x NTM revenue. Its average multiple has been 9.4x NTM revenue. Durable growth (and an expanding NTM revenue multiple) has helped the company achieve almost a 17x return as a public company.
Source: CIQ as of 15-Aug-2022
While these are only three companies, they have been public for a long period of time and have had exceptional durable growth rates. When comparing share price MOIC and implied ARR growth since the first disclosure periods, they are all essentially on the same trendline with an r-squared of 0.99.
Source: CIQ as of 15-Aug-2022
And when looking at share price MOIC and their respective revenue CAGRs for these three companies, there is absolutely zero correlation (see below). This makes sense: each company has a different end market, starting point, margin profile, varying organic vs. inorganic growth rates, etc., but the point remains that durable growth eventually outweighs all other factors and it’s even more pronounced the longer companies are public.
Source: CIQ as of 15-Aug-2022
(5) Closing Thoughts
For public SaaS companies, durable growth is the most important factor in long-term value creation. And while short-term dramatic market movements (as we have seen this year) can create or destroy significant value for companies, durable revenue growth over time will outpace negative changes in multiples and dilution. High share price returns in the public markets for SaaS companies are about time in the market vs. market timing. No surprise, the power of compounding is evident in public SaaS returns just like it is in anything else.
One important caveat here: this analysis does not include the associated margins, cash burn, or overall efficiency of the group of companies in relation to their valuation multiples. Efficiency and strong unit economics are, of course, required if a company is to remain in the public markets for a long time. If you’re not efficient; cash will run low, you’ll be forced to raise dilutive primary capital and / or growth will be forced to slow, stock price can fall, and you may ultimately be acquired, removing you from the public markets and likely capping return potential in the process.
Today, public SaaS companies are more closely valued on revenue growth and efficiency vs. just revenue growth, but that has changed more recently. Early on, private SaaS companies spend more to grow rapidly to help find product-market fit and capture market share, but as a company matures, revenue growth paired with efficiency starts to determine valuation. For later-stage SaaS companies, for example, in the $100M+ revenue or ARR range, there should be significant consideration of the investments required to attain a certain level of growth. There are of course lots of nuances under the hood of an operating model, but the big question for a $100M+ SaaS company to ask is: how much am I burning to achieve, say, 85% year-over-year revenue growth, and if I were to grow 60% year-over-year how much would be saved? And in doing so, does my company stay ahead competitively? As shown with this analysis, the compounding nature of growth – and not the absolute growth rate – ultimately determines returns in the public markets, so this becomes a very important question companies should be asking in this market environment where capital is more scarce. And of course, there are many ways to grow – spend more on marketing to acquire more leads, hire more account executives (salespeople) to sell the product to those leads, launch new products to attach to the base of customers, acquire companies to grow revenue and expand TAM, etc. But growing, not with the fastest growth rate but with the most durable one, is the best way to ensure success (and high returns!) as a public SaaS company.
*Meritech Capital is a current or former shareholder in Alteryx, Amplitude, Box, Braze, Datadog, Domo, JFrog, Okta, Salesforce, Snowflake, Twilio, and UiPath.
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