Seeking Alpha

Correction In SaaS, Finally

by: Jonathan Ang

Update on 'best of breed' enterprise SaaS market post Q2 earnings season.

Industry and corporate developments point to hybrid cloud capabilities being key for success.

Use the correction to accumulate companies with efficient sales models.


Enterprise software is software used by companies and organizations. Global trends which are a tailwind to enterprise software companies include the movement of workloads to the cloud, digital transformation, DevOps and the coming of age of Artificial Intelligence.

This article is an update article post Q219 (May to August 2019) of the 'best of breed' enterprise SaaS market, as represented by the following 30 companies (Enterprise SaaS Group). Crowdstrike (OTC:CRWD) was added post its successful IPO.

Of the companies, Pivotal (PVTL) and Carbon Black (CBLK) are set to be acquired by VmWare (VMW) and will be removed from the group from the next update. These 2 acquisitions were timed rather opportunistically as the Companies' market price had dropped rather substantially this year.

Developments this quarter point to a hybrid-cloud and multi-cloud future in the enterprise space, with ongoing integration of different technologies into increasingly larger platforms.

We also finally witnessed a correction in the space in the last 2 months, which provides an interesting opportunity to selectively accumulate top tier companies.

Price Performance and Overall Valuations

Year to date, the IGV is up 23.93% vs 19.59% for the S&P 500. The performance gap has closed since mid July where there was a rotation from momentum stocks to value stocks. Prior to that rotation, SaaS companies traded like a safe haven sector where returns tended to outperform the market on risk-off trading sessions. The Enterprise SaaS Group has outperformed year to date with a median return of 26.7, down from 33.3% as of the last update. There is significant divergence in the individual company returns, with Zoom (ZS), Shopify (SHOP) and Coupa (COUP) having more than doubled year to date (albeit having corrected recently) while a handful of companies have negative returns.

Overall valuations come down since my last update, with the median Enterprise Value (EV) / trailing twelve months (TTM) revenue multiple dropping to 11.9X (from 13.4X). That said, multiples are still significantly higher than from 2016 and 2017.

Again, we see significant divergence in valuations, with new IPO favorites Zoom and Crowdstrike (OTC:CRWD) trading at over 40X multiples.

Operating Metrics and Relative Valuation

To give a better idea of relative valuation, the charts below compare the EV/NTM sales multiples of the companies with (1) the NTM estimated growth in sales, and (2) NTM estimated growth plus operating margins. The latter takes into account the profitability (or lack thereof) of a company in addition to the estimated forward growth rate.

Zoom remains a clear outlier. In general, valuations have converged somewhat with companies such as Coupa, Shopify and Okta (OKTA) having corrected recently while previous laggards such as Cloudera, Nutanix and Pivotal have rebounded. Cloudera, Nutanix and Pivotal had fallen too far which made them M&A targets - VmWare is buying Pivotal, there was market talk about Nutanix being acquired by Google and Carl Icahn has accumulated a significant stake in Cloudera.

The table below gives an overview of the companies in the Enterprise SaaS Group and their current operating and valuation metrics.

Industry Updates and Developments

Application Performance Monitoring (NASDAQ:APM) and Security Information and Event Management (SIEM) space getting increasingly complicated and competitive

There have been a number of significant developments in the space in recent months.

Firstly, Splunk (SPLK) (which is primarily known for its SIEM solution) announced the acquisition of SignalFX for just over a billion dollars. SignalFX offers real-time cloud monitoring solutions, including application monitoring and infrastructure monitoring.

Second, Elastic (ESTC) has started taking steps towards building out a SIEM solution after having previously developed its own APM solution leveraging on its core log, search, and analytics stack.

Thirdly, Datadog (DDOG) is about to enter the public market and with it gain significant new funds to aggressively go after market share. Starting from an infrastructure monitoring offering, Datadog now offer a full suite of products including log management and APM as well.

In New Relic's (NEWR) recent earnings call, they cited that 'competitive pressures have increased with more work needed to win a deal compared to before'. On reduced guidance, shares fell almost 30% the day after earnings.

The trend appears to be towards building a unified platform offering customers a single pane of glass view across the entire technology stack including various forms of infrastructure (public cloud, private cloud, on-premise) and applications. This fits into the broader multi/hybrid cloud trend and the author believes one can expect further consolidation (both from a technology and M&A perspective) in the days ahead. That said, this is a growing space with an increasingly multi/hybrid cloud world necessitating more sophisticated monitoring solutions.

Datadog's post-IPO performance should be tracked and any significant correction would likely be a buying opportunity in a leader in the space. New Relic could be a buying opportunity with its recent sharp drop provided it is able to maintain its competitive position amid increasing competition.

Powered by the Kubernetes revolution, the race is on to dominate multi and hybrid cloud

Following IBM's acquisition of Red Hat (the leader in Kubernetes through OpenShift), VMWare emphasized at VMWorld that it is moving to position itself as the multi/hybrid cloud of choice. VMWare is fully embracing Kubernetes, incorporating it into its flagship vSphere virtualization software and also announcing the acquisition of Pivotal who previously announced that its flagship product Pivotal Application Service will have a Kubernetes core. VMWare has also been expanding its public cloud partnerships - apart from its preferred partnership with AWS, VMWare has expanded partnerships with IBM, Azure and Google Cloud.

In an attempt to come back from the dead and compete with the public cloud companies, Cloudera will be officially launching Cloudera Data Platform in September. Branded as the first and only enterprise data cloud in the marketplace, the Company is seeking to support hybrid and multi-cloud needs by providing common data management capabilities across on-premise infrastructure, private clouds, and public clouds. The Company is betting that the largest enterprises are looking to avoid cloud lock-in and have a common platform across all environments. By the way, Carl Icahn happened to accumulate a significant stake in the Company and also obtained 2 board seats.

Priced to perfection

Coming into earnings season, a few high flying companies such as Crowdstrike (OTC:CRWD), Zoom (ZM), OKTA (OKTA) and Zscaler (ZS) were trading at Enterprise Value (NYSE:EV) / next twelve months (NTM) revenue multiples above 20 (above 30 in the case of Zoom and Crowdstrike).

High multiples means little room for error and so despite the Companies reporting a 'beat and raise' in terms of revenue, stock prices fell in the day after earnings (CRWD: -12.5%; ZM: -7.85%; OKTA: -4.5%; ZS: -19.4%).

That said, these Companies are best in class in terms of growth as well as sales efficiency and so a deeper correction in price could open up a buying opportunity.


With the recent correction in momentum names, this could be an opportunity to accumulate best of breed names. Names on my watch list include Zscaler (ZS), Workday (WDAY), Elastic (ESTC), Altassian (TEAM), Adobe (ADBE) and MongoDb (MDB). These are names with a more efficient sales model - i.e. less marketing spend is required to add additional recurring revenue adjusted for gross margin, which is a good indicator of product differentiation and/or superior execution. Apart from valuation, the two most important factors in my opinion are sales efficiency and the total addressable market.

On the value front, Nutanix and New Relic present interesting opportunities provided they are able to compete effectively in more competitive markets - could be worth exploring a started position and adding if future earnings releases are positive.

From my previous update, I have divested Pivotal after the announced acquisition by VmWare. I continue to hold Cloudera with a view to assessing whether the Cloudera Data Platform is able to gain traction.

Disclosure: I am/we are long ZS, CLDR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.