AGC's Q2 '24 SaaS Flash Market Update

Public institutional buyers are paying a 60% premium on the valuation of large cap SaaS companies versus small cap, even though the two cohorts have virtually identical performance metrics of roughly 49% on Ro40, 17% growth, and 32% EBITDA margins.

The public institutional buyers prefer to invest in large cap SaaS for: (i) higher predictability and stability, (ii) larger TAM with more room for long term growth, (iii) putting much bigger dollars to work, and (iv) more liquidity, as newly minted IPOs have very little float, making it hard to buy or sell without disturbing the share price. Recent private SaaS companies' PE Recaps with 50% on the rule of 40 between $10M and $100M revenues are trading at 10x-14x '24 revenue which is obviously an awesome 100% premium to the small cap public comps. The scale required to go public is at least $300M revenue and a $2B market cap. Highly successful private SaaS companies between $10M and $1B in revenue will face this small cap IPO discount when it comes time to consider IPO / exits – there will be exceptions like Datadog (15.8x) and Snowflake (17.6x). The lower performing small cap SaaS companies trade in a wide range from 1x – 10x EV / '24 revenue, with a median of 3.9x, very much in line with what we are seeing on the private market for those performing below the Ro40. As we were pulling this analysis together, Thoma announced the acquisition of Darktrace, which pre-deal was trading at 5.0x revenue and was bought for 8.1x. Then, Synopsys sold its Software Integrity Business to Clearlake and Francisco Partners for $2.1B. These deals highlight an ongoing question – is the public market under valuing the small cap SaaS companies, or is the private PE market over valuing these same companies?

There is a massive spread in valuations now between the top SaaS decile, trading at 17.9x revenues and the bottom decile, trading at 1.1x, which also correlates with Ro40 performance at 45% and 9% respectively. Interestingly, the top 9th and 10th deciles are almost identical on Ro40, but the differential in valuation is 17.9x vs. 11.1x, and that lift is entirely driven by the 10th decile's superior growth rate, which is 23% versus 17%. Growth matters as much as it ever has. Looking at the bottom 3rd of SaaS performers, you now have a wasteland of 45 companies with a median of 2x revenues, which actually have a pretty good Ro40 of 21% ☺. We also see further disparity in valuations by sector, as DevOps and Built Ecosystem are now trading at 8.3x '24 revenues while MarTech and HCIT are trading at 3.6x revenues. MarTech and HCIT companies are predominantly small cap. A big part of that is not just sector, but growth rates, as the lower performers are growing at 11% and top performers are growing at 16%. Same is true for European SaaS companies. Once again, bigger is better in SaaS land.

The public institutional buyers prefer to invest in large cap SaaS for: (i) higher predictability and stability, (ii) larger TAM with more room for long term growth, (iii) putting much bigger dollars to work, and (iv) more liquidity, as newly minted IPOs have very little float, making it hard to buy or sell without disturbing the share price. Recent private SaaS companies' PE Recaps with 50% on the rule of 40 between $10M and $100M revenues are trading at 10x-14x '24 revenue which is obviously an awesome 100% premium to the small cap public comps. The scale required to go public is at least $300M revenue and a $2B market cap. Highly successful private SaaS companies between $10M and $1B in revenue will face this small cap IPO discount when it comes time to consider IPO / exits – there will be exceptions like Datadog (15.8x) and Snowflake (17.6x). The lower performing small cap SaaS companies trade in a wide range from 1x – 10x EV / '24 revenue, with a median of 3.9x, very much in line with what we are seeing on the private market for those performing below the Ro40. As we were pulling this analysis together, Thoma announced the acquisition of Darktrace, which pre-deal was trading at 5.0x revenue and was bought for 8.1x. Then, Synopsys sold its Software Integrity Business to Clearlake and Francisco Partners for $2.1B. These deals highlight an ongoing question – is the public market under valuing the small cap SaaS companies, or is the private PE market over valuing these same companies?

There is a massive spread in valuations now between the top SaaS decile, trading at 17.9x revenues and the bottom decile, trading at 1.1x, which also correlates with Ro40 performance at 45% and 9% respectively. Interestingly, the top 9th and 10th deciles are almost identical on Ro40, but the differential in valuation is 17.9x vs. 11.1x, and that lift is entirely driven by the 10th decile's superior growth rate, which is 23% versus 17%. Growth matters as much as it ever has. Looking at the bottom 3rd of SaaS performers, you now have a wasteland of 45 companies with a median of 2x revenues, which actually have a pretty good Ro40 of 21% ☺. We also see further disparity in valuations by sector, as DevOps and Built Ecosystem are now trading at 8.3x '24 revenues while MarTech and HCIT are trading at 3.6x revenues. MarTech and HCIT companies are predominantly small cap. A big part of that is not just sector, but growth rates, as the lower performers are growing at 11% and top performers are growing at 16%. Same is true for European SaaS companies. Once again, bigger is better in SaaS land.

As larger SaaS PE portcos back up in the queue (over 5,300) for either sale or IPO, the public strategics continue to be unlikely buyers and the IPO market is not serving up very attractive valuations. The IPO market is valuing the Rule of 50, $600M in revenue SaaS companies at 6x revenue and 21x EBITDA which effectively leaves only the PE buyers to provide an exit for liquidity at a premium valuation. So, you can hope for the large cap premium comps for your SaaS IPO candidates with $600M in revenue for 12x revenue and 29x EBITDA, but the real comps, post the IPO pop, may be among their smaller cap peers. Clearly the small cap public Ro50 companies with more growth than profit are trading at a premium as high as 11x, but they are still constrained by the small cap public market discount. Take Klaviyo, a smaller cap firm, which is growing at 29% and trading at 6.7x versus the larger cap Cloudflare, also growing at 28%, and is trading at 18.0x. Yes, there are lots of other differences between these two companies other than size, but thought provoking nevertheless.

Many of the PEs are built to add value in their portfolios through acquisitions, which includes not only capital, but experienced manpower as well, with an unapologetic mandate to do as many quality acquisitions as possible. The public strategics since even before COVID, have reduced their velocity of acquisitions, taking it down further post-COVID. Post-COVID, there has also been a big push by strategics to integrate their COVID acquisitions and improve profitability. In recent conversations with Microsoft and other big tech strategics, the large cap tech companies have been single mindedly focusing on building out and commercializing their internal GenAI capabilities over acquisitions. It may be a world where big tech is providing the AI platform for LLM and infrastructure capabilities and many of the new GenAI startups will be sector specific, leveraging technologies for those platforms, like the cloud market today. The combination of the acquisitional acceleration in the PE community and deceleration in the strategic community has created a 4:1 differential in the volume of PE portco acquisitions versus public strategics.

Many of the PEs are built to add value in their portfolios through acquisitions, which includes not only capital, but experienced manpower as well, with an unapologetic mandate to do as many quality acquisitions as possible. The public strategics since even before COVID, have reduced their velocity of acquisitions, taking it down further post-COVID. Post-COVID, there has also been a big push by strategics to integrate their COVID acquisitions and improve profitability. In recent conversations with Microsoft and other big tech strategics, the large cap tech companies have been single mindedly focusing on building out and commercializing their internal GenAI capabilities over acquisitions. It may be a world where big tech is providing the AI platform for LLM and infrastructure capabilities and many of the new GenAI startups will be sector specific, leveraging technologies for those platforms, like the cloud market today. The combination of the acquisitional acceleration in the PE community and deceleration in the strategic community has created a 4:1 differential in the volume of PE portco acquisitions versus public strategics.

There are several possible trends that may emerge from this massive gap in valuations between the small cap public SaaS companies and virtually all the premium performing private SaaS companies.

• Small SaaS IPOs that are not uber growers or heavily AI will remain rare

• More PE take-privates like Darktrace because the PEs can do some more optimization / acquisitions and hope they have a more friendly IPO market or sell to a strategic or another PE in 4 to 7 years

• Increase in large public SaaS companies' acquisition of the smaller publics because of the valuation gap and future optimization opportunities – has yet to happen!

• Small cap valuations could rise because of anticipation of a buyout

The undeniable take away from the harsh realities of small cap IPOs is that the PEs will continue to dominate the SaaS market for full exits and recapitalizations. The tech funds continue to announce ever more and larger funds in 2024, increasing the amount of dry powder while supply of premium SaaS companies will remain scarce. PEs are also leaning more heavily to control deals for lots of reasons, not the least of which is to drive more optimization and higher returns through acquisitions. So, with a continued proliferation of funds and more capital, PEs and their portcos will continue to bid up the valuations of the premium SaaS companies, creating an ever larger and more insulated PE ecosystem. Once these PE companies get to the scale of Cloudflare with revenue of $1.7B and profitability of 18%, then they can go public at 18x revenue with mere mortal growth rates of 28% ☺.

There is still lots to play out, particularly when growth rates start to pick up in the SaaS world. We are seeing a significant increase in new engagements with 10 in the last 30 days, with a possible surge in Q4 closings ahead.