Great write-up, Pat. For argument's sake, will take the other side:
1/ Can't pay fixed charges with ARRs. Mr. Market is clearly stating that in a recessionary environment FCF positive operators should be valued at a premium vs. those with a potential to get there. You say buy the blue b/c it's going to green, but the market is saying the blues haven't yet figured out how to convert to revenue to cash (likely since their APE is too low vs. cash burn) and we are not certain that they ever will (e.g., they are more likely to become red vs. green).
2/ If you are institutional/patient capital, why not wait 1 (or 2 or 3...) more quarters and see if valuations continue to slide, given macro? Decent chance we aren't at the bottom yet (pg. 4, bottom tables), so would expect valuations to continue to deflate, making a more attractive bargain to come in later. For ex., the % of companies in the >30% NTM growth is the same in Q1'22 vs. FY'21 (pg. 3), but fewer of them (13) are growing at a 40% growth rate than just 1 quarter ago (17). Sometimes being too early (and correct) is not too far off from being wrong.
IMO, a fairer question should be not whether we should be investing in SaaS growth (personal/biased view is a resounding "yes"), but how much we should be willing to pay for it. Top of pg. 4 is helpful. >40% NTM growth aside, all categories of growth SaaS are now "cheaper" vs. what they were in '19 and almost as "cheap" as what they were in '17. So, what's the right attachment point? As always, DYODD :)
1) Minor quibble - my argument is that the blues have a good shot at becoming yellows, not greens. If blues could be greens then they would already be greens, so I don't expect any of the blues to become greens, greens are rare and they deserve their multiples. My point is just that if you believe that SaaS is a strong business model, you likely believe that a blue is just a yellow that has chosen to prioritize growth for the time being due to attractive unit economics. If a yellow is just a mature blue, then yellows should trade at a lower revenue multiple than blues (because they are larger and slower-growing), which means the state of the world where blues are cheaper than yellows is a temporary inversion that only exists while Mr Market is demanding FCF. I guess my position is that the likelihood of blue going to yellow is greater than what Mr Market believes it is right now, and that Mr Market is irrationally over-valuing near term FCF (and Mr Market felt completely differently about this in December lol).
2) This is exactly where my argument is weakest - market timing is not in my skill set. That's what we need people like you for. I bought a ton of growth in March-- certainly with the benefit of hindsight I should have waited, but it cleared my bar for "value" at the time.
3) One thing that makes revenue multiples super confusing is that these are all durable growth businesses. I think a lot about this chart -- https://twitter.com/DavidSacks/status/1521914723616247810 -- say you bought a bunch of SaaS in 2016 at 6x and then sold it in 2021 at 15x. So you got 2.5x return from multiple expansion, but if the companies also grew revenue at 25% CAGR, then ARR grew 3x in 5 years and you made a 7.5x return overall (49% IRR). That makes me feel like you can live in a world where multiples stay at '19 or '17 multiples (rather than needing to bet on multiple expansion again) as long as you're buying a business with durable growth persistence, and that means high DBNR companies. So... I think you should pay a lot for growth if it has a high likelihood of persisting for 5+ years, which would make a lot of these companies pretty sizable in just a few years.
Great write-up, Pat. For argument's sake, will take the other side:
1/ Can't pay fixed charges with ARRs. Mr. Market is clearly stating that in a recessionary environment FCF positive operators should be valued at a premium vs. those with a potential to get there. You say buy the blue b/c it's going to green, but the market is saying the blues haven't yet figured out how to convert to revenue to cash (likely since their APE is too low vs. cash burn) and we are not certain that they ever will (e.g., they are more likely to become red vs. green).
2/ If you are institutional/patient capital, why not wait 1 (or 2 or 3...) more quarters and see if valuations continue to slide, given macro? Decent chance we aren't at the bottom yet (pg. 4, bottom tables), so would expect valuations to continue to deflate, making a more attractive bargain to come in later. For ex., the % of companies in the >30% NTM growth is the same in Q1'22 vs. FY'21 (pg. 3), but fewer of them (13) are growing at a 40% growth rate than just 1 quarter ago (17). Sometimes being too early (and correct) is not too far off from being wrong.
IMO, a fairer question should be not whether we should be investing in SaaS growth (personal/biased view is a resounding "yes"), but how much we should be willing to pay for it. Top of pg. 4 is helpful. >40% NTM growth aside, all categories of growth SaaS are now "cheaper" vs. what they were in '19 and almost as "cheap" as what they were in '17. So, what's the right attachment point? As always, DYODD :)
1) Minor quibble - my argument is that the blues have a good shot at becoming yellows, not greens. If blues could be greens then they would already be greens, so I don't expect any of the blues to become greens, greens are rare and they deserve their multiples. My point is just that if you believe that SaaS is a strong business model, you likely believe that a blue is just a yellow that has chosen to prioritize growth for the time being due to attractive unit economics. If a yellow is just a mature blue, then yellows should trade at a lower revenue multiple than blues (because they are larger and slower-growing), which means the state of the world where blues are cheaper than yellows is a temporary inversion that only exists while Mr Market is demanding FCF. I guess my position is that the likelihood of blue going to yellow is greater than what Mr Market believes it is right now, and that Mr Market is irrationally over-valuing near term FCF (and Mr Market felt completely differently about this in December lol).
2) This is exactly where my argument is weakest - market timing is not in my skill set. That's what we need people like you for. I bought a ton of growth in March-- certainly with the benefit of hindsight I should have waited, but it cleared my bar for "value" at the time.
3) One thing that makes revenue multiples super confusing is that these are all durable growth businesses. I think a lot about this chart -- https://twitter.com/DavidSacks/status/1521914723616247810 -- say you bought a bunch of SaaS in 2016 at 6x and then sold it in 2021 at 15x. So you got 2.5x return from multiple expansion, but if the companies also grew revenue at 25% CAGR, then ARR grew 3x in 5 years and you made a 7.5x return overall (49% IRR). That makes me feel like you can live in a world where multiples stay at '19 or '17 multiples (rather than needing to bet on multiple expansion again) as long as you're buying a business with durable growth persistence, and that means high DBNR companies. So... I think you should pay a lot for growth if it has a high likelihood of persisting for 5+ years, which would make a lot of these companies pretty sizable in just a few years.
Would love to see a version of that Battery slide with the companies labelled (especially in the blue zone) - do you know if that exists?
https://drive.google.com/file/d/1w5Loauoscukg5J4ytV-GtKF0CrPeyKon/view