Cloud Index: EBITDA Margins versus Revenue Growth

I got a lot of good feedback on my last post on SaaS: Should You Fix EBITDA Margins or Revenue Growth? The main criticism was that the companies of each cell were not true peer-companies and a such not comparable. I admit that perhaps it was a bad judgment using these companies to illustrate NTM revenue growth and EBITDA margin dependencies of valuations. My point was to make people aware of the variance in NTM revenue multiplies, and how EBITDA margin and revenue growth can affect these multiples.

For years now Byron Deeter at Bessemer Ventures is publishing great insights about the State of the Cloud Industry as well as the BVP Cloud Index, tracking 36 publicly traded cloud companies versus NASDAQ, S&P, and Dow Jones Indexes. Let’s look at these companies for a change:

NTM Revenue Multiples Companies -- Cloud
36 public companies from Bessemer Cloud Index, segmented by EBITDA margin and NTM revenue growth, as of 03/08/2018 (via Capital IQ)

36 companies are not quite enough to fill the matrix with meaningful data: Qualys and LivePerson inhabit their own cell. Below is more data for each of the cells.

 

NTM Revenue Multiples -- Cloud
NTM revenue multiples (low quartile, median, top quartile) of 36 public companies from Bessemer Cloud Index, segmented by EBITDA margin and NTM revenue growth, as of 03/08/2018 (via Capital IQ)

Similar to the previous post, each line in each cell means:

  1. # companies with that EBITDA margin and NTM revenue growth estimates, with an average of these companies of <x% EBITDA margin> @ <y% NTM revenue growth>
  2. Companies in that cell on average traded at their <x%> 52-week high of their stock price on 03/08/2018 when I pulled the data, and they have a <y.y> beta compared to the market.
  3. Average <x%> gross margin
  4. Average <x.x> credit health from 1 (great) to 4 (worst). Capital IQ provides an overall company score based on 24 line-items and ratio ranks across three panels: Operational (12 metrics), Solvency (7 metrics), and Liquidity (5 metrics).
  5. Top quartile NTM revenue multiple of Total Enterprise Value
  6. Median NTM revenue multiple of Total Enterprise Value
  7. Low Quartile NTM revenue multiple of Total Enterprise Value

Option 1: Get Better Within Your Peer Group

That, of course, is generally a good idea. What I mean is: Can you improve within your “cell” in the table above? What happens if you improve from a bottom quartile company to a median or even top quartile company within your cell? Will the valuation effect outperform potential downside from higher cost, lower revenue growth, or other side effects on your valuation? As one can see from the table below with NTM revenue multiples of Total Enterprise Value, not all cells have equal “mobility”:

Cloud -- increase within cell

Option 2: Improve EBITDA Margin

Could you improve your EBITDA margin to land in a different peer group? How would that impact your NTM revenue multiples and Total Enterprise Value? The arrows below show two scenarios: (A) You move from a top-quartile company in your cell to a bottom-quartile company in the next higher cell; (B) you move from a median company in your cell to a median company in the next higher cell.

Again, this is not a good idea. The companies in the cells are not true peers and are not entirely comparable. For example, WorkDay’s 25% NTM revenue growth rate at LTM revenue of $2,143m has a more drastic effect on value creation than AppFolio’s 26% NTM revenue growth rate at LTM revenue of $144m.

Cloud -- increase EBITDA margin
Effects of increasing EBITDA margin – this does not make sense as the companies in the cells are not true peers and are not entirely comparable.

Option 3: Increase NTM Revenue Growth

Again we are looking at the two scenarios: (A) You move from a top-quartile company in your cell to a bottom-quartile company in the next higher revenue growth cell to the right; (B) you move from a median company in your cell to a median company in the next higher revenue growth cell to the right. The case for (A) could be that you sacrifice some EBITDA margin to increase revenue growth, but that comes at a valuation cost. Now, if your decrease in the percentage of NTM revenue multiple is offset by the NTM revenue gain, then your subsequent gain will outweigh the slight decrease in the multiple.

The “decay” in NTM revenue multiples in the 0% to 15% EBITDA margin row will not always get offset by the actual amount of revenue gains: Five9 is valued 7.72x NTM revenue at estimated 16.3% NTM revenue growth rate. Paylocity is valued 6.52x NTM revenue at estimated 21.7% NTM revenue growth rate. Five9 has about $200m LTM revenue. If Five9 could match Paylocities growth rate, and all other things being equal, the difference for Five9 would be $1,796m versus only 1,587m!

The multiple-increase on the bottom row, for EBITDA margin <0%, seems astonishing. But keep in mind that NTM revenue growth is compounding and that multiples reflect a multi-year payback/growth expectation. Callidus has a 7.43x multiple on 19.5% estimated NTM revenue growth and -2.2% EBITDA margin, at $253m LTM revenue. Q2 has a 7.97x multiple on 21.3% estimated NTM revenue growth and -7.7% EBITDA margin.  All other things being equal (which of course they are not, but just for the case of this argument), Callidus’ valuation would increase from $2,246m to 2,446m if it could finance an increase of NTM revenue by 1.8% (or $4.6m) while spending less than $14m.

Cloud -- increase NTM revenue growth

These are a bit academic examples. My point here is to think about financing EBITDA margin expansion, revenue growth, or becoming more competitive within your specific peer group — and know the price, cost, and value of any activity you undertake.

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