Fast Growth SaaS Companies - OPEXEngine · FASTGROWTH!SAAS!...

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FAST GROWTH SAAS

A white paper from OPEXEngine on key indicators of value in fast growth SaaS companies. Includes financial results from 3 different highly valuable public SaaS vendors at the time of IPO and the most recent period. OPEXENGINE 2018 ALL RIGHTS RESERVED

FAST GROWTH SAAS

2018 OPEXEngine www.opexengine.com

Fast Growth SaaS SaaS Market Software-as-a-Service (SaaS), where vendors deliver business applications to customers over the internet on a subscription basis, continues to be one of the fastest growing sectors in the world. Gartner reports an annual growth rate of 20% for SaaS sales. This sector remains the second largest segment in the global Cloud services market, the largest of Cloud business services after the Cloud advertising market.

Customers have shown a strong preference to access software through the Cloud and the SaaS market is expected to reach $76B by 2020. As the market has grown and customer preference has been validated, thousands of SaaS vendors around the world have entered the market.

2016 2017 2018 2019 2020

SaaS Market $ 38.57B $46.33B $55.14B $64.87B $75.73B

Source: Gartner 2017

This paper looks at the key indicators of fast growth SaaS vendors and the key metrics valued by investors and public markets. Financials from three highly valuable SaaS vendors: SalesForce.com Inc., Netsuite and Hubspot are presented for the period two years before IPO and for two years after IPO to show how the performance of these high growth companies evolved as they grew from private to public vendors. In addition, market valuation metrics indicate how investors valued their performance.

Key Indicators of SaaS Valuation Successful and valuable SaaS companies sustain a record of strong revenue growth and profitable economics at the unit or customer level. These two key performance indicators (KPIs) define a valuable SaaS company for management and investors. Of the two


indicators, the revenue growth rate appears to be most closely aligned to market capitalization.

Every SaaS vendor that has gone public since 2004 has demonstrated strong revenue momentum:

• In 2004, the year of SalesForce’s IPO, it reported revenue growth of 88.3% on almost $100M in revenues.

• In 2007, the year of Netsuite’s IPO, it reported revenue growth of 61.5% on revenue of $109M.

• In 2012, the year of Workday’s IPO, it reported revenue growth of 104% on $274M in revenues.

Revenue momentum over 50% growth rates is the norm for pre-IPO companies in the $50M-$100M revenue range, with gradual slowing between $100M-$1B.

• In January 2017, SalesForce reported an annual revenue growth rate of 26% on $8.4B in revenues.

• In January 2017, Workday posted revenue growth of 35% on $1.6B in revenues.

The most valuable companies manage to keep revenue growth rates above 30% through $1B. SalesForce continues to achieve almost 30% revenue growth as it approaches $10B.

Unit Economics A valuable SaaS business is a high growth business that continually adds and keeps subscribers in an efficient process which is profitable at the unit or customer level. This is a process which is not easily captured through traditional, point-in-time financial metrics.

Unit economics are captured through a number of indicators, all non-GAAP indicators. The critical indicators of unit economics are measurements of:


• Customer Acquisition Cost (CAC) – the cost of acquiring an average new customer. Calculated by dividing sales and marketing expense associated with new customer acquisition by the number of new customers acquired.

• CAC pay-back period – the number of months of recurring revenue required to pay back the average cost of acquiring a new customer.

• Cost to maintain a customer – the total cost of hosting and supporting a customer. This metric is typically calculated by adding all expenses associated with the annual hosting and support of customers and dividing by the total number of paying customers. Hosting, non-billable support, customer success and costs associated with renewing contracts are typically included.

• Retention rate of customers – the percentage of customers that renew their contracts in a year. This metric is sometimes referred to as “Logo retention.”

• Net dollar retention rate – the retention and increase (or decrease) in the value of customer contracts in one year.

Fast Growth SaaS Rules of Thumb Investors and successful SaaS companies have established a few rules of thumb in terms of ideal ranges for key SaaS metrics. These standards vary depending on the SaaS business model: an SMB sales model of thousands of transactions versus an enterprise sales model with high average contract values sold to a relatively small number of large companies.


Here are a few of the most well-established Rules of Thumb:

• CAC for SMB sales or annual subscriptions under $20,000/year should be recovered in less than 12 months, ideally closer to six months. In other words, the cost of acquiring a new customer should be less than the value of the annual contract.

• CAC for enterprise sales or annual subscriptions more than $50,000/year may be in the 12+ month range, but should not exceed 18 months.

• The extent to which the pay-back period is over 12 months is valued in relation to the customer retention rate and amount by which an initial customer contract is typically increased. In other words, the payback period may be longer than the norm, if a vendor demonstrates a significant upsell track record with customers.

• Customer retention rates are ideally above 90% except in the case of vendors selling to small businesses (SMB). SMB retention rates may be in the mid-80% range, but new customer acquisition has to greatly exceed customer churn.

Enterprise versus Packaged Software Enterprise software is software designed to meet the needs of an enterprise or organization rather than the needs of an individual user. Enterprise software customers are typically larger organizations. Enterprise software usually can be customized, is more expensive and often requires integration with other systems. Vendors invest in expensive sales account reps, usually supported by technical pre-sales and business development reps (BDRs).

SMB software is sold to small organizations or companies (SMB market). The price points are lower in the SMB market and the applications are less customizable than enterprise software. Vendors selling SMB software typically invest more R&D to build and continually enhance self-serve web applications and marketing, than Enterprise software vendors.


• Net dollar retention rates should always be higher than the customer retention rate and indicate that the customer contract dollar values are not only being maintained, but increased.

• Net dollar retention rates are often over 100%.

A Financial Model that Investors Value: Rule of 40 There is much discussion in the SaaS investment community about the “Rule of 40,” which is an equation adding revenue growth to EBITDA margins targeting a sum of 40 or more. A SaaS company growing at 60% annual growth can have 20% negative margin, but a SaaS business growing at 30% annual revenue growth should have at least 10% EBITDA margin.

Public SaaS vendors that score higher than 40 average revenue multiples of 6.4 times TTM (through June 2017).

It is clear, though, that technology investors continue to value revenue growth MORE highly than operating income in the equation.

• Only seven of the 39 Cloud companies that have gone public since 2013 had positive EBITDA at the time of IPO.

• By comparison, 32 out of 53 companies that went public prior to 2013 had positive EBITDA.


Profitability at the Expense of Revenue Growth Companies that focus more on profitability at the expense of revenue growth may indicate to investors a limited market or customer opportunity despite the strong market growth of SaaS overall. In a recent OPEXEngine analysis of public SaaS companies, two sets of public companies were grouped, both meeting the definition of the “Rule of 40.”

The first group met the criteria with very high revenue growth rates, while the second group met the criteria with stronger profit rates. The first group had an average revenue to market cap multiple of 9.2X as of Dec.31, 2016. The second group had an average revenue to market cap multiple of 2.1X.

The group of profitable companies were maintaining strong customer retention rates, but had lower net dollar retention rates, implying that customer contract values were eroding. Depending on the company, this could be because the market and customer opportunity was eroding, or more likely, that the vendor was not investing enough to expand customer relationship with continued sales, marketing and product expansion. This model becomes much less valuable over time as reflected by market cap multiples.

Cloud Infrastructure to Support Growth Also Valued While companies need to demonstrate strong subscription revenue growth, sophisticated investors will also look at whether a company is preparing for sustained growth with a proven cloud infrastructure capable of supporting long-term customer expansion. A SaaS


company’s cloud infrastructure determines both its ability to add customers and grow their usage of a vendor’s products, as well as being critical to customer satisfaction which drives customer retention.

The market for third party cloud providers has matured enough that analysts generally feel these service providers are better able to provide the latest security and performance capabilities. SaaS companies can effectively leverage the ongoing investments made by service providers in cloud infrastructure and operations. This allows vendors to focus on their core applications and competitive advantages.

In recent research from the Harvard Business Review, analysts found that leveraging an external cloud service provider was more highly valued by investors than building and managing hosting environments internally.

“We found that partnering with an external cloud service provider to deliver SaaS (instead of building and managing the cloud infrastructure on your own) leads to a further 2.9% increase in stock price on the announcement day.” HBR Jan.12, 2017

In summary, a SaaS company’s cloud infrastructure is critical to:

• The velocity of adding customers

• Supporting customer growth and expansion

• Maintaining customer security and privacy

• Delivering high performance in the use of the vendor’s product(s)

• Determining the cost of maintaining each customer


Case Studies Fast growth SaaS companies that go public or aim to go public, need to carefully manage operations to achieve the KPIs that investors value. The following looks at the financial results from 3 successful SaaS companies. SalesForce.com Inc: SaaS CRM platform.

The company IPO’ed in 2004.

Netsuite Inc: SaaS ERP platform. The company IPO’ed in 2007.

Hubspot Inc: SaaS marketing management platform. The company IPO’ed in 2014.


FINANCIAL INSIGHTS REPORT: SALESFORCE.COM INC. Source: OPEXEngine EdgarEngine™ Company SALESFORCE COM Period Start Date/ End Date*** 2016 2004 2003 2002 AVERAGE ($000s) First year after IPO IPO-1 IPO-2 VALUATION COMPARISONS Market Cap (diluted, priced as of the period end date) $55 387 165 $1 518 974 na na $28 453 069 Revenue to Market Cap Multiple 6,60 8,61 na na 7,61

REVENUE COMPARISONS Recognized Revenue $8 391 984 $176 375 $96 023 $50 991 $2 178 843 Annual Revenue Growth 25,9% 83,7% 88,3% na 66,0% 3 Year Revenue CAGR 27,3% na na na 27,3% Recognized Revenue + Change in Deferred Revenue $9 630 006 $222 598 $126 529 $70 162 $2 512 324 Short-Term Deferred Revenue (This Period) $5 505 689 $95 900 $49 677 $19 171 $1 417 609 Deferred Revenue as a % of Recognized Revenue 65,6% 54,4% 51,7% 37,6% 52,3%

COST AND EXPENSE COMPARISONS Cost of Goods and Services Sold as a % of Revenue 26,6% 19,0% 18,0% 20,3% 21,0% S&M Expense as a % of Recognized Revenue 46,7% 54,6% 56,9% 65,7% 56,0% G&A Expense as a % of Recognized Revenue 11,5% 17,2% 17,6% 25,4% 17,9% SG&A Expense as a % of Recognized Revenue 58,2% 71,8% 74,5% 91,2% 73,9% R&D Expense as a % of Recognized Revenue 14,4% 5,6% 7,3% 9,1% 9,1% Total Operating Expense as % of Recognized Revenue * 72,6% 77,3% 78,1% 100,3% 82,1%

PROFITABILITY ANALYSIS COMPARISONS Gross Margin 73,4% 81,0% 82,0% 79,7% 79,0% Total Operating Income/Loss $64 228 $6 520 $3 718 ($10 500) $15 992 Total Operating Profit Margin 0,8% 3,7% 3,9% -20,6% -3,1% Total Pre-Tax Income/Loss $25 383 $9 153 $4 239 ($10 008) $7 192 Total Pre-Tax Margin 0,3% 5,2% 4,4% -19,6% -2,4% Total Net Income/Loss $179 632 $7 346 $3 514 ($9 716) $45 194 Total Net Margin 2,1% 4,2% 3,7% -19,1% -2,3% EBITDA $1 098 555 $25 265 $14 908 ($4 951) $283 444 After Tax Return On Assets 1,0% 2,6% 4,0% -24,5% -4,2%


CASH FLOW Cash as a % of Revenue 19,1% 20,3% 10,9% 17,1% 16,8% Cash from Operations $2 162 198 $55 872 $21 781 $5 213 $561 266 Annual Operating Cash Flow Growth 29,3% 156,5% 317,8% na 167,9% * Operating Expenses: May include other items not included in SGA and R&D, such as restructuring, one time expenses, etc.

** Headcount: Headcount data is as of the most recent full year, so Q1, Q2, and Q3 quarterly reports will reflect the headcount from the end of the previous year.

*** SalesForce.com's fiscal year end Jan. 31 of a new year, but for the purposes of this report, the year given is the previous year

Data Source: EDGAR Online (www.edgar-online.com) make no claims concerning the validity of the information provided hereby and will not be held liable for any use of this information. The information provided herein may be displayed and printed for your internal business use only and may not be reproduced, retransmitted, distributed, disseminated, sold, published, broadcast or circulated to anyone without the express written consent of EDGAR Online and OPEXEngine, LLC.


FINANCIAL INSIGHTS REPORT: NETSUITE INC. Source: OPEXEngine EdgarEngine™ Company NETSUITE INC

Reporting Period Full Year 2009

Full Year 2008

Full Year 2007

Full Year 2006

Full Year 2005 AVERAGE

($000s) Year of IPO IPO-1 IPO-2 VALUATION COMPARISONS Market Cap (diluted, priced as of the period end date) $989 817 $509 649 $382 945 na na $627 471 Revenue to Market Cap Multiple 5,94 3,34 3,53 na na 4,27

REVENUE COMPARISONS Recognized Revenue $166 540 $152 476 $108 541 $67 202 $36 356 $106 223 Annual Revenue Growth 9,2% 40,5% 61,5% na na 37,1% 3 Year Revenue CAGR 35,3% na na na na 35,3% Recognized Revenue + Change in Deferred Revenue $166 233 $153 268 $121 756 $85 893 $70 325 $119 495 Short-Term Deferred Revenue (This Period) $66 360 $66 667 $65 875 $52 660 $33 969 $57 106 Deferred Revenue as a % of Recognized Revenue 39,8% 43,7% 60,7% 78,4% 93,4% 63,2%

COST AND EXPENSE COMPARISONS Cost of Goods and Services Sold as a % of Revenue 33,7% 31,9% 31,1% 34,2% 42,9% 34,8% S&M Expense as a % of Recognized Revenue 45,7% 50,5% 53,4% 65,3% 107,8% 64,5% G&A Expense as a % of Recognized Revenue 17,5% 15,6% 15,4% 21,8% 37,6% 21,6% SG&A Expense as a % of Recognized Revenue 63,3% 66,1% 68,8% 87,1% 145,4% 86,1% R&D Expense as a % of Recognized Revenue 17,2% 14,1% 21,8% 30,8% 68,2% 30,4% Total Operating Expense as % of Recognized Revenue * 80,4% 80,2% 90,6% 117,9% 213,6% 116,5%

PROFITABILITY ANALYSIS COMPARISONS Gross Profit $110 435 $103 894 $74 775 $44 209 $20 749 $70 812 Gross Margin 66,3% 68,1% 68,9% 65,8% 57,1% 65,2% Total Operating Income/Loss ($23 522) ($18 369) ($23 580) ($34 992) ($56 895) ($31 472) Total Operating Profit Margin -14,1% -12,1% -21,7% -52,1% -156,5% -51,3% Total Pre-Tax Income/Loss ($23 472) ($15 904) ($23 786) ($35 319) ($57 265) ($31 149) Total Pre-Tax Margin -14,1% -10,4% -21,9% -52,6% -157,5% -51,3% Total Net Income/Loss ($23 304) ($15 864) ($23 906) ($35 722) ($57 664) ($31 292) Total Net Margin -14,0% -10,4% -22,0% -53,2% -158,6% -51,6% EBITDA $7 158 $11 274 ($447) ($19 646) ($46 235) ($9 579) After Tax Return On Assets -11,5% -7,5% -10,9% -74,3% -163,9% -53,7%


CASH FLOW AND BALANCE SHEET COMPARISONS Cash as a % of Revenue 57,9% 81,1% 156,1% 14,7% 4,6% 62,9% Cash from Operations $4 746 ($9 002) $4 119 $2 768 ($21 100) ($3 694) Cash Conversion Effectiveness - Operating Cash as a % of Revenue 2,8% -5,9% 3,8% 4,1% -58,0% -10,6% * Operating Expenses: May include other items not included in SGA and R&D, such as restructuring, one time expenses, etc.




FINANCIAL INSIGHTS REPORT: HUBSPOT INC. Source: OPEXEngine EdgarEngine™ Company HUBSPOT INC

Reporting Period Full Year 2016

Full Year 2015

Full Year 2014

Full Year 2013

Full Year 2012 AVERAGE

($000s) Year of IPO IPO-1 IPO-2 VALUATION COMPARISONS Market Cap (diluted, priced as of the period end date) $1 654 259 $1 870 731 $388 599 na na $1 304 530 Revenue to Market Cap Multiple 6,11 10,28 3,35 na na 6,58

REVENUE COMPARISONS Recognized Revenue $270 967 $181 943 $115 876 $77 634 $51 604 $139 605 Annual Revenue Growth 48,9% 57,0% 49,3% na na 51,7% 3 Year Revenue CAGR 51,7% na na na na 51,7% Recognized Revenue + Change in Deferred Revenue $301 986 $205 545 $132 019 $86 580 $67 320 $158 690 Short-Term Deferred Revenue (This Period) $95 426 $64 407 $40 805 $24 662 $15 716 $48 203 Deferred Revenue as a % of Recognized Revenue 35,2% 35,4% 35,2% 31,8% 30,5% 33,6% Mean Analyst Revenue Estimate (Current Year) $459 877 $459 877 $459 877 $459 877 $459 877 $459 877

COST AND EXPENSE COMPARISONS Cost of Goods and Services Sold as a % of Revenue 22,8% 26,3% 30,3% 35,4% 32,6% 29,5% S&M Expense as a % of Recognized Revenue 60,0% 61,9% 68,0% 68,5% 67,7% 65,2% G&A Expense as a % of Recognized Revenue 16,7% 19,5% 21,5% 20,9% 15,4% 18,8% SG&A Expense as a % of Recognized Revenue 76,7% 81,4% 89,6% 89,3% 83,2% 84,0% R&D Expense as a % of Recognized Revenue 17,0% 17,8% 22,1% 19,3% 20,5% 19,4% Total Operating Expense as % of Recognized Revenue * 93,7% 99,2% 111,7% 108,7% 103,7% 103,4%

PROFITABILITY ANALYSIS COMPARISONS Gross Profit $209 102 $134 020 $80 796 $50 130 $34 766 $101 763 Gross Margin 77,2% 73,7% 69,7% 64,6% 67,4% 70,5% Total Operating Income/Loss ($44 662) ($46 474) ($48 609) ($34 250) ($18 740) ($38 547) Total Operating Profit Margin -16,5% -25,5% -42,0% -44,1% -36,3% -32,9% Total Pre-Tax Income/Loss ($45 029) ($45 641) ($48 321) ($34 274) ($18 778) ($38 409) Total Pre-Tax Margin -16,6% -25,1% -41,7% -44,2% -36,4% -32,8% Total Net Income/Loss ($45 562) ($46 053) ($48 229) ($34 274) ($18 778) ($38 579) Total Net Margin -16,8% -25,3% -41,6% -44,1% -36,4% -32,9% EBITDA ($32 838) ($38 460) ($42 895) ($29 778) ($16 004) ($31 995)


After Tax Return On Assets -17,5% -20,9% -27,6% -67,8% -28,6% -32,5%

CASH FLOW AND BALANCE SHEET COMPARISONS Cash as a % of Revenue 22,0% 30,5% 106,8% 16,3% 79,6% 51,1% Cash from Operations $19 366 ($423) ($12 464) ($19 808) ($5 807) ($3 827) * Operating Expenses: May include other items not included in SGA and R&D, such as restructuring, one time expenses, etc.



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