How are you supposed to invest in high growth cloud software businesses at these multiples?
Everywhere you look, recent-IPO high growth cloud software businesses have insane multiples. E.g., CFLT, BILL, SNOW, and so on and so forth. Some of these (e.g., CFLT) are not going to be profitable for a while so it would not be reasonable to invest based on profitability multiples in ~5y. And further, investing based on an exit of >10x revenue multiple in outer years of a hold seems irresponsible since the absolute mayhem of the last ~3-4y in cloud software valuations should probably not be assumed to last forever, especially in a cooling macroeconomic environment.
So how the heck are people investing in these businesses at these valuations? Many of these are phenomenal businesses with extremely low TAM penetration in incomprehensibly large and growing markets, so the future is bright for growth. But it's just really hard to wrap my ahead around the valuation stories.
you need to understand the actual economics of software businesses.... they sit on a J curve where they lose money on customers as they incur CAC but CLTV is not yet realized
thus they will generally lose money (short term) as long as they are growing quickly because all the new customers are in the negative portion of the J curve
the big question for these businesses is whether they are correctly assessing CLTV and ensuring CAC spending doesn't exceed it
I do understand the economics of a software business but the issue in my mind is moreso a macro one of: if you have a business that grows 30% YoY but trading multiples all cool to 2018 levels (e.g., prior to the crazy run up in cloud software valuations) then you are potentially still making a bad trade on a healthy, growing company.
That's an investment philosophy question. In hindsight, multiple contraction came before the top line growth and operating leverage, so in the near term, it hurts. If SNOW can become a $50 billion run-rate business, you probably can still make money if you bought it at 50x sales. The key for me personally is to gain massive conviction in that $50bn number.
Of course, a sizable segment of the public market focuses on getting the multiple right as well, so for those buying at 50x sales was not so prudent IN HINDSIGHT, but let's face it: we know this moment is going to come, we know the if, we just didn't know when (we kind of know now). But you know what Chuck Prince said: as long as the music is playing, just gotta keep dancing.
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