Public SaaS Company Valuation

I'm currently working on an investment pitch of a public $5 billion cybersecurity company whose business model is SaaS based. I'm working on forecasting next 5 years revenue growth and was wondering methods I would use to forecast.

Should I be using a top-down approach - TAM * market penetration * # of companies, etc.. Or should I use a more granular approach by trying to forecast billings + % growth. Given that it's a public company, a lot of metrics aren't available. If I were to use billings, I would need to forecast revenue and deferred revenue, which again begs the question of what method to use to forecast those numbers.

I'm stuck and would appreciate advice from someone in PE or HF that has done granular forecasting/modelling for public Saas companies.

 

Depends how detailed you want to go

Number of customers and churn or just overall churn and growth on revenue base. If you know contract structures go switch contracted / revenue or do both. You can get the method on deferred etc. from the financial statemens, they will disclose these things but you can otherwise backsolve and approx.

Given its cyber i however would much more focus on your forecast on the spending side because in cyber the markets willingness to accept aggresive spending is a very swinging pendulum and i would look into sales efficiency where a lot of the companies have weak points masked by multiplikators and partner networks - put a gartner cyber growth rate on the top line. How do the brokers forecast this particular company? Often the fastest way to find out "what is disclosed" in building blocks...

I think it also depends whether its pure SaaS or has an implementation angle. I guess you are talking Proofpoint? We can chat via PM if you want on SaaS / Cyber

 

Thanks for responding. Company is zscaler. ~90% of sales is through channel partners so I think it might complicate things a bit more

I'm looking at some Gartner/IDC reports online and can see the market size and growth rate. Would the number I deduce from the market size * market share % + growth % be a billings, bookings or revenue number?

Would love to chat via PM with you about saas/cyber!

 

sorry for the wording - i typed this very quickly in the car.

A Zscaler pitch is easy on the valuation side - you are trading at 33x revenue, and the question that arises is why could this be the right value? Wouldnt this mean that you have to grow at 40% for 3 years just to be priced at SaaS peers? If so, how could you ever make money?. Take a look at the software equity groups 2018 SaaS report. That is a great overview of multiples and operating stats on listed SaaS. Benchmark Zscaler against the peer group on all metrics. The question then becomes: why is something that was historically a basic rule of 40 company (and is moving towards 60 and 80 soon if all works out) trading at 3x the peer group.

That is the real question to answer and it could take you into 3 areas: growth, differentiation and TAM.

The product / differentiation (who else can offer what they do? Is the scalability and elasticity real? Is this a winner takes it all market? - here i would look into cyber reports that were published. AGC writes good things, some other brokers do to, Gartner and 451 do as well. Its a well covered market). Why do people believe they take this market vs. other upcoming players? Is this a winner takes it all market? Are they really first mover? Can they retain the status? Is there churn? How does the product integrate in the IT stack etc. etc. If this is a tech role you are preparing the pitch for - i would look into the product architecture a bit.

The growth - this is priced for multiple years of 40% growth at increasing margins due to scale. Backsolve what it means to keep growing at this rate - is this doable (is there a market? Do they loose efficiency? How many parters are there? Is there price pressure?) Then focus on the profit: will scale automatically lead to the forecast profit i.e. are moving towards positive territory or is this expensive growth as we see in a lot of cyber stocks?

Lastly i would look into TAM. A lot of cyber (sailpoint is aprime example) is valued on TAM and where the first mover with the "best" product and best execution team could be in 5 years (plus some takeout upside as MS and IBM will need to buy in my view at some point).

You need to also check the basic unit economics, SaaS metrics etc. but i think by starting with the SEG report and really use the peer group's metrics (growth, gross margin, S&M, EBITDA etc.) and benchmark each and elaborate, you are getting there. If you start with a chart that shows your revenue based valuation 3x the peers - the question flows quite naturally.

More difficult to answer on the stock will be how you make money, once you have assessed why it is priced the way it is (i.e. determine how this "could" be the right value). Even if they keep growing at the pace forecast, you just need a sentiment change on where growth should be priced (and you will have that exposure for a while because this is not a hard catalyst stock in my view although there are natural acquirers but it has gotten too expensive and they dual tracked and explored everything...) and you loose money. Lets say people all of a sudden say growth is worth x% less than it currently is (simplified logic obviously) and you work against a deteriarating multiple.

On a last note: with this stock it is worth also looking into the team because chaudry is a visionary and what he has done is amazing in my view. I have interacted (in various forms - all very far away though i.e. this is more a gut feel with a couple datapoints than real knowledge) with some of his past companies and i dont believe there are many people who know the ecosystem as well as he does. Take a look at past roles but also exits. Unless you tell me that this is musical chairs and the IPO was his full exit route (which i dont believe given he holds 46% of the company and is a rich man (multiples billions) in any case and this is about winning), i think you have a team that know what they are doing and there is a plan. They obviously dont control what the market thinks of them but if your answer is that you can make money if they only execute (and i dont know whether that would be my conclusion), then this is a team i would rank significantly higher than other teams on the "execution" trust scale.

 

Thanks for the helpful information-a lot of info for me to go off of right now. Would you classify Zscaler in calculating TAM as secure web gateway (gartner) or cloud security? They defined their TAM as $17.7Bn (from various IDC reports) in their report (https://ir.zscaler.com/static-files/f2f4c074-8bce-4b71-b7a6-16d904c4d778) but looking at SWG + data loss prevention, those 2 market sizes are less thant $17.7Bn.

 

Question on valuation:

In terms of valuing ZS on a relative basis, its ~22.4x ntm revenue multiple is one of the highest among its peers, so would I argue a case for multiple expansion in the future? Would I be saying it's reasonably priced right now given that it can grow 50% now for 3 years to be valued at 7.6x median saas multiple? Is that where the multiple expansion comes in incorporating what you listed -growth, differentiation, TAM?

 
Most Helpful

Let me add one more comment because I dont think i made that clear.

Whilst looking at saas companies is a good valuation starting point (alongside a cyber peer group - check AGC), it is worth noting that you are really looking at a technical product here. Some of the other SaaS companies are easier valued via standard metrics (growth, profit, churn) because the product is not rocket science. Unless you create an ecosystem and therefore moat (:CRM) or other things which make you really ireplacable, some Saas companies are a provider of "something that works". Cyber companies are mostly really technical companies. You are therefore often looking more towards infrastructure IT than web-based offerings. This means its "SaaS" (pricing, delivery or whatever) but this not a "feature parity will not make me loose customers hence i am save because i already provide the "final product"" proposition. For example, if you are a digital health application that ties in insurances into doctor / hospital workflows and the product works really well, people are not changing. If a better cyber/IT infra product comes out however, this is not the case because what your product really does needs to change now, too. You are not abstracting / digitising workflow. You are in the IT world and if something changes to where IT is going and your product is not well suited, you can ignore all basic SaaS churn assumptions - you will get killed. Look at old firewalls or on-prem products that were not cloud ready. To turn that argument around, if you have the technology of the IT "stack/environment" of the coming 10 years (and this again is simplified because it isnt infrastructure really) - look beyond just saying that this is too expensive vs. a 8x8 or whatever because how can you really value a core part of how modern IT works? The pitch needs to really look at what the product does to equal amounts as to how you value the company. If you would pitch this where i am at, i would expect to hear about where the product sits, how it integrates, why the cloud providers cant do it, how it is suited for the landscape of tomorrow (scalability vs. costs etc.) - to equal amounts as i would want to hear a thesis on how to make money on this (which needs to answer why it is priced the way it is and whether that is the right number).

 

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