Why do I continue to stay bullish on SaaS?

After a year of the bull market from Jun’20 to Jun’21 for the SaaS companies where the median B2B Public SaaS company hit a record high value at 16.9x its current run-rate annual recurring revenue (ARR), the public market finally is in tumult. Many SaaS and Cloud leaders are down more than 50% from their all-time highs, resulting in that at the end of February 2022, the median public SaaS valuation multiple had dropped 37% to 10.7x ARR. A deeper look at the performance of these companies shows despite losing nearly 40% of their value, operationally, public SaaS companies continue to perform along historical trend lines. The recent decline in public stock prices is not an indication of any current systemic weakness in the SaaS industry or business model. The recent market tumble is a valuation reset driven out of fear of future operational challenges.

The valuation of the WisdomTree Cloud Computing ETF (track the price of the BVP Nasdaq Emerging Cloud Index, an equally weighted index designed to measure the performance of emerging public companies focused on delivering cloud-based software to customers) is also at a 6-months low.

The trickle-down effect of this decline in the ARR multiple in the public market has started impacting the valuations offered to companies in the private market as well, though the last year hearing >50X multiple on ARR for top-quartile SaaS companies was a common thing, with average private companies ARR multiple being 20–25, the market has started correcting itself and I believe that the downturn would stabilize with average private companies ARR multiple falling to that offered in 2019.

Our belief is that the Covid did create a lot of artificial demand for Cloud products, especially during the lockdown phase. The boosts Zoom (can’t go to the office anymore), and Shopify (can’t go to a store anymore) were real, but could never be sustained. It makes sense the “Covid Boost” is over, and that there would be some market correction to the valuations and the multiple that was offered to such companies during the bull market. Still, even today I continue to be strongly bullish about the SaaS ecosystem, based on the following thoughts -

• The excess dry-powder and the artificial growth in the demand for the cloud products during COVID years led to the higher premium being offered to the SaaS companies valuation, but with the current market correction, I see a huge opportunity to invest in fundamentally strong and those with larger TAM solutions that are now being offered at multiples equivalent to that of 2019.
• I fundamentally believe that the SaaS multiple will continue to grow at a rate of 10–20% YoY following the pre-COVID trend, as we pass along the current bear market. This would be supplemented by the enabling ecosystem that has been built over the last a few years — where now with infrastructure, no-code, IPaaS, product development and adoption, PLG infra, marketing, sales, and revenue intelligence solutions, the time to build, deploy and go-to-market has significantly reduced, alongside with the strong community that is getting built and a whole new GTM being created around the open-source ecosystem, the companies building in India are also well positioned to go global from day-1.
• As companies continue to get more and more digitized, improve their operational efficiency and ensure offering a better customer experience to their users, they would continue to spend heavily across the various verticals of the SaaS ecosystem. Based on Gartner estimates, the minor decline in the growth rate of the software spending is expected to start recovering from the current financial year itself.

I think that’s it for now folks! I hope that you founder this post useful. I would love to hear any comments and feedback on the above. And, if you’re building a SaaS/SaaS-enabled marketplace to optimize the efficiency of SMBs/Enterprises, or are a VC actively following this space, please don’t hesitate to get in touch. My email is abhisheksingh@riverwalkholdings.com. I would love to connect with you to brainstorm and identify the overlaps.