Rule of 40 (Part II) – Public SaaS Valuation Implications
We had a really good response to our recent post about the Rule of 40, with several CEOs reaching out to us to discuss the implications for their business. As a result, we thought it made sense to take a look at the public SaaS companies and see which ones were performing well versus this metric and how their respective valuations compared.
In this blog we looked at the top 50 public SaaS companies by market cap and analyzed where they came out on the Rule of 40. As a reminder, you can see the calculation for Rule of 40 in our prior blog post (click here).
The chart below depicts where these companies rank on the metric – those above the line and in green have a combined revenue growth and margin above 40 and those below the line and in red are obviously score less than 40 on this metric.
Source: S&P CapIQ and company filings.
So, what does this all mean? In reality you can’t really interpret anything from this without looking at these company’s valuations and seeing if they correspond to their rule of 40. So, in the next chart we plot the Rule of 40 versus their corresponding revenue multiple.
Source: S&P CapIQ and company filings.
Those companies below the line are cheap relative to their peers – i.e. trading at a revenue multiple less than the implied median of the group. Obviously, those above the line could be considered expensive (again purely on this metric). Therefore, the furthest distance from the line, either above or below, the more expensive or cheap the stock could be perceived on this one metric.
Let’s focus in on some of the most expensive stocks. Slack (ticker WORK) looks really expensive on this metric with a rule of 40 of 22 but a revenue multiple of 35x! While the company has pretty robust revenue growth of 50%, its EBITDA margin is negative 28%. Anaplan (Ticker PLAN) is another one that stands out with a rule of 40 that comes in at only 8 but a revenue multiple of 27x! This is a similar story to Slack, where Anaplan has a revenue growth of 37% but is losing money at a rate of a negative EBITDA margin of 29%.
On the cheap side of the equation, Cloudera (Ticker CLDR) is the furthest under the line with a rule of 40 score of 61 but a revenue multiple of only 3x! Cloudera’s revenue growth has been particularly strong at 57% and their EBITDA margin is 6%. When compared to some of the “expensive” stocks highlighted above, these metrics look great!
It seems that while there is an interesting correlation of rule of 40 to value, there are also many outliers that are currently being valued purely on revenue growth. But even on this one metric, some of the multiples seem very elevated especially when investors will at some point want to see if these companies can actually make money.
Quick disclaimer – this is not investment advice and we are not investment advisors. A much broader analysis is obviously required in determining if a stock is expensive or cheap.
About Sampford Advisors
Sampford Advisors is a boutique investment bank exclusively focused on mid-market mergers and acquisitions (M&A) for technology, media and telecom companies. We have offices in Toronto, Ottawa and the US and have done more mid-market tech M&A transactions than any other adviser.