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Hm. Thing is as profitable big tech companies get larger and the TAM of tech sectors grow it makes some sense that early stage valuations would increase. This

by kypro 4y ago

Hm. Thing is as profitable big tech companies get larger and the TAM of tech sectors grow it makes some sense that early stage valuations would increase. This is both because there is more opportunity for a company to scale, but also because when you have several trillion dollar tech companies out there happy to acquire innovative tech companies then multi billion dollar exits become much more feasible. Companies like Microsoft are making close to $100b a year today and they have to put that money to work somewhere. Google's digital ad business was big relative to the size of the internet in 2010, but it was absolutely tiny in comparison to today. And it's not just the size of the digital ads market, but everything - digital audio/video content, ecommerce, hosting, social, productivity tools, etc. All companies operating in tech sectors today have far more potential than they did in 2010 if they execute well. So no, in my opinion 20x EV/sales isn't that crazy for a good SaaS company. Profitable tech companies at scale with high gross margins typically trade at 5-10x sales because if you can achieve operating margins of say 30-40% (which isn't uncommon for SaaS companies) then you're basically trading at a 20-30x projected earnings multiple. Which yes is high compared to the historical market average (15-20), but if you're also growing at 50% YoY and have steady recurring revenue streams then that's not a hard multiple to grow into at all. Perhaps what was stupid about 2020-2021 valuations was that a lot of investors assumed that the extremely low interest rates and accommodative monetary policy was going to persist. Some companies did trade at valuations very hard to justify without the low interest rates and pandemic-era tech growth rates (Zoom, Shopify, Peloton, etc). I'm sharing because I seem to have a fairly controversial take on this and I don't know why. It seems to me everyone has just forgotten that companies like FB traded at sales multiples in the mid-teens for years after they went public and they haven't been bad investment at all. It depends on the company obviously, but a company growing at 50% YoY with 80% gross margins would be ridiculously cheap at a valuation any less than 10x sales based conservative earning projections. In my opinion most of the reason for this crash is just macro headwinds. Tech companies saw a huge growth boom in 2020-2021 which has now reversed. Interest rate risks have also been dragging on public valuations and this caused a drop in sentiment for tech investments generally. My guess is that in a couple of years once we're through this period tech valuations will trend back to 2018-2019 levels. But I guess we'll see. Finally this current crash is hardly isolated to tech. Companies like Fedex, Starbucks and Nike have all seen ~50% valuation declines from their peaks this year.

nateburke 4y ago
> So no, in my opinion 20x EV/sales isn't that crazy for a good SaaS company. I agree but with the specification that the only way to get that "good SaaS company" multiple now from an acquisition is with the stick rather than the carrot. What I mean by "stick" that is the target (e.g. Figma) needs to be a active threat to the acquirer's (e.g. Adobe's) business -- as opposed to the "carrot" wherein the target (e.g. any AI-first company making interesting pictures) has a valuation driven by narrative ("humans will prefer AI-generated content over celebrity-generated content). Acquirers have more leverage on price now.
EwanToo 4y ago
To comment on the statement: "Companies like Microsoft are making close to $100b a year today and they have to put that money to work somewhere" They'll make stock buybacks, and they'll pay out dividends, far less risky to their stock price and long-term management incentive schemes than most value destructive large acquisitions.
- kypro 4y ago
  A little late, but this is only somewhat true. Stock buybacks only make sense if the stock is cheap to fairly valued. You need to think of buybacks in terms of a return on equity. If a company spends $10 billion buying back stock of their overvalued company which later falls 50% in value then that company is allocating capital extremely poorly. Companies should decide whether to buy or sell stock depending the company valuation. Tesla is an example of a company which has made some incredibly smart decisions from a capital allocation perspective not from buybacks, but by issuing stock when their stock is high. That's not to say companies won't do buybacks though, just that they have a duty to shareholders not to blindly buyback their own stock if they believe they could allocate that capital better with an acquisitions, etc. At a time like this when unprofitable, yet very innovative companies have lost a lot of value relative to big tech companies like Microsoft and Google I'd argue that they might be better off allocating that capital more towards acquisitions than buybacks. This is also why I don't really understand why shareholders of Apple support their current buyback program. Given their stock trades at a near record-high valuation both absolutely and relative to the market large buy backs makes very little sense from a capital allocation perspective. Although I guess they would argue there is literally no where else to put those billions of dollars. Still, that doesn't mean it's a good thing for shareholders, just that they're now forced to allocate capital poorly given their size.

by kypro 4y ago

nateburke 4y ago

> So no, in my opinion 20x EV/sales isn't that crazy for a good SaaS company. I agree but with the specification that the only way to get that "good SaaS company" multiple now from an acquisition is with the stick rather than the carrot. What I mean by "stick" that is the target (e.g. Figma) needs to be a active threat to the acquirer's (e.g. Adobe's) business -- as opposed to the "carrot" wherein the target (e.g. any AI-first company making interesting pictures) has a valuation driven by narrative ("humans will prefer AI-generated content over celebrity-generated content). Acquirers have more leverage on price now.

EwanToo 4y ago

To comment on the statement: "Companies like Microsoft are making close to $100b a year today and they have to put that money to work somewhere" They'll make stock buybacks, and they'll pay out dividends, far less risky to their stock price and long-term management incentive schemes than most value destructive large acquisitions.

kypro 4y ago
A little late, but this is only somewhat true. Stock buybacks only make sense if the stock is cheap to fairly valued. You need to think of buybacks in terms of a return on equity. If a company spends $10 billion buying back stock of their overvalued company which later falls 50% in value then that company is allocating capital extremely poorly. Companies should decide whether to buy or sell stock depending the company valuation. Tesla is an example of a company which has made some incredibly smart decisions from a capital allocation perspective not from buybacks, but by issuing stock when their stock is high. That's not to say companies won't do buybacks though, just that they have a duty to shareholders not to blindly buyback their own stock if they believe they could allocate that capital better with an acquisitions, etc. At a time like this when unprofitable, yet very innovative companies have lost a lot of value relative to big tech companies like Microsoft and Google I'd argue that they might be better off allocating that capital more towards acquisitions than buybacks. This is also why I don't really understand why shareholders of Apple support their current buyback program. Given their stock trades at a near record-high valuation both absolutely and relative to the market large buy backs makes very little sense from a capital allocation perspective. Although I guess they would argue there is literally no where else to put those billions of dollars. Still, that doesn't mean it's a good thing for shareholders, just that they're now forced to allocate capital poorly given their size.