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Welcome to the Spring ‘24 edition of my European SaaS Musings! I’ll cover some of the game-changing need-to-know’s in the European SaaS world.
You can expect opinionated commentary and data on the public markets, macroeconomics, the most interesting, notable and exciting VC rounds in European SaaS, and finally some of the top things we’ve been reading.
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1) What’s going on in the public markets?
Everywhere you look, the public markets seem to be breaking all-time-highs. This is very much tech-driven – with the Wall Street Journal reporting that:
“The S&P 500 is back at record levels for the first time in two years. Information technology is the only one of the index’s 11 sectors that can say the same”.
In the last week or so, we’ve seen the return of the ‘meme stock’ frenzy from 2021. Keith Gill (a.k.a “Roaring Kitty”) returned from a multi-year absence which drove phenomenal activity in the shares in GameStop and AMC, two of the retail investor favourites from 2021. GameStop’s share price temporarily tripled, whilst AMC gained 135%. Both quickly then lost most of the gains.
This is a somewhat sobering reminder of where we appear to be sitting in the economic cycle, certainly regarding where the public markets indices are trading.
Zooming in on the software industry – the BVP Emerging Cloud Index has seen some softness – down about 10% since the start of 2024. But on the 15th of May the index erased about half these losses as the US April inflation numbers came in weaker than expected at 3.4% – increasing the probability of earlier Fed rate cuts and immediately spiking stock prices.
Generally we’ve seen a tightening in the spread of public SaaS valuation multiples, with the median having found a ‘new normal’ at 6-7x ARR.
We expect it to persist in this sort of range for some time – due to the balance of several factors:
Clear downward pressure on interest rates (creating upward pressure on valuation multiples)
But - these are expected to be higher for longer; certainly vs the last 15 years - increasing the discount rate applied to future cash flows providing a balancing effect
SaaS company performance outlooks are soft and deteriorating – more companies are in ‘slow’ or ‘medium’ growth buckets and therefore trading at commensurate multiples
Market bifurcation mix-effect – AI businesses growing fast with multiples accelerating; non-AI businesses stagnating with multiples slightly down
To dive into point (2) in a bit more detail – overall public SaaS ARR growth rates continue to slow, and business’ drive towards more profitable growth to compensate. Typical ARR growth is now <20%.
This masks a big difference by sector. Security companies are the fastest growing at nearly 30% (i.e. ~50% faster than the median), with data companies in the low 20’s and fintech/horizontal SaaS are low teens (per Tomasz Tunguz at Theory). Jamin Ball at Altimeter comments in his Clouded Judgement newsletter that Q1 software earnings are ‘not pretty’. He goes on to say “the median “beat” (Q1 revenue over Q1 consensus estimates) was 1.5%, which is the lowest it’s been in the last 4 years”…
Not only is revenue growth dwindling, but other key KPIs are still being pulled down. David Spitz at Benchsights shows further that the set of public SaaS businesses are struggling on NRR. Of the 19 companies that reported NRR figures in Q4 ’22 vs Q4 ’23, 16 of them saw a deterioration (and 5 of them had a deterioration of >20 %pts).
So – the backdrop is one of slowing ARR growth, relative underperformance vs consensus, and deteriorating fundamental unit economics. It’s going to take clear, sustainable positive traction for companies to break out of this slump and for the majority of businesses to trade back up to higher multiple brackets.
Diving into point (3), regarding AI being a different beast entirely – if you segment public AI software companies – they are projected to grow a massive 63%(!) faster in 2024 than non-AI companies.
The natural conclusion of this is that the market is pricing forward revenue multiples on public AI software businesses nearly 3x that of non-AI businesses. And to amplify this effect as you can see below – the gap between the have’s and ‘have-not’s’ is widening (it was <2x just 15 months ago). Faster growth and a wedge in comparable EV / ARR multiples means that the value shift towards AI is expanding at a serious rate.
This tough (general, non-AI) performance environment, combined with relatively low EV / ARR multiples (vs the last 5 years) means the IPO window remains pretty firmly closed. We did see one company, Rubrik, go public in 2024, which was the second business (after Klaviyo) to test the waters in the last ~2 years.
What does it take for a SaaS company to go public in this market? Meritech wrote an excellent memo on the company’s S-1 (here), but at a high level, stated
“Rubrik is at almost $800m growing almost 50% year-on-year, the fastest LTM growth rate among all current public SaaS companies”.
If that’s the bar – that’s a serious bar.
How did the markets react to the business post IPO? Well the stock bounced on day 1 of trading, from its initial range of 6.5x NTM revenue. At its peak – it traded up to around 8.0x forward revenue (in line with its high-growth peers); but it settled at closer to 7x NTM revenue around a month later. For a 50% YoY growth business at nearly $800m – that’s a sobering number for the multitude of non-AI native privately held unicorns who last raised in 2021 or 2022.
Speaking of which – it’s worth highlighting this slide from Battery’s Open Cloud report – showing the volume of private companies that have last raised at a unicorn valuation. Many of these on the top left are still <<$100m in ARR, which puts their potential public range well underwater of the last private round. Sapphire separately in their report note that ~400 of these software unicorns haven’t raised any capital in at least the last 18 months, and Goldman reported that 40% of private unicorns have been held for 9 years or longer…
Given the slow IPO activity – and the plentiful supply of companies - has M&A (either PE or strategic) been filling the gap?
Well there have been a few big deals, most notably Hashicorp (IBM) – $6.4bn, Darktrace (Thoma Bravo) – $5.3bn; but also some tougher sales at colossal discounts – eg Lacework being acquired by Wiz for $200m – which was around a 97%(!) discount from the >$8bn valuation it raised at during 2021.
My view is that there’s still too much of a bid / ask spread in these companies (VC secondaries in 2023 were trading at an average 68% discount to NAV) for externally-led private up-rounds, and many are now on a slower, more capital efficient trajectory towards an eventual raise.
I think this means that PE and Strategic M&A activity will pick up in H2 2024, ahead of the IPO market really starting to re-open, which I don’t expect with any momentum before early 2025. Investors want to see a) the outcome of the global election deluge; b) some stability in interest rate forward projections, c) a few more quarters of healthy company growth momentum before sentiment can swing back into risk-on.
2) Macro
As ever there's lots of focus on rates and inflation. In the US core CPI cooled for the first time in 6 months, with swap rates implying that the Fed could be cutting rates as soon as September. In Europe the BoE and ECB are likely to start their loosening cycles sooner.
US consumer spending appears to be softening. The country’s consumers have depleted their ‘pandemic savings’ particularly fast vs other major economies, and also are increasingly indebted (though not close to levels seen in prior financial crises).
A lot hangs on the outcome of the US election. Krugman wrote an op-ed on Trump’s ‘quack-economics’ recently which is a good read – and explains the likely impact of some of his touted economic policies (seeking to influence the Fed to keep rates abnormally low; levying high tariffs on imports, particularly from China but also all other nations, embarking on massive fiscal stimulus packages to increase government spending; reducing taxes) – all of which are clearly severely inflationary in nature. Let’s not forget what happened in the 70s with US inflation, which the Fed believed they had solved…
And the other elephant in the room is the impact on the US’ deficit. We’re running out of comparative financial amounts to quantify the sheer scale of the US’ debt and the required interest payments – they now spend more on interest payments on debt than the entire US defense budget…
In a warning that surprises absolutely no-one, the IMF has noted that this poses ‘significant risks’ to the global economy. And Ray Dalio at Bridgewater joined the bandwagon this week – warning of the dangers of the US debt levels to the Treasury market (the articles are worth a read – he also would back Taylor Swift for President; and estimates a >1/3 chance of an outright civil war…)
3) Small momentum shift in mid-late stage venture deals
We’ve now had two consecutive quarters of growth in deal counts and value in private scale-up software rounds after six consecutive quarters of significant cutbacks. Phew! We generally review about 80-120 scale-up stage B2B SaaS rounds happening each quarter on average across Europe and Israel ($5-30m equity rounds in B2B SaaS businesses that are named Series A – C rounds).
Activity levels were much lower in 2023, but have rebounded to close to this range in Q1 2024. As you might have assumed – this was mostly Series A driven, and a big part of this was AI-related funding rounds.
The picture is the same for deal value – you can clearly see the spike in Q1 for Series A, B and C’s in this size range. It’s also clear that the value of funding into ‘other’ bridge rounds has continued to fall in absolute and relative levels, now at the lowest level since mid-2020.
What’s driving this? Well, the AI elephant in the room (again) which is enabling a new set of companies that are emerging at a phenomenal trajectory. But also the natural expiry of runway for companies that raised A rounds in later 21/22, bridge rounds in late 22/early 23, and now have to come back out to market. Like the public market picture – we’ve seen a lot of companies testing the VC markets with potential fundraises, having grown well and capital efficiently, and this steady stream will continue through the rest of the year and into 2025.
Below are my top European SaaS Deals announced in Q1 2024. Congratulations to the companies raising - some great businesses and rounds here! If there are any other companies and rounds you think I should have included, LMK.
4) Thanks for reading!
I hope you enjoyed reading this spring update. If you have any feedback, please do reach out (pej@oxx.vc); all comments or recommendations are welcome.
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