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Welcome to the Summer 2023 edition of my European SaaS Musings! As usual, 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?
Zooming out to a 3-year time series of the BVP Nasdaq Emerging Cloud Index clearly shows that public cloud stocks have broken out from the valuation floor that occurred around Q4 of 2022. The first few months of 2023 represented a bit of a false dawn, as the index grew rapidly through January and February, before it began a steady slide down to a local low-point at the start of May. But early-summer exuberance then hit the markets, with another rapid period of growth in May and June, which peaked in early August.
August itself cooled significantly, before bouncing back in September. As I write this, I realise the index growth for 2023 has a perfect correlation with London's sunshine...
The positive movement in the index has come at a time of continued deterioration in public company revenue performance. Battery looked at the Q2 guidance which shows a Y/Y average contraction of 35% in net new revenue, the 8th consecutive quarter of falling growth rate, and the 3rd consecutive quarter of a worsening Y/Y drop in net new revenue. Ouch.
Perhaps surprisingly, the deteriorating revenue performance has been met with resilience in public company valuation metrics. Median EV / ARR multiples are now 7.3x for public SaaS companies, which has been steadily increasing for the last year, but still remains below long-term averages.
If you peel the onion and adjust for revenue growth, you’ll see that growth adjusted revenue multiples have bounced back even faster during 2023; and are back to where they were pre-Covid (see below chart per Jamin Ball at Altimeter to illustrate). It means that growth-adjusted multiples are around 50% higher than the long-term average. He points to the 10Y rate being above 4%, which is 80% higher than the long-term average(!).
What all of this means is that given where inflation/rates are, and how much revenue performance has deteriorated, multiples appear to be much higher than one might expect based on these basic fundamental micro/macro factors.
Jamin then goes on to point out the impact from the shift in prioritisation from growth to profitability – as it's now common knowledge that the bottom line is being disproportionately rewarded in valuations vs the last few years.
Many public SaaS companies have materially improved their FCF margins, as you can see clearly in his chart below on forward 12 month FCF margins. If you then look at valuations vs FCF metrics, the markets are pricing public SaaS in-line with historic expectations.
So – against this backdrop of (surprisingly?) robust valuation health (given company performance and the macro situation), how’s the IPO window looking?
The freezing of the IPO window remains in place, but per SVB, perhaps you can hear the “creaks of the window starting to open”.
The main story from the analysis above is that if you have great FCF margins and OK growth, you’ll price particularly well in this environment. Fortunately in the last few weeks, we saw Klaviyo’s S-1, who have sufficiently exceptional metrics to be the first significant software company to test the public markets in some time.
There’s lots of breakdowns of the company’s outstanding performance, but my favourite chart was from David Spitz at BenchSight and is shown below, but it does need a little explaining (or at least, it did for me). It charts LTM FCF margin on the y-axis, and LTM growth on the x-axis. For each company, there are 2 data points, representing the 2022 and 2023 co-ordinates of performance. So the direction and magnitude of the vector indicate the movement in absolute and relative performance on both growth and FCF margin. Most companies have big leftward movements from 2022 to 2023 – indicating dramatic growth deceleration for many players. Klaviyo’s line does slow, but minimally – from +63% to +52% – this high growth persistence means LTM growth now exceeds that of recent top performers including Crowdstrike, Snowflake, Zscaler and Gitlab.
But now look at the Y axis – despite the relentless focus in profitability, very few businesses have been able to improve their FCF margin materially, measured by the vertical movement from 2022 to 2023.
Looking at the Klaviyo line – the business moved from a 20% FCF margin loss to almost a 10% FCF profit in the last 12 months(!) This elevates the business into the top tier of growth/profitability in the SaaS public markets, and arguably represents the best momentum of the entire set of companies in the last 12 months.
And let's not forget the imminent listing of a potential dial-mover in ARM going public next week at an estimated valuation of $50-54bn. That would make it the biggest IPO since Rivian in 2021.
The FT noted “some fund managers had expressed scepticism that SoftBank [ARM’s owners] would be able to persuade investors to pay as much as $50bn for a company that reported flat revenues and falling profits in the run up to the IPO”.
So – two diametrically opposing financial profiles between Klaviyo and ARM, which will provide a fascinating test of the public market appetite for new listings; and eyed closely by many pre-IPO businesses and growth investors who are waiting hungrily on the sidelines.
2) UK's macro continues to disappoint
The inflationary picture across major regions now shows quite a clear divide. The US saw the sharpest acceleration in inflation, which hit its peak early, and has seen the most rapid deceleration to relatively normal levels. By contrast, the UK and Eurozone grew to higher peaks, and the UK in particular has struggled to bring inflation back under control as effectively as other major economies.
Though the below chart uses retail price index (RPI) for the UK, not consumer price index (CPI) – so they're not directly comparable – we can see that there's been more volatility and persistence in 5-year forward inflationary expectations in the UK, which is likely to lead to more persistently high interest rates.
The Fed's more aggressive action on rates appears to have been effective, it's most likely that the US rates have peaked and will start falling, whereas the jury is out on UK and EU rates. Mohamed El Erian recently predicted that in this month's central bank policy meetings, there's a 85% probability that the BoE hikes UK rates by 25 bps; a 55% probability that the ECB hikes EU rates by 25 bps; and a 85% probability that the Fed leaves US rates unchanged.
Finally, relatively recent data from Carta on startup hiring / departures showed 5 consecutive months of net departures through Q1 2023 – as hiring slows, restructures are executed, and employees stay in-place for longer, reducing the need for backfills.
Anecdotally, we've seen the largest impact through the lack of availability of employees as few look for jobs unless they were part of a restructure – the labour market in tech certainly still feels quite tight from our vantage point.
3) Slowness continues in European early stage VC rounds
No-one’s surprised that it’s been a relatively slow few months in terms of new VC activity. And perhaps that’s not just because all European’s took the summer for vacationing and everyone in the US was at Burning Man (and might still be stuck there)…
We generally review about 100 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). Q1 of 2023 saw 77 deals, lower than average and the lowest volume since 2019. This fell further in Q2 2023, with 67 deals, which was the lowest total in the last 5 years. The summer hasn’t shown any signs of recovery – with just 20 announced (so far) for July and August, which is extraordinarily low vs prior years.
There’s also typically a further 50 B2B SaaS rounds per quarter that happen, with the same fundraising parameters, but are not named “milestone” A-C rounds. This can include typical smaller “Growth Equity” transactions, but also is the most typical labelling for internal follow on, or “Bridge” style financing rounds. Below we show a chart of the rolling average deal count per transaction type. This shows a continuation of the marked slowdown in A’s and B’s, whilst bridge, internal and otherwise un-named rounds show stronger resilience.
Carta’s State of Private Markets Q2 2023 shows the same pattern in the US: “in terms of both deal count and cash raised, this was the slowest Q2 since at least 2018”. They also note that down rounds represented ~20% of all rounds in H1 of 2023, which was more than double the average rate from the prior 4 years.
Against this backdrop, it’s particularly important to reflect on the businesses that have had strong raises during the quarter. Below are my top 18 European SaaS Deals announced in the last 5 months. Themes recently have been (obviously) Gen AI (both horizontal infrastructure and vertical platforms); fintech/insurtech, cybersecurity and data platforms.
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, let me know.
Looking forward at anticipated activity levels, Albion launched their aVC Index, inspired by the PMI index, which is a survey of 40 investors on expected levels of future activity. For Q2 of 2023, the index came in at 54% – representing a slight expected expansion in anticipated activity.
In the US, SVB released their H2 2023 State of the Markets report, which included several illuminating stats on when they expect the recovery to start. On a historic basis, typically 12-18 months is the duration to the floor of new deal activity. We’re currently on their measure approaching month 18, and almost the same peak – trough drop as per the dot-com bust.
On a more microeconomic level, there’s dwindling runway across the industry, but maybe at a slower rate than expected. SVB estimate that in the next 12 months, only 46% of US VC-backed tech companies must raise, which is actually lower than historical pre-pandemic levels. Due to activity to rapidly reduce burn rates, most of these companies now require a relatively small amount of capital to extend runway materially.
A likely consequence of runway extensions outweighing lower investment activity is there will be a more steady surge of new investment activity, rather than a 'big bang' that some investors were hoping for...
4) Great things I read this quarter
We're now far enough through the year that lots of reports have interesting micro data on 2023 company performance vs prior years. Below are some of my favourite resources for both benchmarking and macro data that have come out in the last few months:
· Bessemer – Cloud 100 Benchmarks 2023
· ICONIQ – 2023 Growth and Efficiency
· ChartMogul – SaaS Growth Report 2023
· Carta – State of Private Markets Q2 2023
· Albion – aVC Index Q2 2023
· Pitchbook – Accounting for the Overcapitalization of VC
5) Thanks for reading!
I hope you enjoyed reading this summer update. If you have any feedback, please do reach out (pej@oxx.vc); all comments or recommendations are welcome.
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