Heading into 2022, it seemed like we were poised for a big year in M&A. This was especially true for enterprise SaaS companies that saw their values begin to fall in late 2021, a trend that extended into this year. Why are we not seeing more aggressive M&A activity and some good old-fashioned bargain hunting while many software companies could be considered grossly undervalued?
It’s a reasonable question.
A quick look at a handful of SaaS stocks shows some deals to be had. While Zoom’s value is still a bit rich, perhaps, at $21 billion, consider that DocuSign is down to $10 billion, Dropbox is around $7.5 billion, UiPath is under $7 billion, Box is resting at just $3.7 billion worth of value, and Sumo Logic is valued at under the $1 billion mark.
Step right up, folks, because there are bargains to be had, whether you’re one of the usual acquisitive suspects (Salesforce, Oracle, Microsoft, Amazon) or a private equity investor looking for some good values.
It’s not as though we haven’t seen any activity. As you probably are aware, there have been some major deals this year, but with so many SaaS stocks down so far, why aren’t we seeing more activity? We decided to dig in and see if we could figure it out.
A quick look at 2022 M&A so far
Looking at the sizable M&A deals this year, the biggest by far is Microsoft grabbing gaming company Activision/Blizzard for a scintillating $69 billion in an aggressive move, one perhaps so aggressive that regulators are concerned. For now, that deal remains in regulatory limbo and is far from enterprise SaaS.
Next, we have Broadcom snagging VMware for $61 billion.
Then there is Elon Musk trying to have his way with Twitter for $44 billion — then changing his mind. That deal, as you no doubt know, is currently ensnared in litigation and who knows what the final outcome will be; it just keeps getting messier.
And most recently, of course, was the $20 billion Adobe-Figma deal, which took the promising startup off the table. As with these other major deals, it will face some major eyeballing from regulators. Figma was probably not on your M&A bingo card this year, and certainly not with Adobe, but it goes to show you just never know how this all plays out.
If you want to look at public enterprise companies other than VMware, we have seen three large deals: Vista bought Citrix for $16.5 billion in January, Thoma Bravo nabbed Anaplan for almost $11 billion in March, and Permira and Hellman & Friedman snagged Zendesk for around $10 billion.
Notice that all three companies were acquired by private equity companies (and it would be a stretch to call Citrix a SaaS company). If you take away the gaming and social deals, and just look at the enterprise, you have a chip company buying VMware and Adobe buying a startup for 50x ARR. The undervalued SaaS companies? They’re all still standing.
What’s going on?
If you liked software companies in 2020 and loved them in 2021, there’s little reason to not find yourself still enamored with the corporate contingent this year. After all, many software companies are meeting growth targets set by public-market investors this year and they are now discounted massively from their 2021 valuations.
TechCrunch has spent ample time reporting on incremental changes to the value of software companies in the last year. But the changes are better viewed in aggregate:
- Leaning on data collected by the Bessemer Cloud Index: The median forward revenue multiple for public-market cloud companies has dipped from around 16x in early 2021 to less than 5x today.
- Leaning on data collected by private-market investor Jamin Ball: Median forward revenue multiples for the most richly valued SaaS stocks out there have fallen from around 80x in late 2021 to 15.4x today.
Ball has a similar median forward revenue multiple figure for SaaS stocks (5.5x) to Bessemer’s more cloud-focused metrics. Both datasets show a massive decline in the value of software revenue.
This should surprise; after all, the bullish case from 2021 is still valid in 2022. The general idea underpinning a good portion of public-market enthusiasm for SaaS companies was their market was larger than previously anticipated and their growth rates would hold up better over time than had been projected. In short, the companies were going to get bigger, faster. That meant more future cash flow, and therefore more present-day value.
We have not seen a massive slowdown in the growth of public software companies. Bessemer’s dataset shows a median 29% growth rate in early 2020, and the same figure for today; 2021 did include short periods of time when growth looked a bit quicker, but we’re simply back to where we were pre-COVID, just with lower prices attached to the same growth rate across a larger software-industry revenue base.
The bad news is therefore more technical than material for software companies; they are still fine, at least as good as before. It’s just that the market doesn’t love them as it once did.
So much value, so little action
This should be a recipe for takeovers, acquisitions and other forms of M&A activity. After all, investors are flush with capital. Private equity, for example, hit the midyear point in 2022 with more dry powder than ever before. And yet deal volume is not what we would expect.
Keep in mind that we’re not only discussing public companies as takeover targets; we’re also considering the more than 1,400 global unicorns in the mix as well. They’re also potential targets for private equity funds sitting on capital, busy collecting fees while not pulling the trigger on as many deals as we might have anticipated.
The issue may simply be price. If you were the CEO of a software company last year, you recall your valuation’s peak, either priced or merely inferred from comps. If you tried to sell your company today, however, what fraction of your peak worth might you be able to snag? Half? Maybe?
Private equity loves a bargain, especially one that comes with positive cash flow. Unicorns and other startups have been told to generate more cash by private-market investors, and many public-market SaaS companies do kick off cash from their operations. And yet.
If our hypothesis — that software companies are unwilling to sell cheap if they can avoid it — is correct, they are setting up a game of financial chicken with private equity types, betting that they can stay solvent longer than the investing groups can stay patient.
If that works out, then private and public software companies may be able to wait out low prices and not cash out until valuations recover at least somewhat. But if they don’t, and run low on cash, then private equity may get their discount and then some.
Dropbox generated $205.9 million worth of operating cash flow in its most recently reported quarter. Box’s operating cash flow for its own most recent reporting period was $28.3 million. Sumo Logic’s operating cash flow was negative in its most recent quarter, but given its cheap price, perhaps it should be on the market as well.
So why are we not seeing more deals, dang it? Figma might have something to do with it. Sure, the company happened to have a competing incumbent that had plenty of value to bring to bear to buy it out. But the company didn’t sell cheap, despite the changing market for software valuations. Indeed, Figma managed to double its 2021 price in the transaction, proving that such deals are possible, even if we don’t expect them to prove common.
Figma sold because it could do so while making all of its investors happy at once. If you are holding tech stocks you bought last year, are you really going to want to vote for a deal that sees someone else make off with your equity at a massive discount to the price that you purchased it? Perhaps not.
The question, then, is just one of time. How long until software valuations rebound, and can the software companies of the world hold off long enough?