Tech companies are getting the hang of making money — or at least they’re losing far less than they used to when money was cheap and “growth” was sexy. We’re seeing this happen across the tech sector: in enterprise software, fintech, and heck, even in the tech-adjacent digital direct-to-consumer market.
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It’s hard to tell exactly how much more frugal startups have become as they seek to conserve cash. But if they are indeed aping their larger brethren, the technology space as a whole could be finding its profitability groove in a way that should change how we value these companies.
We’re collecting string this morning, pulling in data from across the space, including Klarna’s recent H1 2023 results, and quarterly results from Amplitude, Asana and GitLab, as well as recent IPO filings. The resulting picture demonstrates that generating cash, instead of burning it, is increasingly table stakes in tech, especially so for those still building in the later stages of the private markets.
Once that’s done, we’ll take what we’ve learned and put it into context by comparing historical valuations. New data from Altimeter investor Jamin Ball argues that tech startups today are more expensive than you might think, but when we add in the point about profitability, how does that perspective change?
Let’s have some fun!
Profitability’s so hot right now
This quote from Amplitude’s CEO when it reported its Q2 2023 results has remained stuck in my mind:
We generated record operating cash flow of $20.4 million and positive free cash flow of $19.3 million. With this result, we expect to be firmly in free cash flow positive territory as a company going forward.
Amplitude, which enjoyed a massive bump to its value near the end of the COVID period only to get hammered by investors when its growth slowed after it went public, is a nearly perfect example of what tech companies have been through in the last few years. So it’s interesting that it is now generating lots of cash — here’s a company that has managed to take control of its own destiny, wrangling its finances so that it can now fund its own efforts.
But Amplitude is hardly alone. After Klarna disclosed its Q1 2023 results, this column noted that both Q4 2022 and the first quarter of this year showed that the company was making material progress toward cutting its losses to the bone.
Then Klarna reported its H1 2023 results a few days back, which included the following note from its CEO, Sebastian Siemiatkowski:
It’s also very different in the sense that I can now talk about Klarna’s return to profitability in real terms. Fast-forward from our pledge a year ago to return to profitability, and here we are marking our first month in the black in Q223 and smashing our targets ahead of schedule!
Everyone loves a rebound. Airbnb’s COVID mess followed by its rapid ascent to the public markets after demand returned; Apple recovering from needing Microsoft money to a market cap of $3 trillion . . . You get the idea.
Klarna, somewhat similarly to Amplitude, started off as a venture darling with a valuation that towered toward the sun, then became a fintech unicorn suffering from massive cuts to its valuation, and now, well, it is the company it is today: still growing and in control of its cost profile.
Two companies do not a trend make, however. Thankfully, we got more data yesterday. Here’s how Asana discussed its cash usage in its quarterly report:
Cash flows from operating activities were $20.2 million, compared to negative $41.6 million in the second quarter of fiscal 2023. Free cash flow was $14.6 million, compared to negative $42.3 million in the second quarter of fiscal 2023.
That’s a dramatic flip to positive cash flow. What’s more, the company said its GAAP and adjusted operating and net losses narrowed dramatically.
GitLab is part of the trend, too. Here’s what the company’s CFO, Brian Robins, said on its earnings call yesterday afternoon:
I’d like to emphasize, it’s point about driving responsible growth, as we achieved over 2,300 basis points of non-GAAP operating margin expansion. . . . Non-GAAP operating loss of $4.3 million or negative 3% of revenue compared to a loss of $27 million or negative 27% of revenue in 2Q of last year. . . . We generated positive operating cash flow of $27.1 million in the second quarter of FY ’24, compared to a $36.3 million use of cash in operating activities in the same quarter of last year.
Hot damn, that’s a lot of progress in a year.
There’s more to consider. When Instacart and Klaviyo filed to go public the other week, we found that they were doing quite a good job of being profitable. Here are our notes on Instacart’s bottom-line improvements:
According to its S-1 filing, the company’s operations burned $204 million in 2021, a figure that flipped to +$277 million in 2022. Even better, in the first half of 2022, Instacart’s operating cash flow came to $99 million. That figure rose to $242 million in the first half of 2023.
And here’s Klaviyo’s own journey, from our reporting:
In 2021, the company charted a GAAP net loss of $79.4 million, which narrowed to $49.1 million last year. The company’s results have been perkier recently, though. In the first half of 2022, Klaviyo reported GAAP net loss of $24.6 million and managed to get into the black with a profit of $15.2 million in the first six months of this year.
A good question to ask at this juncture is whether we’re extrapolating too much from this handful of data. We are not. Here’s a chart from Altimeter investor Jamin Ball, tracking median next-12-months free cash flow margins for a basket of public SaaS companies:
Would you look at that!
What’s the catch?
Something had to give, right? Well, as companies cut costs and increase profits to survive for longer without needing to raise more money, we’re seeing the rate of revenue expansion come down. Yes, it is impressive to see tech companies of all sorts figure out how to make money, but they aren’t making so much revenue as fast as they used to anymore. Don’t take my word for it. Ball summarized the situation well:
As we know, growth has been hard to come by in the last few quarters. Just about every software company has seen their growth slow down (and in most cases the slowdown has been dramatic).
This favoring of profitability over growth has resulted in growth-adjusted revenue multiples looking a bit expensive for many tech firms. But when you factor in their improved profitability, those numbers look a bit more square. Ball closes his examination of that particular trend by arguing that software valuations — a massive chunk of the tech market — are in fact a bit expensive.
Still, I contend that when the economy improves, not only will these increasingly profitable and cash-rich companies have a strong base to grow from, but they will also do so from a position of wealth. My expectations for tech companies are a little bit higher than what the Street has in mind. Tech doesn’t look as expensive from my perspective as it does from some others.
But it’s easy to be an optimist when you are not an investor. I just get to watch, you know?
In closing: Investors demanded that tech companies turn their red ink into black ink, or at least free cash flow ink. They got what they wanted. The question now is: Just how happy are investors now that tech companies did what they were told to? Growth has slowed and profits are up. Now what?
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