SaaS Stocks: How Much Punishment is in Store?

The stock market feels like Nordstrom Rack these days:

• Salesforce at $56/share
• Tableau at $38/share
• ServiceNow at $47/share
• Zendesk at $15/share
• Workday at $49/share
• NetSuite at $54/share

Redpoint’s Tomasz Tunguz points out that SaaS forward revenue multiples have been more than cut in half, dropping from 7.7 in January 2014 to 3.3 today.

So where’s it all going to end?  Much as the P/E  of the S&P 500 tends to converge to around 15 over time, I have always felt that quality on-premises enterprise software companies converged to a valuation of 2.0 to 3.0x revenues and there was a floor around 1.0x revenues.  That’s not to say that Wall St doesn’t over-correct and you’d never see on-premises valuations less than 1.0x revenues — but that should be rare and anything less 2.0x could indicate a good buying opportunity and anything near 1.0x — for a healthy company — could mean a real bottom-fishing opportunity.

The question is what are the equivalent numbers for SaaS companies?  I think the norm range is 3.0 to 5.0x revenues and I think the floor is around 2.0x.  That would suggest that in a bad case — despite all the recent carnage — there’s still 30% downside potential in SaaS stocks.  And that’s not including the case where you think we’re in a macroeconomic situation such that the forward four-quarter revenue estimates drop, which would mean more downside potential on top of that.

But I do think at 3.3x, we are now near the bottom-end of the norm range so the question is which sentiment is going to win out in the market:

• Fear of the 30%+ remaining downside potential in SaaS stocks
• Greed to capture the potential 50%+ return of a SaaS bounce back to the mid/high-end of the range.

I’d speculate on more fear in the short-term followed by some nice greed in the mid-term.

See my subsequent post, the SaaSacre part II for more in this vein.

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See my disclaimers:  I am not a financial analyst and I do not make recommendations on specific stocks.  The purpose of this post was to share my non-scientific rule of thumb for SaaS trading ranges and do some analysis based on that.