If revenue growth slows, companies need to show strong free cash flow generation in order to have top valuation multiples.
Lots of companies are figuring out how to balance revenue growth slowdowns and becoming more efficient.
Quick 🧵
Lots of companies are figuring out how to balance revenue growth slowdowns and becoming more efficient.
Quick 🧵
A company’s stock price can increase from:
1⃣Increasing the level of revenue
2⃣Increasing valuation multiples (i.e. multiple expansion) such as EV/Revenue
1⃣Increasing the level of revenue
2⃣Increasing valuation multiples (i.e. multiple expansion) such as EV/Revenue
The first one is obvious - the more revenue a company generates, the more it should theoretically be valued.
The second point is where people can get tripped up because valuation multiples can be a moving target.
The second point is where people can get tripped up because valuation multiples can be a moving target.
Software EV/Revenue multiples can move based on:
1⃣Macroeconomic factors - such as interest rates
2⃣Company-specific stuff - revenue growth and profitability metrics (i.e. Rule of 40)
1⃣Macroeconomic factors - such as interest rates
2⃣Company-specific stuff - revenue growth and profitability metrics (i.e. Rule of 40)
There are a couple of companies below that stick out:
-DropBox has strong FCF, but growth is slow so the valuation multiple is much smaller
-Zuora, Domo, and Twilio all stick out here. They still have negative free cash flow, but they are barely growing.
-C3 is in trouble...
-DropBox has strong FCF, but growth is slow so the valuation multiple is much smaller
-Zuora, Domo, and Twilio all stick out here. They still have negative free cash flow, but they are barely growing.
-C3 is in trouble...
So as revenue growth expectations come down, free cash flow must go up in order to receive the same relative valuation multiple.
The hope with all software companies is that they become cash cows at scale.
If they can't then they will receive a much smaller valuation multiple
The hope with all software companies is that they become cash cows at scale.
If they can't then they will receive a much smaller valuation multiple
Direct payroll-related costs typically make up 70%+ of a software company’s expenses.
It's by far the largest line item for software companies.
So if they need to become significantly more efficient, payroll expenses will be impacted in some way.
It's by far the largest line item for software companies.
So if they need to become significantly more efficient, payroll expenses will be impacted in some way.
High revenue growth can hide inefficiencies, but when growth slows, the ugly inefficiencies appear for everyone to see.
Growth is slowing a ton in 2023 for a lot of software companies.
Some companies will be found naked...
Growth is slowing a ton in 2023 for a lot of software companies.
Some companies will be found naked...
Companies should cut non-headcount waste first. There likely is plenty of that and it is fairly easy to find.
But companies with drastically slowing revenue and burning lots of cash will still likely need to look at their total payroll costs as well to improve efficiencies.
But companies with drastically slowing revenue and burning lots of cash will still likely need to look at their total payroll costs as well to improve efficiencies.
Full post here 👇
open.substack.com/pub/onlycfo/p/…
open.substack.com/pub/onlycfo/p/…
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