How to Estimate a company’s health

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Companies such as NetSuite, Marketo, LinkedIn, LogMeln, and Fleematics have been merged or acquired for a combine value of $50 billion over the past few months. The Public SaaS companies have become scarce which is being viewed by PE investors and huge tech companies as a sense of opportunity.

What separates the selected companies from the others?

To separate the best SaaS companies from the rest, the Rule of 40 is considered a simple management trick. It is easy to calculate by just adding a company’s current growth rate and its profitability. The calculation helps to compare a company growing at 100% with -60% profit margins with a company growing at 40% at break-even or a company growing 10% but with only 30% profits.   

Portfolio companies and potential investors remain in a search of techniques in order to balance growth and profitability. The main focus for companies is growth which comes at a cost. Therefore a new approach has been taken to enhance the efficient growth. By entering the Bessemer Efficiency Score, which measures efficiency of the company by taking total sum of a company’s percent growth + percent free FCF margin (Cash Flow). In this way a given cloud business’s growth efficiency is calculated. The efficiency score keeps on changing at different levels but a public company with above 40 efficiency score is considered good.

But the question arises whether this efficiency score is really of a good use than just being discussion point at board meetings?

A company’s efficiency score has more than 70% correlation with public SaaS company’s revenue multiple. The highest quartile of public SaaS companies by revenue multiple is considered to have an efficiency score of 445 whereas the lowest have a score of 9%.

A lot of debate goes on over the right place for putting the money by public investors but with this simple method they can get a clear idea of how their company will be valued in coming years.

Are Companies improving?

With respect to efficiency scores, the SaaS companies have been pretty consistent over the past four years by ranging within 28% to 31%. But the maturity of the SaaS companies is shown by the changing of the composition of the score. In 2012, the average public SaaS Company had a growth rate of 55% a year with a loss of -28% in FCF. But in 2016, the growth came to 28% with an average profitability of 3%. With companies such as Salesforce and Workday getting bigger with declined growth and greater profitability, this all was very much expected.

In year preceding IPO, the SaaS companies usually have a goof efficiency score. The cloud companies had 73% as an average efficiency score three years before IPO as opposed to mid-30s level post-IPO. While growing, the best companies are incredibly fast and as they mature their FCF grows as their growth declines. Generally the companies become less efficient as the growth in profitability seldom makes up for the stratospheric growth.

Efficiency Score is not the focus of attention for just public investors. A list of public SaaS companies is given in the following chart in which the companies are ranked by their 2016 efficiency scores. Fleetmatics, LinkedIn, LogMeln, and Marketo are four companies that have been acquired or merged. Out of these four companies, three were among the 11 companies ranked by efficiency score at the time when they were acquired. All the companies were completely different industries like they belonged to social networking, fleet management, and remote connectivity. But they stood among top performers on the basis of their growth and profitability.

As compared to their efficiency score, these companies were trading relatively cheer. The top ten efficiency score companies traded on a median of 8x but Fleematics traded at 4.8x. LinkedIn traded at 6.9x and LogMeln traded at 6.9x.

The network security company Qualys could be the next public SaaS Company as it is in the top 10 Efficiency Score companies with 23%FCF margins and 21% growth. This company is trading cheaply at just 5.5x revenues as compared to other companies.

Via: Tech Crunch