What Covid means for SaaS business valuations?

Banking & Finance
| The European | 11 January 2021

Andy Moseby of Kemp Little unpacks a rollercoaster year for technology firms, and looks at who the winners and losers might be 

In a wretched year for many European companies, there are some that have excelled. A recent report from KPMG confirmed that, unsurprisingly, the sectors that have been least affected by the Covid-19 pandemic have been information technology and online consumer staples.

Since March, tech businesses offering software as a service (SaaS) solutions that promote remote working and collaboration have seen record revenues. Covid-19 has turned Zoom into a household name; its stock rose dramatically during the initial lockdown with over 300 million participants using Zoom video calls a day during April. By the end of that month, corporate use was up more than three times that in 2019 whilst its Q2 revenue (reported in late August) was $664m. 

Before news of a vaccine, the market cap of Zoom Video Communications topped out at $161.65bn – more than that of IBM or, more soberingly, more than three times the valuation of the world’s biggest seven airlines combined. 

What has happened to SaaS valuations? 

Not all tech companies have seen the eye-watering growth of Zoom, but there are indications that the valuations of technology companies remain high, as the current pandemic became the catalyst for the acceleration of digital transformation plans. The BVP Nasdaq Emerging Cloud index, which tracks the performance of emerging public companies primarily involved in the provision of cloud services, has consistently outperformed the main Nasdaq throughout the year.  

The ten public cloud companies which have seen the biggest jump in value since the start of 2020 – including Zoom, but also Salesforce, Shopify, ServiceNow and DocuSign – have together witnessed their market value rise by close to $0.5tn, representing half the increase in the global cloud index for the calendar year.  

Europe has seen its fair share of success too. American venture capital firm, Accel, predicted in 2019 that it would take until 2022 for Europe to generate its first “decacorn” (a company with at least a $10bn valuation). UiPath, the Romanian robotic process automation providers, achieved that milestone this summer, merely nine months after Accel’s projection. In July, HgCapital’s Saturn team and its investors acquired a stake in the Oslo-based business optimisation software provider Visma in the world’s largest ever software buyout, valuing the company at $12.2bn.

However, the true impact of Covid-19 on SaaS valuations has been fairly localised. Ignoring businesses which sell into distressed sectors like air travel or hospitality (where valuations have plummeted), when you remove the 20% or so of cloud companies which have seen extreme acceleration (primarily those in video conferencing, remote collaboration, e-commerce, security and business automation), on the whole valuations have remained steady.   

Partly this is due to buyers wanting more reassurance that what they are acquiring is not going to just be a short-term fix for a problem that will not exist next year. There is also concern that whilst a business may have been performing well during the current pandemic, that it is not necessarily an indicator of long-term success. As many commentators have pointed out, the economy has not been in a normal state the last year, and prospective buyers are wary of potentially inflated sales or artificial climates that will not last.

Investors, too, are becoming more cautious. According to PwC, investors are more keen to understand investment risks and make more informed decisions. This means that, increasingly, granular valuation details are being challenged, with a focus on trading numbers rather than forecasts of what might happen. In that environment, valuations based on revenue rather than growth tend to become the norm.

We are also starting to see business owners start to look ahead at what may impact the proceeds they receive on any sale. The economic cost of Covid-19 has been huge for governments, many of which are now beginning to look for ways to recoup the spending that was necessary over the summer to keep economies afloat. The UK government has already hinted that changes to capital gains tax will be coming in 2021. The prospect of paying income tax type rates on sale proceeds has caused a quandary for some founders: should they accept a lower valuation now or wait until next year when further trading results could see a higher valuation but a reduction to their overall net gain. All of these factors have played a part in damping high valuations across large parts of the industry, baring the outliers. 

How to make the most of this situation

Successfully steering a company through a period of market unpredictability (like a global pandemic) is only possible if the business is able to accommodate change and react quickly to market opportunities. SaaS companies have an inherent advantage in that their offerings are almost limitlessly flexible, are able to be deployed remotely, and leverage technology trends as they occur.  

It is highly unlikely that business will return to the way it was prior to the Covid-19 pandemic. People will work more flexibly between offices and home, and online shopping is here to stay. According to research by Deloitte and Fortune Magazine, 77% of CEOs reported that Covid-19 had accelerated their digital transformation plans; indeed, even in April, CEO Satya Nadella delivered Microsoft’s quarterly earnings report to Wall Street with the words: “We’ve seen two years’ worth of digital transformation in two months”.

This is not a one-off change, either. New ways of working and doing business require organisations to respond in an agile way, continually revamping their efforts to adapt and remain competitive in the post-Covid-19 era. The digitalisation of customer and employee experiences has emerged as key to ensuring business continuity, during and following the pandemic.       

Who will be the winners?

The large challenge of adopting the technologies that will enable this customer and employee digitalisation to occur and continue historically made businesses pause. To undertake a full digital transformation process forces great behavioural and structural changes, like new business models, operating procedures, worker skill sets and mindsets. It can even affect whole business cultures.

It is hugely unlikely that operational plans designed to take two or more years, that have now been rushed through in a matter of months, will have been executed properly. There will be issues that need to be addressed, unforeseen problems that need to be fixed.

Despite the need to focus on technology implementation, it may actually be that a company’s employees are the parts of the business that need the most attention. According to latest research from McKinsey, almost 12 months into the crisis, employees – especially women, LGBTQ+ employees, people of colour, and working parents – are desperate for additional support. McKinsey reports that women are 1.5 times as likely as men to face “double shift” challenges: difficulties with mental health and increased household responsibilities. LBGTQ+ employees may be feeling acutely isolated, whereas people of colour cite concerns around workplace health and safety and career progression.                                                          

Businesses which can successfully deal with the dual challenge of implementing and managing a once-in-a-decade digital transformation project whilst maintaining a motivated workforce are most likely going to emerge as winners in the post-Covid era.  

As with all crises, some companies won’t make it through, some will slowly return, new business models will surface that were born in a remote working, Zoom-using, agile environment. We can be sure that whatever the post-Covid-19 world looks like for businesses making use of cloud services, it will certainty not look like it was pre-pandemic.

Further information 

www.kemplittle.com

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