SaaS Business : The Hidden Compounders

            I have  seen lot of eyebrows raised by Indian Investors when some SaaS company gets valuation of 10-15 times sales and making losses. Not only novice investors but even reputed investors raise the concerns that venture capitalist gone mad, they will burn their fingers. Where is EBITA margin, ROE, ROCE or cashflow?  Don’t VC love to make money? Are they doing charity by valuing SaaS companies so high? Defiantly, they will lose money in some but will make extraordinary return in some. Indian investors are not able to understand power of SaaS business model with annual recurring revenue and having some growth in customers and negative churn rate. Yes, negative churn rate is possible even if 4-5% customers leave your product. SaaS companies archive negative churn rate when 4-5% leave but existing 95% gives more than 5% growth in variable charges.

I am attempting to explain SaaS business model with annual recurring revenue with example where Indian investors will get some connect. I am explaining with real estate rent in commercial building with long term lease.

Let’s assume a businessman gives 100 cr each to his son and daughter and ask them to invest in annual recurring revenue (ARR) business model.

Son choose to invest in real estate rent in commercial building while daughter choose to invest in a SaaS product with ARR.

Our accounting standard captures capex of old business properly but not new business-like SaaS product with ARR. Dad asked son to follow same accounting standard as his sister going to follow. It will show unform picture.

It means all the capex will be treated like expense and it will not be shown as asset under balance sheet.

Let assume some conditions in business

•  Commercial rent yield was around 8 to 8.5% before pandemic. Let’s assume son is able to earn 10 yield on current market price of commercial property.
•     Inflation is around 6-7% and market value of property is increasing with CAGR of 7%. Market value is getting calculated previous year value + 7% of it + This year reinvestment.
• All the ARR (Rent) spent on reinvestment for purchase of new commercial real estate.
•  Accounting standards allow to put commercial property under asset in balance sheet but remember what dad said “follow accounting standard similar to daughter’s business”. Dad has given money can’t go against him.

Now, check how P&L Account will look for 20 years.

 

Last two rows not available anywhere in P&l , Balance sheet or cash flow . It was not ready made available to investors.

Son contacted some investors after two year to sale his business. Investors who invested whole life based on P/E, P/B , cash flow , ratios , margin looked at balance sheet and p&l accounts . They said, you don’t have positive EBITA margin, loss making, negative ROE & ROCE, burning cash and nothing is balance sheet. You have revenue of 11.70 crores. We will give max 0.5 times to revenue or rounding figure 6 crores. Will son except this offer? No. He is aware about last two rows of above screen shot. He knows market value of property is 137 crs.

Same happened after even 20 years, still company making losses (6 crores) . No investors were giving required valuation. They offered just 100 crores. Now, he approaches a VC which is big player in SaaS but open for other business as well.  VC figure it out that general commercial rent yield is around 8-10% . So, asset behind the scene (without looking last two rows) should be 10-12 times. He offered him 197.48 * 10 = around 2000 crores which is close 2310 – accumulate losses. Should he accept that deal now? It is pretty close; he can negotiate some for future growth factor and make deal. Finally, they made deal at 2100 crores. Is the story end now ? no .

VC invested to make money and not for charity. He decided to reinvest only 20% and rest 80% distributes as dividend. Now, P&L will look like below.

After year 3 he came for IPO. Will the investor will complain no. It will be high margin business with margin more than 70% , high ROE & ROCE , no debt , light balance sheet.

Paying dividend more than profit even after investing for future growth. VC decided valuation of 20 PE. Market cap will be 20* 211 = 4220. He paid only 2100 but after business achieved scale, he reduced re-investment and he made another 2x in 3 years.

Now, you try to calculate daughter’s SaaS business with ARR. It is similar to it but defiantly there will differences. e.g. Re-investment rate in real estate was 100% that can’t be in SaaS business but that will be compensate by higher yield. SaaS business is going to have much higher yield than 10%.

• 30% growth in ARR
• 70% reinvestment 
• 30% other expenses 

 

P&L

 

If she able to sell this business at 20 times PBT then valuation will come around 30000 crores to 40000 crores which was making losses till 20 years .

I hope everyone able to understand why SaaS business with ARR are valued on revenue multiples of 8-20 times or even more. Please note term ARR, even SaaS business doesn’t have 100% ARR there is always one-time components in revenue of SaaS business. If it is less than 10% then also, we can apply revenue multiples else need to do some adjustment.

I don’t know exact revenue of HighRadius(promoted by NRI Sashi Narahari) but as per my understanding it is around $230 to $250 million. It is valued at $3.1 billions in latest funding which is 12.4 to 13.5 times revenue. Do you still think that is too much?

There are very few SaaS player is listed space  and none of them is the pure SaaS player. E.g. Intellect Design has some portion of revenue from SaaS . I don’t want to name a tiny smallcap as SaaS Player to spoil generalness of this article .

Emagia the IDC MarketScape players for worldwide SaaS Account Receivable Product valuation.

We will start with position of Emagia’s O2C SaaS products in worldwide market.

Emagia positioned as a leader in IDC MarketScape: Worldwide SaaS and Cloud-Enabled Accounts Receivable Automation Applications for Enterprise from last two years.

The following screenshot from 1 year old article of Robert Solomon. He has nicely explained all players of worldwide SaaS players in Account Receivable automation. Bob Solomon is founder, President, and Chief Bottle Washer of Software Platform Consulting, Inc

https://www.softwareplatform.net/2020/02/10/growth-equity-cash-flows-to-saas-accounts-receivable-applications/  

Our task to estimates the valuation of Emagia a SaaS player. In Agile framework, if can't estimate task then we can use relative estimation. It means if that task was that much complex and taken this much time then compare our task with the already estimated task. We can use the same for estimation of intrinsic value or market value of Emagia. We are right now interested in the whole company valuation instead of around 67% stake of TechnVision. We can adjust that during the intrinsic valuation of TechNVision.

We will find out competitors and their current valuation. We know the current revenue of Emagia is just few millions.

We are having the following clues.

HighRadius : I don't know the exact revenue of HighRadius(promoted by NRI Sashi Narahari) but as per my understanding it is around $230 to $250 million. It is valued at $3.1 billion in latest funding which is 12.4 to 13.5 times revenue. We can give that multiple but HighRadius is 25 times more than Emagia . We need to check few more companies.

Versapay : Great Hill paid C$126 million for VersaPay in an all-cash deal when Expected 2019 Revenue: C$9 million and EBITDA loss for 2019 will be about -C$8 million. Great Hill paid 14 times to revenue.  Link : https://platformsoftware.net/2019/12/16/great-hill-to-acquire-versapay/

Rimilia : It has £6.18 million ( $8.55 millions) revenue in 2019 . Loss-making (EBIT 5.7 milions). BlackLine acquired Rimilia in Oct. 2020 at $150 million. It paid around 17.5 times. https://www.accountingtoday.com/news/blackline-acquires-european-ar-software-provider-rimilia

As per IDC MarketScape HighRadius is the leader. However, Emagia is ahead of Versapay and Rimilia. Versapay and Rimilia both were loss making when got acquired .

Before coming to valuation, we should know Emagia's revenue. So , Emagia had revenue around 16 crores in 2019. It is growing very fast .It has revenue of just 2 crores in 2018 , then 6.7 in 2019 then around 16 crores in 2020.It may come around 20-30 crores in 2020. We are waiting financials of the company for 2020 ( USA Financial Year) .So , valuation is also tentative till get confirm figures but I am assuming 25 crores.

Versapay was acquired at 14 times revenue while Rimilia was acquired at 17.5 times revenue valuation recently and both are the same size as Emagia.

Now, you can apply revenue multiples of your understanding to revenue of 20-30 crores for the current valuation for VCs and another fund. Mind you this is not valuation I or you are going to pay this is valuations that other companies or VCs and other funds can pay or strategic fit for a bigger company. Majesco shareholders made money because they know how much VCs or Fund houses can pay or market value.

Will you be able to find the market value of complete Emagia with these hints?  15 to 20 times will be the answer based on peer evaluations. However, Emagia has a better product and there is the rush for digital transformations. If we assume 18 times valuation and 25 cr revenue then valuation will come to around 450 crores INR . You are not paying this but this is the market valuation of Emagia today which can grow more in the next 4-5 years. Please also not Emagia can strategery fit for many companies . If BlackLine can pay Rimilia $150 millions then someone can even pay at least that much to Emagia if it strategically fit for that company.Emagia's products are better .

However, this is not a TechNVision valuation in Emagia. One will have to calculate as per 66.24% holding (around 298 crores) and give some discount for tax/holding/doubts and add a premium for growth of tech business. Discount and premium needs to be given by shareholders of TechNVision.

This will be the TechNVision valuation for Emagia Stake. But to complete the valuation of TechNVision, we need to add Solix's valuation which has 80 crores revenue last year and around 100 crores this year. Can anyone calculate that?

Next article, I will explain why the valuation of 10-20 times the revenue for SaaS companies with ARR is not expensive. In fact, I will be buyers for 10-15 times in companies like Highradius which is planning an IPO next year in the USA, or even Emagia for direct investment.

Note : Bad news on TechNVision. It is put on GSM : Stage 3 from earlier 2. This is a problem with illiquid stocks.SEBI & Indian exchange don't understand the intrinsic value of new generation tech biz which shows losses. Most of the Indian unicorns are making losses if listed then will be on GSM. I will request retail investors should stay away from TechNVision unless they can afford this type of illiquidity risk.

Disclaimer :  Please treat this post as starting point of your research and not conclusion to invest in any discussed stock. As always , please take the advice of a SEBI qualified financial adviser which I am not .

View on Route Mobile Ltd after watching DHANDHA by Varinder Bansal

My views on route mobile after watching DHANDHA: ROUTE MOBILE by Varinder Bansal. 

First of many thanks to Varinder Bansal for this initiative,

You tube link . https://www.youtube.com/watch?v=1Ar7Zqfx68o&t=1s

This is not complete analysis but my views after watching DHANDHA: ROUTE MOBILE by Varinder Bansal.  I hold Route Mobile and I have some exposure to Route Mobile ltd in my portfolio . My avg price is around Rs 1150 but exposure is very limited.

       Some has doubts about moat in the company products. After watching this webinar, I think the company product does not have a strong moat but the company has a strong moat because of its relationship with telecom providers over the years. This is my view anyone can disagree.

        The main feature of the product is to send email or SMS. Sending an email is not a complex task anyone can build a product around it. In fact, most of computer programming languages provides APIs for it. But, sending SMS is a little bit tricky. But, there are so many APIs presents that can send SMS. If you just search "send global SMS api" you will get huge list of companies. So, copying this product is not difficult. However, as per management, they have built-in some AI and Big Data Solution behind the scene which decides the best and cheapest route for sending SMS. It can also be easily built. It's not very difficult to make a similar product for a company that is already sending emails/SMS as OTP in their solution for example Infosys Finacle, Tech Mahindra, Sasken, or Intellect Design. Products can easily add SMS functionality using these APIs or built their own. Of course , they will have to handle NFRs(Non Functional Requirements) and products desirable Quality Attributes like Functional suitability, Reliability,  Operability,Performance efficiency, Security, Compatibility, Maintainability ,Transferability and so on . Product can be build but they cannot build this relationship with global operators in 1-2 years. Especially companies like Infosys will avoid it while Tech Mahindra or Sasken can try their luck given opportunity size in CPaaS. Becoming a global player will time consuming process, that is the moat for ROUTE MOBILE. Will they able to beat on rates offered to ROUTE MOBILE? It will be difficult.I have not done much research on existing competition threat.

         Even though product level moat is weak but there is a huge addressable market ($25 Billion by 2025). ROUTE MOBILE is one of the leaders in this space. So, the good portion of pie will go to them. It is like anyone can make a product like Nestle Maggie. But, it is hard to beat Nestle and grab market share from them. Now, Marico is trying their luck. 

ROUTE MOBILE has the following advantages.

• ROUTE MOBILE provides a Global solution. Most of the MNCs want A one-stop solution. When MNC player will float RFP,  ROUTE MOBILE will be the preferred choice and they are already having big giants as their reference customer.

• ROUTE MOBILE has strong relationship with telecom providers, they can leverage it to cross-sell the other products to them, for example, they have already started to selling Firewall solutions to them.
• ROUTE MOBILE is one of the cheapest providers as per the discussion in the webinar.

I think ROUTE MOBILE is also lucky(serendipity) they entered 15-16 years back in such a product which does not require a lot of new features regularly. It is just sending SMS or Email or nowadays messages to App. So, there is not much scope for adding new features or pressure from the competition. Most of the other IT product companies are involved in a rat race for new features development and feel pressure from competition for adding new features. Because of this their product development cost increase, every year and they are not able to make sufficient profit.

ROUTE MOBILE business is like toll bridge business like IEX(Indian Energy Exchange Ltd
), they generate revenue on traffic and same time product require little reinvestment. The company can generate good free cash that can be utilized for acquisitions, developing new cross-salable products, or even dividends.

IT is a very rapidly changing field but these types of product are going to be relevant even after 10 years. The reason is multi factor authentication requirement for security. Most of critical transactions like banking requires multi factor authentication . It means authentication from more than one channel. Multiple-channel Authentication (MCA) is a method of Multi-Factor Authentication where one or more of the Authentication Factors involved are communicated over separate communication channels or protocols. It mitigates the ripple effect of compromised credentials, even if someone has stolen your password by Web channel but he can't hack your OTP sent by SMS channel. Another option to use a physical token which also not convenient. Right now, I don't see any other alternative to distribute OTP over SMS.

As per my personal opinion, Even though the product has a weak moat but the company has moat due to cost, relationship with telecom operator, experience in the field, and offering a global solution.

Disclaimer :  Please treat this post as starting point of your research and not conclusion to invest in any discussed stock. As always , please take the advice of a SEBI qualified financial adviser which I am not .

 

Valuation SaaS Cloud Product Companies

 

You might have heard SaaS companies are trading at high sales multiple in the USA or I have mentioned Snowflake is trading more than 170 times sales in a previous article .

http://value2wealth.blogspot.com/2020/11/snowflake-inc-vs-technvision-can.html

 

 

Source : @jeevanpatwa Twitter for the Image

US-based investors give SaaS Product companies valuation based on SDE (Seller Discretionary Earnings) or  EBITDA or Revenue.

There are very limited SaaS Players in the Indian stock market ( I am betting on TechNVision) but Indian stock investors are conservative in their approach and will not give a valuation based on sales.Similar stuff was playing in pharma or API. Investors love to give a valuation based on P&L mainly PE. Sajal Kapoor sir ( @unseenvalue ) has seen something that PE-based guys were not able to see a few years back. Once, EPS improved everyone can see. Now everyone is seeing EPS and growth, valuation improved and stocks become 3-4 times in a quick period.

A recent tweet from Sajal

He is an expert in pharma/chemical but I am not an expert in SaaS/Cloud even though I am working in a software product company. I am trying my level best to understand it. If you are interested in SaaS/Cloud or software product companies then you will have to learn about it.

I am trying a simplified valuation model for Indian Investors who can give PE based valuation to software product companies even loss-making.

What a crap? how can we value the loss-making companies on PE loved by an Indian investor?

Wait, read till the end, you may give PE valuation to a loss-making company. Let's consider this company A .

If I ask you to value this company based on PE then you may say how can we give multiple to -5 crores PBT. But, you can get data to give multiple based on PE from my simplified method.

For this, you will need some basic accounting knowledge, I am also not an expert but have gained some basic knowledge over the years. Romancing the Balance Sheet is a very good book for beginners, https://www.amazon.in/Romancing-Balance-Sheet-Manages-Business/dp/9350294311/ref=sr_1_1?crid=1OTTUEX6MOTZ2&dchild=1&keywords=romancing+the+balance+sheet+by+anil+lamba&qid=1613274578&sprefix=romancing+%2Caps%2C267&sr=8-1

There are two sections in accounting P&L and balance sheet.

A wrong entry such as Inventory in the balance sheet can impact P&L, some companies used that trick to manipulate P&L. Leave it that is not our topic for today.

We already know expenses go to P&L and asset goes to balance sheet. Every expense should satisfy the test of consumption. E.g. 20 cr raw material used to get topline of 100 cr then 20 cr raw material will be expenses, next year if company again makes 100 cr, it will have to use another 20 cr raw material. If the company brought 100 cr machine, will it go as whole 100 crore expenses the first year if that machine is going to use for 10 years? If all 100 crores go to expenses in P&L then the company will show losses in P&L. 100 crores spent on the machine which can produce revenue for 10 years will go to the balance sheet as 100 crores asset. P&L will only have depreciation (around 10%) . Now, P&L can show a profit of course depends on other expenses.

Mostly if a company spends on capex and the gestation period is long then P&L will be impacted by  depreciation and initial expenses that provide an opportunity to deep drivers like Sajal Sir. Everyone can’t see it. Professor Sanjay Bakshi sir and some other investors identified the similar type of discrepancies in Relexo and other companies which spend on branding. Advertisement cost doesn’t fully satisfy the test of consumption but it is still treated as expenses in P&L which causes depressed profit figure for the current year.

Now, come back to our example product based company A. It has spent 100 crores on employees salary. If they are doing product development that can be used for let's say 10 years then does this expense satisfy the test of consumption.

No, then it is not an expense but it should be an asset under Balance Sheet. But, as per current conservative optional accounting norms they have put in expenses which causing 5 cores loss. Should we put 100 crores under the balance sheet as an asset?

Not entirely, most of the product companies have two buckets in timesheet entry. Billable and non-billable development. Billable development works to satisfy the test of consumption because you are doing some specific work for some customer which may be used for others or may not. Most product companies put even this billable work in product with some flag/switch If this feature can be re-used by other customers, it enhances the product features. It is debatable if Billable development works as an expense or asset. For simplicity, assume it satisfy the test of consumption, so it is an expense. Let assume Non-Billable and Billable development works in the ratio of 70:30 . Non-Billable product development works don’t satisfy the test of consumption then it should go to the asset under the balance sheet. Now new P&L will look like …

New PBT is now 65 crores. Can Indian conservative investors give PE based on PBT ? Yes. One can give 5, another 10, some 20 or some even 50. If someone gives PE of 25 to PBT then the valuation of stock will come around 65*25 = 1450.

Almost 10 times to sales.

Please note Solix Technologies USA and Emgia Corp USA combine spends 95.24 as Employee Cost out of total revenue of 125 cores and posted PBT loss of 2.44 crores last year. Please also note, corrected annual report of TechNVision shows fewer figures due to their stake of around 67-70% and reducing inter-cross revenue between them. I am going to request the company secretary of TechNVision to put audited reports of subsidiaries on their website. So, we can get a clear picture. If you are an investor then please you also request to him.

I don’t want to go deep into TechNVision for this article now let's decide PE for company A.

While deciding PE for SaaS product companies, you will have to check some factors.

1. Is it cyclic? then give PE of 5-10 , of course not
2. What is the addressable market size?
3. Growth & expected dilution of equity
4. Subsidiaries structure
5. Competition
6. Recognition of product in Industry
7. Product Maintenance & competition features cost
   
8. Revenue Model ( Upfront or recurring)
9. Promoter stake and their skill set
10. Location of the addressable market
11. Peer Valuations
12. How strategic fit this company for acquisitions by a big company.
13. and many more ...
    

 

 

Most of the SaaS cloud players get higher valuation because of their recurring revenue model. Initial revenue is low but it came at a regular interval ( like renting flat vs selling an entire flat). Both can't have the same PE ratio.

Now, come back again to product company A . P&L submitted to exchanges will show a loss, It will trade less than 100 crores with prices to sale ratio of around 0.67. Around 99.9% of investors will feel this loss-making company doesn’t even deserve 100 cores valuation. As per exchanges, it is making losses they will put in GSM/ASM category. Most of the brokerage houses will not allow trading in this counter.

Now management decided the product is features rich and doesn’t want to develop new features or develop an entirely new product for 1-2 years. They will cut non-billable development by 80% and do compliance changes, the competition features to survive in just 20% of non-billable bucket. No company can fire 80% of the employee for few years then take back again. Most of the product companies either invest in the same product for new features or create a new product. Some kind of virtuous cycle. Amazon did the same thing that's why investors who bought initially based on free cash flow instead of PE got multibagger returns. But, let’s assume for simplicity they will cut non-billable costs by 80%.

Next year they also grow by 30% then P&L with the old model and new model will be the following.

Now, PBT is around 100 crores with new model and even PAT will be around 100 crores since the company had carried losses from so many years, the tax will not be applicable. Now, even a 1000 crores market cap will look less against the earlier 100 crores within 1 year for the same set of investors.

Happy Investing ……………

 

Disclaimer :  Please treat this post as starting point of your research and not conclusion to invest in any discussed stock. As always , please take the advice of a SEBI qualified financial adviser which I am not .