I read that TEAM’s earnings after the close on Thursday night was one of the reasons listed for the further drop of SaaS stocks yesterday. Given that TEAM was down around 9% at one point on what I’ve read are pretty good earnings, I decided to look into TEAM a little more. Their market cap of $28.2B was disappointing as I would rather invest in smaller companies that have more opportunities to grow at very high rates. Seeing their Q1 revenue growth of 36% to $363M was also disappointing given the higher growth companies we follow. Their TTM revenue is $1.21B and have cash of $1.8B. That gives us an EV of 26.4B and an EV/sales of 22. This seems really expensive for a company growing revenue at 36% with such a big market cap. With this being Q1 earnings, they gave their full year guidance which was $1.57B so if we look forward, the EV drops to 17. This still seems pretty expensive as it is around the same EV/sales ratios as companies like MDB and AYX which are smaller and growing more quickly. And AYX has higher gross margins in the low 90s vs TEAM in the low 80s.
So why is TEAM so expensive on an EV/Sales basis given the higher market cap and slower growth? It’s because we are evaluating it on the wrong metric. With more mature software companies, we need focus less on sales and start paying more attention to free cash flow (FCF). TEAM looks so expensive on an EV/Sales basis because they pump out a lot of cash, which makes sense given how big they are. Their forecasted Cash flow from operations is expected to be in the range of $525 million to $535 million and free cash flow is expected to be in the range of $465 million to $475 million for the full year. I think free cash flow is the key and if you take mid point, they are projecting $470M of cash flow, which gives them an EV/FCF of 56 times. That’s a little more palatable compared to an EV/sales of 22 given the large market cap and slower growth.
So instead of saying that in 1 or 2 years, the EV/sales would be X times if the stock price stays the same, we should be looking at future cash flows. Many of our high growth software stocks currently have minimal FCF as they are smaller and investing into future growth. They are not yet at the stage of a TEAM where they have slower growth and can produce a lot of FCF. So how do we recognize the FCF of tomorrow? Obviously revenue growth is still very critical as the more revenue we have in the future, the more FCF we can produce. The other critical component is margins and I like to focus on gross margins as the costs below this can be lowered in the future. Sales expenses and R&D are obviously always real costs but will likely be a lower percentage of revenue for a more mature company. I like AYX with its high gross margins of 91% combined with its accelerating 59% revenue growth. With an EV of 5.8B and forecasted full year sales of $375M, they trade at a reasonable 15.5 times this year’s sales. Those concerned that we are using forecasted full year sales instead of TTM, note that AYX is already more than 75% complete with the year as their year-end is 12/31. In February, they will come out with forecasted sales for next year, so then the EV/forecasted sales will drop even further.