I’d like to introduce a few measures that I and others have touched on to compare SaaS companies. Many of the traditional measures fail because SaaS companies look pretty terrible in their infancy and middle age if you look at them by P/E or similar measures. Many of our companies are in the, “Land and Expand” part of their growth cycle. How can we make sure they are actually creating value and not just growing with no hope of having a feasible business at the end of it all? How do we compare a company growing 60% with no earning, burning cash with a company growing 30% and earning cash? I’ll introduce a few ideas below and what goes into them.
The first is Efficiency of Capital. Simply put you take Revenue/(equity+debt). In english this basically is looking at how much capital has it taken to generate the revenue for that year. For companies that have successfully IPO’d and lived their efficiency of capital ratio is >0.6. So they have created 60 cents of revenue for each dollar of capital invested. Shopify’s efficiency of capital is currently lower than usual because they have raised money but not spent it.
SHOP 0.6 OKTA 0.7 MongoDB 0.37 AYX 0.45
The second is Efficiency Score. Revenue growth + (free cash flow/revenue) . This measure allows us to correct for companies that are growing like mad but burning cash with companies that are growing but actually cash flow positive. Is SHOP’s growth really all that good? (yes it is).
SHOP 0.72 OKTA 0.6 MongoDB 0.21 AYX 0.65
Finally we have the dollar revenue retention rate . Each company calls this something a little different. I like to think of this as how sticky the company’s revenue is. I think DRR can be an indirect proxy for moat and you can follow DRR with some context to see if a companies moat is increasing or decreasing. This is calculated by taking the beginning of year revenue + upgrades from existing customers – churn – downgrades from existing customers divided by beginning of year revenue. So basically are your existing customers in aggregate spending more with you each year (>100% DRR) or less (<100%DRR). Not all companies give us the DRR and each calculates it a bit different and even may call it something differently. For example. SHOP just tells us it is >100%. OKTA gave us 123% one time and then stopped reporting. MongoDB says they have an “attractive” DRR and AYX tells us each quarter which hovers around 131%.
So, why is land and expand so powerful for these companies if they only receive 60 cents for each dollar they spend. The thing is they get that 60 cents every year as most of that revenue is recurring and if their DRR is high then they get more than 60 cents every year. So most of these companies (except MongoDB) are earning a profit on a customer after one year. This business model is doubly powerful in that customers are loath to switch back to a large occasional capital outlay because it screws up their accounting and planning. This is one reason why I’m excited about MongoDB despite their relatively poor numbers. Their atlas program will make switching to another database very very difficult. I’d be interested in Nutanix’s numbers but have run out of energy for today.
-Ethan