Given all the talk about valuations and P/S, I thought I would work out some numbers today to estimate possible results of declining P/S’s for our high growth companies as well as declining revenue growth rates and see what I come up with.
First I took our high growth companies and laid out their current market cap, revenue (both trailing 12 months, as well as annualizing the latest quarter), and the current P/S (again P/S based on trailing 12, and P/S from annualizing the latest quarter):
market cap trail 12mo rev Latest Q annualized P/S trailing P/S annualized YTD rev growth% Last Q ended
MDB 4,760,000,000 214,738,000 259,940,000 22.2 18.3 56% Q3
ZS 5,090,000,000 213,611,000 253,192,000 23.8 20.1 59% Q1
NEWR 4,930,000,000 413,392,000 459,584,000 11.9 10.7 35% Q2
AYX 3,830,000,000 182,384,000 216,716,000 21.0 17.7 55% Q3
OKTA 7,390,000,000 361,533,000 422,304,000 20.4 17.5 53% Q3
TTD 6,150,000,000 419,474,000 475,300,000 14.7 12.9 54% Q3
TWLO 9,350,000,000 561,001,000 675,580,000 16.7 13.8 57% Q3
Then I applied a rate of decline on both the P/S ratio and Revenue growth rate for each of the next three years. Here I show using a 10% annual decline in P/S ratio and 10% annual decline in growth rate. To be conservative, everything is based off the trailing 12 month revenue (not annualizing the latest quarter):
Year1 P/S Year2 P/S Year3 P/S Year1 Rev% Year1 $ Year2 Rev% Year2 $ Year3 Rev% Year3 $
MDB 19.9 18.0 16.2 50% 322,965,952 45% 469,463,308 41% 661,117,009
ZS 21.4 19.3 17.4 53% 327,038,441 48% 483,330,112 43% 691,215,226
NEWR 10.7 9.7 8.7 32% 543,610,480 28% 697,724,051 26% 875,748,343
AYX 18.9 17.0 15.3 50% 272,664,080 45% 394,135,928 40% 552,164,728
OKTA 18.4 16.6 14.9 48% 533,984,241 43% 763,223,676 39% 1,058,110,407
TTD 13.2 11.9 10.7 49% 623,338,364 44% 895,986,564 39% 1,248,700,635
TWLO 15.0 13.5 12.1 51% 848,794,513 46% 1,240,682,940 42% 1,756,223,922
And these are the resulting market cap valuations three years from now:
Scenario 1 -10%
Year 3 P/S Year 3 Revenue Market cap year 3 Cumu 3yr MC inc Compound Annual %
MDB 16.2 661,117,009 10,683,262,695 124.4% 30.9%
ZS 17.4 691,215,226 12,007,013,362 135.9% 33.1%
NEWR 8.7 875,748,343 7,613,628,883 54.4% 15.6%
AYX 15.3 552,164,728 8,452,948,568 120.7% 30.2%
OKTA 14.9 1,058,110,407 15,767,215,657 113.4% 28.7%
TTD 10.7 1,248,700,635 13,346,147,779 117.0% 29.5%
TWLO 12.1 1,756,223,922 21,338,082,611 128.2% 31.7%
So what does this tell us? Even with “sky high” (as some would say) Price/Sales ratios today, and assuming that those ratios contract over the next three years, and assuming that their current revenue growth rates slow, this would still show most of our companies valuations more than doubling three years from now. 30%+ compounded for three years…I’ll take that all day long.
Of course, many other factors will impact how these companies are valued in the future, including their ability to control margins, opex, cash flow, competition, and potential remaining TAM. Also, a big one for growing companies like ours will be the impact of stock dilution which admittedly isn’t factored in above.
“But mekong, you’re only forecasting a drop of 10% per year on P/S and rev growth %…that’s not exactly conservative from where they are at today!” you say. And I wouldn’t disagree. Let’s see where the numbers fall out if both P/S and Rev Growth % drop by 15% per year for the next three years:
Scenario 2 -15%
Year 3 P/S Year 3 Revenue Market cap year 3 Cumu 3yr MC inc Compound Annual %
MDB 13.6 598,298,771 8,144,659,580 71.1% 19.6%
ZS 14.6 623,211,897 9,119,828,716 79.2% 21.5%
NEWR 7.3 816,457,060 5,979,639,162 21.3% 6.6%
AYX 12.9 500,332,670 6,452,495,003 68.5% 19.0%
OKTA 12.6 961,257,038 12,066,819,135 63.3% 17.8%
TTD 9.0 1,132,934,387 10,200,738,261 65.9% 18.4%
TWLO 10.2 1,587,358,276 16,247,244,391 73.8% 20.2%
and what if the P/S ratios and Rev growth %'s decrease by 20% per year each:
Scenario 3 -20%
Year 3 P/S Year 3 Revenue Market cap year 3 Cumu 3yr MC inc Compound Annual %
MDB 11.3 543,487,037 6,168,182,287 29.6% 9.0%
ZS 12.2 564,017,041 6,881,076,016 35.2% 10.6%
NEWR 6.1 763,731,891 4,663,325,586 -5.4% -1.8%
AYX 10.8 455,070,223 4,892,833,276 27.8% 8.5%
OKTA 10.5 876,540,361 9,173,569,862 24.1% 7.5%
TTD 7.5 1,031,758,507 7,744,940,538 25.9% 8.0%
TWLO 8.5 1,440,133,497 12,289,117,265 31.4% 9.5%
So even in a scenario where the P/S contracts significantly, as does the revenue growth rate, the overall market cap valuation rises three years from now, compound growth rates on par, or a bit above the stock market’s long term historical averages (with the exception of NEWR in this example). Of course, we aren’t invested in these companies to settle for single digit returns, but it still shows that we probably aren’t going to lose our shirt, or even lose much money at all, even after the P/S ratios come down significantly from where they are today, assuming they keep growing the way we expect (which assumes that growth will slow over time).
Some of our companies may not do as well as even the -20% worst scenario that I’ve modeled above. New competition or poor management could cause them to do far worse. I’m not suggesting that -20% is “the worst scenario possible”, it’s just the worst of the three I’ve modeled.
But I would argue that several of these companies should do even better, much better, than even my best scenario above (Scenario 1, that shows -10% declines/contractions) given the possible TAM available to be gobbled up over the next few years by these companies.
Even Scenario 1 shows only 3 of these 7 companies reaching $1 billion of revenue three years from now, and none of them reaching $2 billion. I would wager that a few of them will do much better.
Also, I used total revenue %'s in my starting point above. Some of these companies have software revenue growth rates even higher than the legacy business, which are becoming a bigger part of their businesses, and should help to keep the overall total revenue growth %'s from slowing as quickly than I may have modeled.
Ultimately, these are just numbers, and just a small subset of the numbers and performance that will ultimately determine how successful these companies will be and how well our investments in them will do. But I think this is an excellent exercise to show that you shouldn’t be completely scared of high P/S valuations. These companies are in the right place at the right time, will have recurring revenue, and incredible margins. Some will fail or ultimately be mediocre. Some will probably get acquired or taken private in the next three years.
But just a couple of them achieving outstanding success should lead to big overall investor profits, even from today’s valuations.
-mekong