The Kloud Konnect - #001
Periodic SaaS newsletter by Kae Capital, talking about recent developments in the industry and our recommedations.
The collapse of Silicon Valley Bank shook the global startup ecosystem. It was shocking how it collapsed within two days, causing panic. That weekend was very stressful, but thankfully, regulators stepped in. Indian startups had more than $2Bn in deposits with SVB. Some companies still have a fraction of their deposits stuck at SVB, and they are facing trouble moving it to India. At Kae, we have been in constant touch with our portfolio companies throughout this. We understand the kind of stress founders are going through and are open to chat and share our learnings. Startups have become more cautious post this debacle, and there are many lessons to learn from it. Diversification, extending banking relationships across different institutions, building treasury management early, and hiring a CFO early in the startup journey are some of them. We liked this article on learnings.
We have all witnessed the fall in public market multiples. Revenue multiples of public cloud companies (EM cloud Index) have fallen from ~19x (median) in Sep'21 to ~5x in Jan'23. This bear market has erased multiple gains of the past 4 years. In the last 3 months, we have seen a slight recovery from 5.6x to 6.5x but we are not out of the woods yet. Cloudflare and Snowflake are still trading at a multiple of ~17x. Companies which are trading at more than 10x are dominated by infrastructure and developer companies. There is a common theme with high multiples companies; they all fare well on Rule of 40. The market is still rewarding business critical softwares built on strong fundamentals.
We have analyzed the latest earnings report of major cloud companies to identify trends, understand their plans for 2023, and synthesize learnings for startups. The growth rates of the three top cloud providers, AWS, GCP, and Microsoft Azure, have slowed down in the last three quarters. While they are overall growing, the growth rate has decreased due to challenging macroeconomic conditions. Cost reduction has become the focus for companies which is causing cloud spend optimisation efforts. The deceleration is expected to continue for two more quarters but is expected to come back eventually. From Microsoft’s earnings call: “At some point, the optimizations will end. In fact, the money that they save in any optimization of any workload is what they’ll plough into new workloads, and those workloads will start ramping up.”
If you look at the earnings call transcripts of major public cloud companies, you can identify market trends early and strategize accordingly. We looked at the recent transcripts of 14 major cloud companies and have collated some insights here.
We are listing down our key learnings below-
All companies are focusing on profitable growth, with the majority of them becoming more profitable in the last quarter. However, Shopify reported an operating loss of $822.3 Mn (15% of revenue) in 2022, compared to an income of $268.6 Mn (6% of revenue) in 2021.
Lower expansion and increased contraction- Customers are growing at a slower rate and cutting costs, leading to decline in expansion revenue. As a result, NDR have decreased, even snowflake’s NDR came down from 170+ (industry best) to 158.
Elongated sales cycle, smaller contracts, lower close rate- Customers are negotiating contracts with more scrutiny, hesitant to sign multi year contracts and are moving from pay as you go to minimum annual commitments. This is impacting growth. Tomasz has analysed it pretty well.
Focus on new logo acquisitions and cross sales to drive growth. Some of the competitors are reducing their performance marketing spend, which can be a good opportunity to acquire new customers if you have a long runway.
Customers are consolidating softwares and preferring end to end offerings, which can be an opportunity, you should consider extending product offerings. From Datadog- “Client is looking to get a platform, create efficiencies, etc., they have increasingly been consolidating on Datadog, and we see continued opportunities for that.” Some of our portfolio companies have seen the similar trend, their customers are asking for more features and end to end offerings.
A vertical sales channel can be a growth driver, as vertical solutions can deepen the customer relationship. Even Salesforce, bellwether horizontal CRM, is seeing strong momentum from its vertical solutions and it is a key driver of their growth strategy.
AI is the main theme of 2023, with tech giants and startups all jumping in. This is also evident in earnings transcripts, as 12 out of 14 companies spoke about AI initiatives. Nvidia, which powers most of the GPUs for computation of AI models, is the biggest beneficiary of value accrual in the AI race. Nvidia’s share price has seen impressive growth, gaining more than 87% since Jan'23 and over 100% in the last 6 months.
We wanted to gauge the pulse of Indian SaaS ecosystem, how they are impacted in this doom and gloom. So we reached out to SaaS founders and conducted a survey in Feb'23. We got responses from a breadth of companies from less than $1 Mn in ARR to more than $30 Mn. The observations we gathered resonated with the global sentiments we’ve covered above.
Around 60% of the respondents have started seeing the impact of the global slowdown in their customer conversations. They are seeing revenue contraction, decreased rate of new customer addition and expansion, and elongated sales cycles. Customers are becoming more price conscious and negotiating for shorter contracts.
Surprisingly, for around 57% of respondents faster revenue growth is the top priority for 2023. These are well-funded companies, many with 18+ months of runway. In India, many SaaS startups raised funds in 2021 and 2022, with enterprisetech receiving the most amount of funding. Many respondents have closed their rounds and are looking to grow into those valuations, which explains the focus on faster growth. For the remaining 43%, decreasing burn and increasing runway is the priority.
2023 is surely not the best market to raise funds, investors are taking time in diligence, there is no rush to close the rounds. SaaS revenue multiples in the private market have come down significantly compared to last year. Around 30% of the respondents have pushed the fund raise to later and plan to raise when the market improves. Around 25% are open to raising a bridge round or raising at a lower than earlier expected valuation to increase the runway.
This brings us to the end of this edition. We believe this is the best time to build. Companies built during this time would be more capital efficient and fundamentally strong.
You can expect the next edition in your inbox in two months, please ping me if you have any suggestions. Feel free to drop me a line at veenu@kae-capital.com to discuss anything SaaS.