The Kloud Konnect - #003
Periodic SaaS newsletter by Kae Capital, discussing recent developments in the industry and our recommendations
The public cloud market has shown signs of recovery in the last few months, reversing a trend of declining growth observed over several quarters. Driven by increasing demand for AI solutions, mitigating the impact of reduced IT spending. Microsoft Azure has been gaining market share, with its revenue surging to $31.8 Bn in JAS’23 quarter, growing at 24% YoY and exceeding analyst expectations. This growth was significantly driven by AI , particularly the Azure OpenAI service, which saw its user base expanding to 18,000 organizations, 67% growth from the previous quarter. Meanwhile, AWS experienced stabilisation in its YoY growth rate at 12% in Q3, with revenues reaching $23.1 Bn and operating income growing by 29% compared to the previous year. Google Cloud, however, reported a slowdown in growth to 22%, making its slowest pace since early 2021. Nonetheless, growth trajectory of the cloud market has been positively influenced by AI workloads.
Gartner predicts that global software spending will exceed the $1 trillion milestone in 2024 for the first time, though it has reduced its growth forecast from 13.8% to 12.7% as of Jan’24, nearly mirroring the growth rate of 2023.
This revision underscores the persistent "change fatigue" CIOs are experiencing due to the accumulation of new apps in recent years. Although GenAI is recognized as a key driver of change, it has not yet had a significant direct impact on spending. The primary motivation behind IT investments remains the pursuit of efficiency. As such, 2024 is expected to be the year organizations begin to strategically plan the integration of GenAI into their operations.
The current median revenue multiple for publicly traded SaaS companies (BVP cloud index) is around 6.4x, marking a modest increase from the 5-6x range seen in the last few months. Companies in the top quartile are trading at multiples above 10x. However, the median revenue growth rate has decreased to 18% in Q3 from 26% at the start of 2023, signaling a slowdown in growth velocity. Jamin Ball has done a deep analysis on the quantitive metrics, highlighting that the net new ARR growth rate (YoY) experienced a slight improvement in Q3’23, following a persistent decline since Q2’21. This suggests the beginning of a recovery, with the aggregate net new ARR rebounding from its lowest point in Q1’23. The median Net Dollar Retention (NDR) suffered significantly in 2023, with a Q3 figure of 112%. Notably, Snowflake's Net Revenue Retention (NRR), once surpassing 160%, has declined over the last four quarters to 135% in Q3 2023, still the best in class.
These trends indicate early signs of stabilization and an upward trajectory from the recent trough. Moreover, there's a noticeable uptick in consumption, driven by AI and unstructured data workloads, pointing to a nascent recovery phase after a prolonged downturn.
2023 was a landmark year for AI. OpenAI crossed $1.6 Bn in ARR in Dec’23. Throughout the year, we witnessed a pivotal shift towards open-source LLMs. Notably, the year saw the release of smaller, efficient LLMs by leading organizations, democratizing access to AI technology and emphasizing optimization over size. This trend marks a significant move towards enhancing the accessibility and utility of AI tools, fostering a collaborative ecosystem for innovation. Meta is leading the charge, with its models recording 30% of the downloads, alongside OpenAI, Google, Microsoft, and Stability, who are also key contributors to the ecosystem.
In 2024, the excitement around GenAI is expected to stabilize as the industry transitions from experimentation to production. Companies are increasingly favouring smaller, more specialized models for production over large, general-purpose models. We will also witness advancements in AI agents with a network of interconnected agents, opening up enterprise opportunities. Multimodal models, which process and interpret information from multiple types of data simultaneously (e.g., text, images, videos, audio), are set to become more prevalent. Significant advancements are already occurring in computer vision and AI wearables, including the launch of Apple's Vision Pro, Meta’s Ray-Ban Glasses, and Humane’s AI Pin. An increased focus on governance, data privacy, and security is anticipated. The cost and time associated with building software are decreasing significantly, thanks to readily available AI models and frameworks. This shift is likely to empower bootstrapped and modestly funded tools to disrupt existing solutions and capture a share of the SMB market.
2024 is shaping up to be a very exciting year for SaaS and AI.