Trident Capital Blog

Second Annual SaaS Portfolio CEO Meeting

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About a week ago I hosted the second annual meeting of our SaaS portfolio companies’ CEOs.  Like last year, we met in our office in Palo Alto to share relevant experiences from the past twelve months, and exchange ideas relating to sales, marketing and product development initiatives.  In addition to our CEOs, I also invited David Spitz, MD at Pacific Crest to provide us with his perspective on the public markets.  Below are the major points made during the meeting:

Sales

• More of the companies have established separate sales teams to acquire new customers and to cultivate/expand existing customers.  Our companies are starting to use of Success Managers for customer cultivation/expansion.  These individuals are part of the inside sales team and become involved after a customer has been acquired and onboarded.  Typically each Success Manager is assigned 30-40 customers. The first goal of a Success Manager is to ensure each customer uses the product correctly and gets the maximum benefit from the product.  In the process, the Success Manager at the minimum assures that the customer will be willing to renew the contract at the right time.  More importantly, however, the Success Manager cultivates the customer for an upgrade/upsell.
• There is a more concerted effort by our portfolio companies to further develop the self-service channel in order to reduce sales costs.  But, as SaaS is being aggressively adopted by the Global 2000, our companies find it necessary to also establish field sales teams.  However, they require the field sales people to engage only if a minimum deal size is established (typically $100K).
• One of our CEOs eliminated his entire field sales effort but now regrets letting the best of his field sales people go because he thinks that based on the opportunities his company is pursuing, they would have been able to perform very well even working as inside sales capacity.
• The sales process is becoming more complicated, particularly with larger companies.  Now our sales people need to “sell” to more executives from different organizations within each such prospective customer.
• Quickly and frequently experimenting with different pricing and terms and conditions is viewed as important by all CEOs.  They believe that only through such experimentation they can maximize the results of their sales efforts, particularly in today’s market environment.

Marketing

• SEO is more effective than SEM for lead generation.  In addition, emails combined with inside sales outreach efforts are very effective for lead generation.  Quick and frequent experimentation of various approaches to lead generation is very important.
• The companies are not adequately leveraging social media in their lead generation efforts.  We have urged them to start doing so.  We pointed to the fact that User Generated Content (UGC) is ranked higher by search engines.  For this reason companies such be using more UGC in their marketing efforts.  The companies should also try to not only use the communities they have started building but also partner communities.
• The comprehension of the SaaS model and market by the industry analysts is improving by the month.  The CEOs mentioned the analyst firms they think “get” SaaS and the ones that remain skeptical about the model.  Interestingly, none of the participants considered any of the analyst firms to be thought leaders today in SaaS.  They believe the SaaS thought leaders are independents.

Market conditions (David Spitz’s comments with additional commentary from our CEOs)

• SaaS companies are benefiting disproportionately from the recovery, though not all SaaS are performing in the same way.  The public SaaS companies tracked by Pacific Crest demonstrated strong growth over the past two quarters with companies either meeting or exceeding their 1Q10 targets (as I had also written here).
• Company growth is very important even if the company doesn’t generate much free cashflow (FCF).  But in general the markets are looking at growth rate, revenue, and FCF. Investment analysts are also starting to pay close attention to the bookings of SaaS companies and to the additional net new subscribers per reporting period.  Investors are becoming savvier about SaaS and are now able to analyze the relationship between Customer Acquisition Cost (CAC) and customer Lifetime Value (LTV).  However, it is unclear whether these metrics really matter to corporate development executives looking into acquisitions of SaaS companies in addition to the three metrics mentioned above.  Financial buyers, e.g., private equity firms, are also becoming interested in SaaS because of the recurring revenue model.
• More private company financings are getting done, more acquisitions are being contemplated, including some larger deals, and companies are more open to filing to go public (with the strong encouragement of investment bankers).  SaaS companies with at least 15-20% YoY growth and at least $15M in Annual Recurring Revenue (ARR) are of particular interest since they show that they can achieve scale.

Time for SaaS M&A

The recent acquisition activity by public IT companies provides just an initial taste of what will be a very active year for cloud-based vendors.  To recap, IBM bought CastIron to improve its capability in data integration among SaaS applications as well between on-premise and SaaS applications, SuccessFactors bought CubeTree to improve its cloud-based collaboration capabilities, Salesforce bought Jigsaw to enhance its sales force automation offering with cloud-based sales-related content, CA bought 3Tera and Nimsoft so that it can start offering cloud computing solutions, and VMWare bought GemStone to provide data management for the applications developed under SpringSource.  There are several reasons for my conclusion:

1. Improving macroeconomic environment.  The recovery appears to be taking hold, and companies are investing in IT again (we continue to expect a 5% growth in this year’s IT budgets).  Public IT companies are reporting strong results.
2. Cloud computing is considered the next IT platform.  SaaS applications are demonstrating significant successes and they are now being adopted aggressively even by Global 1000 companies.  The move to cloud computing is considered inevitable.  Companies are starting to spend disproportionately for SaaS applications than for on-premise applications.  CIOs expect that at least 10% of IT workloads will be running in the cloud by 2013.  During the recession, corporations have been impressed with the lower TCO they achieved through the use of SaaS applications.
3. Public IT companies, e.g., IBM, Microsoft, Google, have large cash reserves and are getting low returns from the interest this cash is earning.  For example, Cisco has $39.5B in cash, Microsoft has $36B, Google has $26B, and IBM has $14B.  In addition, over the last 6 months 4 of the 5 public SaaS consolidators have raised over $1.1B (Concur $250M, SFDC $600M, Taleo $150M, and SuccessFactors $200M).  Salesforce and SuccessFactors are obviously starting to put this money to use.  I’m sure Google is thinking that it will need to improve Google Apps through a combination of internal development, partnerships and acquisitions.  Microsoft could also use some of its cash for acquisitions aimed at further rounding out Azure.
4. Based on their 1Q10 financial results and subsequent stock movements, the public markets are rewarding SaaS that have reached scale and have strong growth rates.  However, the markets still don’t reward (as they used to) IT companies with less than $100M in annual revenues that are going public.  Furthermore, the management teams and investors of such private companies realize that it takes a long time to build a SaaS company of scale.  As a result, the bigger and higher growth SaaS companies will aim at getting bigger “inorganically, and, for the right price, private companies would prefer to be acquired rather than attempt to go public, providing liquidity to their investors and employees.

The anticipated M&A wave will be led by the SaaS vendors.  IT vendors primarily with on-premise solutions, e.g., Oracle, SAP will not be as aggressive for another 12-18, i.e., until they determine that they cannot transition to cloud computing on their own but will need to acquire the right DNA.  CA provided an early example of such a strategy, through its acquisition of 3Tera and Nimsoft.  Over the past year Adobe, Compuware and the SAS Institute had shown a similar approach with their acquisitions of Omniture, Gomez and IDEAS respectively.  Applications, analytics, data management, and security are some of the areas that will attract the acquirers’ attention.  I can tell that management teams, venture investors and investment bankers are all getting ready for a very busy year.

The 1Q10 is Done. Good Reasons for SaaS Companies to Remain Optimistic

Several public SaaS companies (Netsuite, Concur, SuccessFactors) reported their quarterly results and they were positive.  Our own SaaS portfolio companies did the same (over the last week and during this coming week my partners and I are participating in a long series of board meetings) and the results are from positive (companies met their quarterly financial targets) to exceeding expectations (companies beat their quarterly targets).  Obviously this is very good news.  But beyond the good news, here’s what we are learning from the information we are receiving from our portfolio companies:

1. Corporations are investing in applications in general but SaaS is winning more than its fair share of opportunities.  The majority of our SaaS companies won most of their deals this quarter against on-premise vendors as opposed to other SaaS vendors, i.e., they are winning in situations where the customer may not know upfront whether a SaaS application will be chosen.  Gartner had predicted earlier in 1Q10 that spending in SaaS applications will be 5x higher than spending for on-premise applications over the next 5 years.
2. Large companies (over $500M in annual sales) are adopting SaaS applications faster than smaller ones (I believe that smaller companies are still reeling from the effects of the Great Recession).  In our SaaS portfolio over 60% of the wins came from such large companies.  Furthermore, the 2Q10 sales pipelines of these companies reflect a similar mix of prospects.  So much so that a few of our SaaS companies are starting to hire additional sales people and my sense is that, if this trend continues, we will see more hiring by the end of 2Q10.
3. While the impact of the Great Recession on corporations of every size has been brutal, subscription renewals during the quarter remained over 95%, indicating both the importance of these applications to the business of these corporations, as well as the high value they are receiving from using these applications (otherwise, why renew?).
4. Upsells were also on target, either because companies are moving from experimentation to broader adoption of SaaS applications, or because they have been satisfied enough with the SaaS application(s) to expand the usage to additional organizations within the same company.
5. Some of our SaaS companies raised their license prices during the quarter and didn’t see any slowdown in the sales cycle, again indicating that customers consider SaaS applications to be a great value even at a higher price.
6. Customers are evolving.  Rather than seeing SaaS applications simply as a more convenient and better value alternative to on-premise applications, they are now starting to ask for features that only cloud-based applications can deliver, e.g., social computing and community, collaboration, quicker release cycles and faster upgrades.

We are getting ready for the next meeting of our SaaS portfolio companies that will take place on 5/14.  In addition to spending time to elaborate on the points above, we will be delving into the ways the sales models of these companies are evolving (particularly around lead generation and customer lifetime value).  We are also going to discuss how SaaS applications will evolve as a result of the broad adoption of tablet computers in general and the iPad in particular.  Will these platforms enable SaaS vendors to offer applications in a way that will cause companies such as Apple to start claiming that “there is an enterprise app for that?”