3Q11 Was a Solid Quarter for Trident Capital's SaaS Portfolio

Against a continued volatile world economic environment that was dominated by the European debt crisis, and the persistent 9% unemployment here at home, SaaS companies had a very good quarter.  We were particularly concerned this quarter because around July we started to read about the deteriorating sentiment and buying behavior among consumers and small businesses.  3Q11didn’t have the same number of pre-announcements we saw during 2Q11.  Of the public SaaS companies I track only SuccessFactors pre-announced.  None of our portfolio companies offered any pre-announcement surprises (good or bad).  Like in the previous quarter, 90% achieved their revenue and bookings targets and 85% their bottom line objectives.  We saw similar solid performance by other private SaaS companies that we considered for investment during the quarter.

Of the public SaaS companies I’ve been tracking (SuccessFactors, NetSuite, Concur, Realpage, Kenexa, SciQuest, SPS Commerce, Vocus, AthenaHealth) reported results that met expectations.  Salesforce will report on 11/17 and is expected to meet expectations. The big M&A news during the quarter was Oracle’s acquisition of Rigthnow which followed the company’s announcements on upcoming cloud-based solutions during OpenWorld.  Salesforce continued acquiring social enterprise application companies with the acquisition of Assistly, and Citrix acquired Cloud.com.  Valuations of equity investment rounds in private SaaS companies continued to defy reason and always exceeded public company comps and the multiples public corporations were paying to acquire private companies.

Positive conclusions from our SaaS portfolio performance:

1. While the SMBs may continue to feel uncertain about the economy and not investing in new technologies, enterprises (particularly the mid-upper enterprise segment that represents the ideal target for our SaaS portfolio companies) are starting to invest heavily.  Our portfolio companies project a strong 4Q11, a sentiment we share.
2. Adoption of SaaS applications is accelerating in the mid-upper enterprise segment, particularly in the US, with human capital management, analytics, collaboration, social customer-facing applications and mobile (mostly tablet-based) applications leading the way.  Interestingly enough, retailers that typically stop buying new technology by the end of 3Q appear to be changing their purchase patterns and are expected to continue their strong adoption of SaaS applications during 4Q. 
3. Social and mobile applications are attracting disproportionate buyer interest.  During the quarter we saw several companies engaging our relevant SaaS portfolio companies in the development of business cases that led to software licensing deals by the quarter’s end.
4. Very smooth distribution of deals.  Our portfolio companies’ ACVs range from $40-120K.  While we were again glad to see some $300-500K ACV opportunities in the sales pipelines of some portfolio companies, we were glad that none of our companies had to rely on such deals to make their quarterly bookings targets.
5. Discounting levels remained similar to 2Q.
6. Our drive to get our portfolio companies to “templatize” their onboarding services has started to pay off.  Our companies have continued to accelerate the time it is taking their teams to onboard a newly signed customer thus improving their time to revenue recognition.

The performance elements we didn’t’ like included:

1. Higher than expected churn rates particularly in those companies offering social enterprise applications.  For our SaaS applications companies we expect 8-10% annual churn rates.  In our social and mobile application companies we are seeing annualized churn rates that approach 20% and this is worrisome.  My sense is that many, particularly smaller, clients that licensed such software are not able to achieve the ROI they had envisioned, though I am still trying to find out what is the right ROI that will make such new applications attractive to smaller companies.  Our portfolio companies certainly don’t have this issue with larger corporations.  More of our companies are now putting in place “farmer” sales teams that will be tasked exclusively to sign the customers whose subscriptions are up for renewal.
2. The majority of the quarterly business continues to close towards the quarter’s end.  In fact, I would say that this is trending in the wrong direction.  In the past I had reported of increasingly more of the business closing during the last month of the quarter.  This time we saw more business closing during the last 2 weeks of the quarter and very little closing in July.  While I’m hoping that this will not become a trend and will only be viewed as the result of the world economic events we are experiences, October performance didn’t give me reason for optimism.  Therefore, sales execution remains a concern.
3. Competition from large IT vendors continues to increase and is also impacting sales and marketing execution.  Through marketing messages around what constitutes a cloud-based application these vendors often confuse the market.  So the public, private, and hybrid cloud-based applications are all getting in the mix leading to longer and more expensive sales cycles. The marketing organizations of our SaaS portfolio companies will need to increase their efforts (and unfortunately their spending) to educate the market (customers, partners, analysts/influencers) about the benefits of true SaaS solutions.

We think that our SaaS companies will have a strong 4Q.  IT budgets for 2012 remain unclear.  For 2012 we project a smaller than initially anticipated budget increase.  We expect IT budgets to increase somewhere in the range of 3-4% over 2011.  Applications in general and SaaS applications in particular will fare well with social, mobile, and analytics continuing to be in strong demand.