3Q12 Performance for Trident Capital’s SaaS Portfolio; the Enterprise is Still Holding Back

This time I waited longer than usual to write my commentary on the performance of our SaaS portfolio because I wanted to have the benefit of the quarterly results announcements by the public SaaS companies so that I can better compare it to that of our own portfolio.  Also, starting with this post I will start including in my commentary our adtech platform companies, e.g., Turn, Brightroll, Exelate, Appia, JiWire and Sojern, which, as I mentioned in my previous post, we view as part of our cloud computing portfolio.  These companies offer SaaS platforms that are being used by enterprises, either directly or through large advertising agencies representing them, use subscription and transaction business models, and typically sign term contracts.

My overall conclusion from the quarterly results posted by our SaaS portfolio companies is that during 3Q12 the macro environment, in conjunction with the slower procurement environment that is typically encountered during the summer months, resulted in moderate growth, in several cases below budget, for those of our SaaS portfolio companies addressing the more traditional business processes.  Our adtech platform companies performed very well, in all cases exceeding their budgets.  We will need to adjust our growth expectations for 2012 and 2013 for at least part of our SaaS portfolio.  The enterprise continues to hold back on its IT investments and is trimming its IT budgets for the remaining of the year.  By the end of the quarter, many of our SaaS portfolio companies heard what we had heard from our SaaS advisory board a few weeks before (and had found it hard to believe): enterprises have more unallocated capex budget, which can be used for on-premise applications, and not as much opex budget which is used to license SaaS applications.  We found that hard to believe and we are in the process of trying to understand what is really going on.  These trends will undoubtedly impact the financial performance of our SaaS portfolio.  I expect that we will see slower growth in the 2013 IT budgets than we had projected in 2012, i.e., closer to 2-3% YoY growth.   

Based on the results announced to date by the public SaaS companies we monitor, e.g., Netsuite, Brightcove, Demandware, ServiceNow, Jive, their performance during 3Q12 remained strong, in-line with analyst expectations.  They continue to be impacted by the global macro environment decreasing IT spending.  We follow smaller cap SaaS companies that are selling to the mid –upper enterprise and the global enterprise, i.e., their characteristics match those of our own SaaS investments.  The announced results led me to two observations. First, these companies are starting to show consistent YoY growth in the range of 25-50%.  Therefore, as we continue to monitor the breakout SaaS company metrics (see also here) that we have established for our own SaaS portfolio companies, we take this into account.   I expect that for 2013 we will consider YoY growth above 60% as being indicative of breakout performance.  Second, despite this more moderate growth, compared to what we’ve seen in the recent past, public SaaS companies continue to spend aggressively on sales and marketing, and their COGS remain higher than one would have expected particularly given the accelerating adoption of SaaS applications.

This was another active quarter for SaaS M&A.  The biggest SaaS transaction during the quarter was IBM’s acquisition of Kenexa and VMWare’s acquisition of Nicira (thought this was cloud infrastructure than SaaS application).  We’ve also see several smaller transactions led by recently public SaaS companies.  Of particular interest was Bazaarvoice’s acquisition of Longboard which also underlines again the gradual merging of adtech platforms (Longboard) with enterprise SaaS platforms (Bazaarvoice). 

Positive aspects of our SaaS portfolio’s performance:

1. Strong license revenue growth of 25-35% QoQ for the adtech platform companies, and 15-20% of the remaining SaaS companies with increasing subscription ARR.  We are seeing significant upside in our adtech platform companies for 4Q12 and 1H13.  Like with IT, 4Q typically is the biggest quarter for the adtech companies.  It is also the quarter during which the budgets for the following year will be set.  On this issue, our direct checks with advertising executives and through our portfolio companies lead us to be optimistic for 2013.
2. Steady renewal rates (85-90%) with strong upsells in 15-20% (similar to last quarter) of the renewing customers.  In most cases the customers that are not renewing are not customers our companies want to keep, primarily because their solution is not a good fit for those customers’ needs.  The high renewal rates and the significant upsell rates provide the strongest indications that the customers are realizing strong ROI from the use of these applications.  The most significant risk regarding renewals is coming from our social application SaaS companies, because corporations have started to scrutinize the ROI these solutions are able to demonstrate consistently. 
3. Growing pipelines, underlying the continued interest in SaaS applications by the segments targeted by our portfolio companies.  Though with the particular macroeconomic backdrop it remains difficult to assess whether the sales cycles will start accelerating.

Negative aspects of our SaaS portfolio performance (none of these are new compared to what we reported in the past):

1. The macro environment and the uncertainty it results in remain a concern as corporations continue to back on their investments.
2. Price pressure and margins.  We continue to see customer pressure for 5-10% discounts for an annual subscription and 5-7%/year for multiyear contracts.  This, in conjunction with the need to invest in sales and marketing, results in continued lower gross and operating margins.
3. Lead generation and nurturing still uneven.  Lead generation is becoming more effective due to the strong interest in SaaS solutions.  However, nurturing these leads and converting them into sales qualified opportunities is still lacking, particularly for the more complex SaaS soutions, negatively impacting CAC.

We expect that our SaaS portfolio companies will have a strong end to the year.  We continue to keep a vigilant eye to the trends we are observing in both our own companies and relevant SaaS companies as we try to help our portfolio outperform the market, as well as we try to determine which SaaS companies and under what terms to bring into our portfolio, during this period of moderating performance but inflated valuation expectations.

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