As I prepare to host our SaaS advisory board on Wednesday I thought that this is a good opportunity to analyze the 3Q13 of our relevant portfolio companies, and reflect on the sector in general. Despite what is typically a slow quarter for most IT and adtech companies, during 3Q13 our portfolio companies in both of these areas performed extremely well with 90% meeting plan and a 3 of them beating it. We are also seeing strong sales pipelines for 4Q13 making us optimistic that this quarter will be equally strong, if not stronger. The public SaaS companies we follow are also starting to report strong results. For the quarter most of the growth continued to come from North America. The foreign markets appear to have bottomed out providing additional optimism for additional good quarters assuming the companies maintain their focus and execution level.
The public enterprise SaaS companies we follow, e.g., Netsuite, Workday, Demandware, Marketo, ServiceNow, Splunk, Jive, Cornerstone OnDemand, have either started announcing or are expected to announce strong 3Q13 results, that are at least in-line with analyst expectations. A big event for the quarter was Veeva’s extremely successful IPO, which, along with the continued strong performance of Athena Health, and Realpage, provide proof points that vertically focused SaaS applications are another growth area for SaaS. The market is also becoming more positive on the public adtech companies driven primarily by RocketFuel’s strong IPO and Adap.tv’s acquisition by AOL for a very nice multiple. The market is also taking into consideration the potential benefits of Facebook’s exchange, starting with the companies that are already part of it. Valueclick and Millennial Media remain in the penalty box. In the case of Millennial the concern is primarily coming from Facebook’s and Google’s moves around mobile adtech. The market is now waiting for Criteo’s IPO in the next few days.
While there was no blockbuster SaaS company acquisition during the quarter, we continued to see strong M&A activity, particularly of smaller companies offering mobile applications. In addition to strategic acquirers, large private equity firms continued to aggressively invest in or acquire smaller, higher growth SaaS companies.
Some thoughts from the quarterly results and the broader market:
- IT budgets remain stagnant regardless of what analysts have been predicting in the beginning of the year, and for that matter every year for the past couple of years. While the U.S. commercial sector was better in Q3 than in Q2 and EMEA spending appears to have bottomed, during 2013 IT budgets will not grow faster than GDP, i.e., around 2%.
- Businesses increasingly realize that they must aggressively transition to digital/online and are turning to SaaS applications, including analytic applications, and cloud-based platforms to achieve this goal. As a result, while IT budgets are stagnant, budgets for SaaS applications continue to increase significantly. Business leaders view that SaaS solutions provide them with faster time to market and superior ROI.
- Enterprises, including global enterprises, are increasingly comfortable with SaaS solutions. On-premise software continues to lose market share to SaaS solutions. Trident’s SaaS portfolio companies like Host Analytics and ThisMoment are winning contracts to replace on-premise solutions whose deployment is severely behind schedule and their ROI is now being regularly questioned. Brands using cloud-based adtech platforms are also increasingly comfortable with longer term, subscription like contracts. However, we need to start differentiating between flavors of subscription. In adtech we are not yet seeing the guaranteed subscription revenue that software companies drive. Instead we are seeing minimum subscription guarantees along with some percent of the marketing spend that goes through the adtech platform, or the promise to spend up to a specific amount of money during particular a time period (usually 1-2 years) with a particular vendor for a product or service.
- Public and private investors remain attracted to SaaS companies (both because of the revenue predictability they offer and because they take advantage of the cloud’s economics). Investors continue to place a premium on high revenue growth over profits rewarding companies whose revenue is growing in excess of 50% YoY. The stock performance of public SaaS and adtech companies that demonstrate revenue predictability and offer a cloud-based platform and the valuations offered by venture investors to private companies raising new rounds provide the best proof of this trend.
- The sales pipelines of our SaaS portfolio companies continue to grow well, further underlying the broader demand for SaaS solutions. Inside sales groups continue to outperform the field sales groups and drive down CAC. Even large enterprises are now more comfortable interacting with inside sales groups and completing a multi-channel sales process that involves phone and the web and oftentimes very little or no support from the field organization. As a result, our portfolio companies are shifting more resources to inside sales and increasingly use field sales only for very large opportunities or unique situations. In most cases we have encouraged our SaaS companies to create hybrid sales groups rather than have distinct and separate inside and field sales organizations. In most of our SaaS portfolio companies we now see 3.5-4.5x coverage over the quarterly bookings objective and 3-4 month sales cycles making plan achievement increasingly predictable. As a result we continue to see a strong list of sales candidates coming from on-premise software companies who feel they can make more money working for SaaS companies.
- Enterprises are consistently satisfied with the ROI they receive from SaaS solutions. This leads to strong renewals and upsells that contribute "negative" revenue churn, in other words the amount being upsold to existing customers is higher than the amount of revenue that is churning. However, the initial ARR contracted by enterprise customer remains lower than we would have expected, having a direct impact on CAC.
- While we are very happy with the inside sales process, larger corporations still expect more handholding through post sales services than we would have liked. Many of these services are now being offered for free or at a low margin by both public and private SaaS companies in order to facilitate the sale of a subscription.
One final note: The subscription economy is taking hold in several industries. The SaaS model is quickly migrating to other industries, e.g., retail, publishing, manufacturing, travel. As a result there will be a need for the development of a broader software solution ecosystem that facilitates the functioning of this economy.