Cloud software stocks that have been red hot are taking a beating this session, one day after the group surged following a historic acquisition from Salesforce (CRM). The $116 bln cloud pioneer and leader in customer relationship management made its biggest acquisition of all time, buying big data/analytics company Tableau (DATA) for $15.7 bln in stock.
As we mentioned yesterday, enterprise cloud software stocks have been on fire ever since Salesforce acquired a recent IPO MuleSoft at a mid-teens forward sales multiple in March of 2018. That deal raised the bar for software valuations.
Speaking to the aggressive valuation, there are three dozen software stocks that trade with a double-digit forward sales multiple. There are nine enterprise software stocks that trade at +20x sales (ZM, ZS, OKTA, MDB, TEAM, VEEV, COUP, SHOP, PD), and most of them IPO'd in recent years.
A 10x sales multiple used to considered quite egregious, but it has become the norm for the highest quality software stocks in the market as investors hope to own the next Google or Facebook.
What do you need to qualify for a premium valuation, i.e., a double-digit sales multiple? Very strong top-line growth in a large and growing Total Addressable Market (TAM). High gross margins make the software sector attractive, but investors are willing to wait for operating leverage (profits) if there is a long runway for growth.
Just like in biotech and consumer packaged goods, software is a sector where the largest, most growth-hungry companies flush with cash are looking to make strategic deals to improve their standing in a hyper-competitive world.
Salesforce will now presumably be out of the sizeable acquisition market over the intermediate term as it integrates and digests Tableau. Microsoft (MSFT), Oracle (ORCL), and Adobe (ADBE) have been acquisitive, but Google (GOOGL) and Facebook (FB) seemingly have their hands tied as regulators swarm their dominant businesses.
As we mentioned yesterday, while the CRM for DATA deal immediately leads to the question, "Who's next?", it can also mark a near-term top for sentiment as reality sets in as the hysteria dies down.
Eventually, the combination of aggressive valuations on overbought stocks will lead to some nasty corrective moves. Skeptics have called for the technology stock bubble to pop for many years. While a cyclical slowdown is inevitable, investors continue to bid up leading software stocks posting enviable growth.
The occasional large deal seems to validate valuations. Salesforce acquired Tableau for 11.5x revenue estimates for this year using its own stock (trading at 7x sales and 30x FCF) as a currency. Tableau investors have to be happy with this exit because the data analytics space was increasingly competitive.
One laggard this session is a particularly interesting equity to follow. Recent IPO Zoom Video (ZM) is the leading the sector lower after hitting a new high yesterday. The best in class enterprise video conferencing business is the most expensive software stock on our radar, trading at over 40x revenue estimates for this year. Last week, Zoom guided for at least 62% revenue growth this year after reporting 103% top-line growth in the first quarter. Impressive numbers, to say the least, but it's still tough to justify investing in a marginally profitable company at 40x sales as the stock seems to have already priced in a lot of future success.
Other laggards among cloud software stocks this session include: DOMO -8.78% MDB -6.74% ZM -6.26% AVLR -5.20% PINS -4.90% COUP -4.44% PCTY -4.53% ZEN -4.52% TEAM -4.44% HUBS -4.42% CLDR -4.34% RPD -4.20% BL -4.07% PAYC -4.05% FIVN -4.03% PVTL -4.04% WDAY -3.86% SCWX -3.65% NEWR -3.88% RNG -3.73% QLYS -3.78% NOW -3.67% ZUO -3.42% AYX -3.34%