1ST ASX Valuations

In this thread, I will strive to shed a light on the often opaque, confusing, and volatile practice of valuing a public SaaS company: 1ST Group.

At its core, the intrinsic value of an asset is determined by the cash flows you expect that asset to generate over its life and how uncertain you feel about these cash flows. In this first post, I will provide a valuation based on an ARR multiple method. In a later post, I will provide an alternative valuation based on the discounted cash flow method.

Ultimately, the ARR multiple method stipulates that the valuation of a SaaS company is simply described as equal to the annualised recurring revenue (ARR) times by a multiple factor that encompasses many factors and dictates how much investors are willing to pay for each dollar of revenue earned.

• ARR x Multiple = Company Valuation

There are many factors which influence the valuation of a SaaS company using the ARR multiple method, however, the most important two factors are:

1. Public market valuations at the time.
2. Revenue size and growth rate.

Firstly, we must determine what SaaS companies are currently trading for in the market. The ARR multiple method largely relies on understanding how the market is valuing the reference group. In this instance, the reference group I have used comprises a range of companies with revenue between $4 million and $45 million p.a. The chart below represents the median public SaaS company Trailing Twelve Month (TTM) revenue multiple over the last 5 years.



The data is from the same set of 21 companies over the 5 years and is therefore not impacted by new entrants or exits. The average value of a public SaaS company over this period has been as low as 4.8 times revenue to as high as 9.9 times.

Secondly, we need to determine the relationship between revenue growth rate and SaaS valuation multiples. It will not be news to you that the biggest driver of what multiple of revenue will be applied to your business is how fast it’s growing. This relates back to estimating the potential future cash flows of the company. A higher growth business will likely generate more cash in the future relative to its size today than a slow-growth company of the same size. The chart below demonstrates the strong relationship between growth and revenue valuation multiples.



Thus, we can now apply the calculation, to provide an informed estimate of the current intrinsic value of 1ST Group. 1ST Group's historical revenue growth rate is approximately 30-40%. The total sites CAGR is 43%.

Thus, the comparison set of data suggests 1ST Group is currently deserving of a 7-10x TTM revenue multiple. 1ST's TTM revenue is $4.3 million ($1.2m + $1.18m + $0.96m + $0.95m). Thus, the valuation method suggests a starting baseline valuation of ~$30m to ~$43m is currently appropriate (8.4 cents to 12 cents).

Is that overly simplistic? Of course. What about Total Addressable Market (TAM), retention, gross margins, and “leadership,” you ask? All are important, and all those inputs help explain why all the dots in the chart are not on the straight lines. The world is full of variability and nuance. However, if you step back and look, the formula will certainly give you “most of the answer” and provide a good place to start an informed valuation discussion.

We now need to refine the starting baseline valuation further to account for:

1. Addressable market size (TAM)
2. Revenue retention
3. Gross margins
4. Customer acquisition cost
5. Leadership

Firstly, the market size is important. This is a key valuation battleground. The businessmust be able to simply and credibly articulate it willgenerate large profits in the future. Keeping in mindthat small businesses in small markets do not evergenerate large profits, it is the size of the addressablemarket that establishes the upper bounds of yourfuture cash flow and therefore refines the valuation. There is little public data connecting the size of anaddressable market to a revenue multiple becauseTAM itself is subjective. Generally speaking, TAMenters the valuation equation on the downsideif the market size is too small. For many VCs and funds, thetarget minimum TAM is $1.0 billion. Anything less than this will lower than multiple. Fortunately, 1ST has a TAM of $1.9b, thus at this stage we retain the 7-10x TTM multiple.

Secondly, revenue retention. Revenue retention is a significant driver of enterprise valuebecause it touches upon all the key factors that impact thefuture cash flows of a SaaS business. High retention increasesthe size of the addressable market, increases revenue growth,and very importantly, improves predictability which reducesperceived risk. It also improves unit economics and profitability. From 2016 survey data, the median net retention rate (includes cross-sell, up-sell, and price increases) for privateSaaS businesses is 100%. Above that level, a valuation multiple premia is justifiable. How much of a premium is hard to determinebecause retention rates are not consistently reported in public or private valuation data. SaaS Capital estimates the impact at a premium of 1to 2 times ARR. Likewise, a SaaS company with a retention rate below 80% will result in a reduction in the valuation multiple. 1ST Group's retention rate currently stands at 97% and is thus close to deserving of a valuation premium. For the moment we retain the 7-10x TTM multiple.

Thirdly, gross margins. Gross margin indicates the profitability level of the business per dollarof revenue when it reaches a more mature phase and is a significantdriver of valuation. Gross margin also determines how much casha business can reinvest back into sales, marketing, and productdevelopment and, therefore, how capital efficient the business canbe. Related to the comparator set, the overall gross margin was 84% compared to 1ST at 80%, Thus again, there is no change to the 7-10x TTM multiple off this factor.

Fourthly, CAC. Both investors and strategic buyers are typically looking tocontinue growing a SaaS business by deploying more capital insales and marketing. How efficient the business is at convertingthat spending into new customers is highly relevant to bothprojected future cash flows at maturity, and also the amount ofcapital it will take to grow. A related metric to CAC Ratio is the “payback period.” How long does it take (in terms of cash), to recoup sales andimplementation costs? This is actually a purer measure of capital efficiency and is becoming an increasinglyimportant valuation driver. A less-than-one-year payback is a good target for this metric. Given a lack of data on this metric, I will adjust the multiple backward to 6-9x TTM off this factor to be conservative.

Lastly, we arrive at leadership. From my discussions with fund managers, Klaus has a strengthening reputation. The early stages of the company were slow and challenging yet in the last year, 1ST has grown from strength to strength, particularly with the signing of the 3 major landmark deals. The valuation multiple may be unfairly being discounted on this topic currently because of a "wait and see" approach to implementation across the coming quarters.

So, with a lowered 6-9 TTM multiple, we arrive at a more refined current valuation of 7.3 to 11 cents. Note that this is what the company should be currently worth not a 12-month price target valuation which would use a forward multiple. Given that the 3 major landmark deals are expected to result in an extra 5000 sites and that old pricing of ~$40/site/month is being replaced with new pricing of $130/site/month, it doesn't take an Oxford student to work out that the revenue across the next 12 months is set to grow strongly.

• 10,079 sites x $40/site/month = $1,209k per quarter (Q1-FY20)
• 15,000 sites x $60/site/month = $2.7 million per quarter (Q2-FY21 estimate)

In a separate post, rather than conduct a intrinsic valuation of current value (7.3-11 cents). I will use the discounted cash flow valuation method to show how I have arrived at a 12-month price target similar to the Lodge Capital report which predicts a future 12-month target price of 38 cents in their latest report.

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All thoughts greatly welcomed, but let's keep this thread to a discussion on the topic of valuations.