Why software valuations may drop more if things don’t change quickly – Vidak For Congress

Why software valuations may drop more if things don't change quickly - Vidak For Congress 1

Startups have seen better years. Last year for example.

We’ve done our best to bring out some good news where possible (signs of resilient software revenue growth, indications that valuations may partially recover, and a large number of startups have loads of cash on hand), but working today us in the opposite direction.

A good question to ask today is whether technology stocks, especially stocks of software companies, are being sold too easily. If so, we can expect their revenue multiples to rise in time in the public markets. For tech startups compared to their public counterparts, this would be a huge relief.

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There is reason to believe that this could happen. Altimeter Capital partner Jamin Ball, who we consider a pro-bono data journalist, wrote earlier this week that the “median software multiple is now 5.7x,” which is “nearly 30% lower than the long-term pre-COVID average for the cloud software universe.” (Note that Mary D’Onofrio and Andrew Schmitt of Bessemer Venture Partners arrived this week at a 6.6x median ARR multiple for public cloud companies, which is close enough to give Ball’s math extra weight.)

Why software valuations may drop more if things don't change quickly - Vidak For Congress 2If you believe that cloud and software stocks should not be trading for less than their historical average, then you have reason to cheer. But is that a valid perspective? Should we expect cloud and software stocks at a discount to their pre-COVID revenue multiples? Let’s find out.

The bear case

The Federal Reserve is expected to raise interest rates sharply today, perhaps by as much as 75 basis points. The hike comes in the wake of a 50 basis point hike in May, marking the first time the Fed has raised rates by that much in 22 years. Not only is the Fed tightening interest rates – the price of money – but it is also dropping its total asset base.

In general, rising prices are expected to be inversely proportional to the value of high-priced assets, including stocks that traded at above-average revenue multiples. That means technology and software stocks. There were several reasons for the huge increase in the value of software revenue last year, but their decline and the resulting market hangover are inversely correlated with the price of money, which is about to go up. Again.

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