One of the arguments often made in defense of the steep valuations now granted to so many cloud/SaaS software names is that the business models of these companies make them fairly immune to an economic downturn.
The guidance cut just announced by CAD/CAM software giant Autodesk in its July quarter earnings report is a reminder that while SaaS firms might see their sales hold up better than other tech companies during a downturn, they're vulnerable to macro pressures as well.
Autodesk is down about 7% in Wednesday trading after it beat its July quarter revenue, EPS and billings estimates, but also issued below-consensus October quarter guidance and moderately lowered its fiscal 2020 (ends in Jan. 2020) guidance. The company now expects fiscal 2020 revenue of $3.24 billion to $3.27 billion, billings of $4.02 billion to $4.08 billion, non-GAAP EPS of $2.69 to $2.81 and free cash flow (FCF) of roughly $1.3 billion. Those numbers compare with prior guidance for revenue of $3.25 billion to $3.3 billion, billings of $4.05 billion to $4.15 billion, EPS of $2.71 to $2.90 and FCF of roughly $1.35 billion.
On the earnings call, CFO R. Scott Herren said Autodesk, which now gets the lion's share of its revenue from subscriptions, hasn't yet seen "any material impacts" to its business from trade disputes and geopolitical issues. However, he indicated his firm is taking "a prudent stance" regarding its guidance due to "customer spending environments in the U.K. due to Brexit, Central Europe due to a slowdown in the manufacturing industry there, and China due to trade tensions."
Herren added that while Autodesk's global deal pipeline and renewal rates remain strong, the company "began noticing some changes in demand environments in these [regions] towards the end of July."
The remarks come about five weeks after German enterprise software giant SAP (SAP) slightly missed its Q2 estimates, albeit while maintaining its full-year guidance. At the time, SAP, which still gets a lot of revenue from traditional software license sales and related maintenance revenue streams, noted that "trade-related uncertainty" was hurting its Asian software sales. Since then, a slew of enterprise hardware firms -- a group of companies that are admittedly also hurt by cloud infrastructure adoption -- have also signaled that macro pressures are weighing on their sales.
Though Autodesk's full-year guidance cuts aren't that large on a percentage basis, its multiples limited its margin of error. The company went into earnings sporting an enterprise value (market cap minus net cash) equal to 26 times its expected fiscal 2020 FCF, and 21 times its expected fiscal 2021 FCF. While such a valuation was still meaningfully lower than what many SaaS peers have been trading at, it was high enough to guarantee a harsh reaction to any guidance cut.
Meanwhile, the explanation Autodesk provided for its guidance cut drives home that while macro pressures might not hurt subscription software sales as much as traditional software sales, since companies don't have to commit to large, up-front, software license purchases and related investments in IT systems and administrators, they can still impact things such as new account signings and the up-selling and cross-selling of subscription plans to existing clients.
In the case of Autodesk, the fact that the company is strongly exposed to verticals such as manufacturing and construction probably makes it more vulnerable to current macro/trade headwinds than many other SaaS firms. It's worth noting here that a number of SaaS vendors issued solid guidance in July, and firms such as Salesforce.com (CRM) and Veeva Systems (VEEV) have more recently done the same.
But in the event that macro conditions worsen and a protracted downturn occurs, it's not hard to imagine many other SaaS firms getting stung as well to some degree. For example, widespread layoffs and hiring freezes among multinationals would likely weigh on the sales of human capital management (HCM) software providers, while cuts in enterprise sales and marketing investments would impact the sales of customer relationship management (CRM) software firms.
And as I noted last month when looking at the market's cool response to Microsoft's (MSFT) strong calendar Q2 report, and its harsh response to SAP's mildly disappointing report, valuations for many SaaS names have reached a point where -- in contrast to chip companies and other tech firms pricing in a lot of bad news -- anything other than a beat-and-raise quarter invites a selloff.
A lot of the SaaS pure-plays that are now producing meaningful cash flows sport enterprise values that are equal to over 40 times their expected FCF for fiscal years ending between mid-2020 and mid-2021. And many of the growth-stage SaaS firms that for now are producing little or no FCF carry enterprise values equal to more than 10 times their expected billings for upcoming fiscal years.
At the least, such a valuation environment requires that software investors tread carefully and have a high degree of confidence that the companies they're investing in will keep topping analyst estimates.