TDM Growth Partners on “through-the-cycle" exit multiples

https://twitter.com/TDM_Growth/status/1534397678880444416?s=20&t=xpM2QhOQVGQ2Ox0D7AUpYA

Key takeaway

For entrepreneurs: the importance of focusing on sustainable growth rates and the ability to generate Free Cash Flow (FCF) over the long term, rather than prioritizing high growth rates that have not yet proven sustainable or profitable in the long run. This approach aligns with the concept of "through-the-cycle" exit multiples, suggesting a more conservative and realistic valuation that considers the company's performance across different market conditions.
For investors: anchor valuation expectations on reasonable "through-the-cycle" exit multiples, rather than being swayed by outlier high valuations. A conservative approach focused on long-term fundamentals and sustainable growth is prudent when evaluating investments, especially in the software sector.

Summary

TDM Growth Partners, a global investment firm, shared insights on "through-the-cycle" exit multiples in a tweet thread. The discussion centered on the appropriate multiples to use when evaluating long-term investments, particularly in Software as a Service (SaaS) companies. The thread, authored by Tim Le, analyzed 123 listed software companies over the past decade, noting the evolution of SaaS from its early stages in 2011 during the European debt crisis to its current state. The analysis highlighted the relationship between company growth rates and valuation multiples, the historical context of median Enterprise Value to Revenue (EV/R) multiples, and the comparison of these multiples with acquisition multiples over time. The tweet thread suggested that a "through-the-cycle" multiple is 13.4x for high growth (30%+), 7.5x for medium growth (20-30%), 6.6x for low growth (10-20%) and 5.1x for mature businesses (<10%).

Insights

TDM Growth Partners debates the appropriate "through-the-cycle" exit multiples for long-term investments, especially in the SaaS sector.
The analysis covered 123 listed software companies over the last decade, observing the maturation of the SaaS business model and its valuation in the context of varying interest rates.
The study found that valuation spreads across different growth rates tend to narrow during times of market fear, with faster-growing companies often not yet proving their ability to generate Free Cash Flow (FCF) over the long term.
The tweet thread pointed out that absolute multiples, rather than percentage changes, can exaggerate the valuation spread.
A historical look at median EV/R multiples showed that in December 2017, these multiples were at the 10-year median, with the majority of listed companies trading at less than 8x revenue.
The thread also compared "through-the-cycle" multiples with acquisition multiples paid over time, noting that financial sponsors often pay below fair value, while strategic acquirers may pay more due to anticipated non-financial benefits.
The concept of "through-the-cycle" exit multiples has gained attention, with the thread suggesting that a reasonable exit multiple across growth rates is more conservative than anchoring to a few standout winners.

Implications

Investors should consider "through-the-cycle" exit multiples as a more conservative and long-term approach to valuation, especially in the SaaS industry.
The analysis implies that during market downturns, investors may find opportunities to invest in high-growth companies at more reasonable valuations.
The historical perspective on EV/R multiples suggests that current valuations could be high relative to the 10-year median, indicating potential overvaluation in the market.
The comparison of acquisition multiples indicates that different types of acquirers value companies differently, which could influence exit strategies and valuations.