The Forbes M+A Group, SaaS Quarterly Sector Update. By Dan Pellegrino

In Q3 we have seen deal flow for the SaaS industry continued its downward trend shown from the first two quarters of 2022. The key drivers for SaaS Companies include Growth Rate, Capital Efficiency (i.e., LTV/CAC Ratio, payment terms, etc.), Market Demand Premium, and Certainty of Continuity (i.e., size of ARR, churn, cash flow, etc.).

We also include interviews with industry experts to give insights on industry trends, qualitative insights and what to expect in the short and midterm.

This quarter I had the privilege to speak with Lucky Gilja from Alpine Investors.

Please feel free to reach out with any feedback or specific questions to add to next quarter’s industry update.

Dan: Hi Lucky, thank you for taking the time to speak with me today.

Lucky: Thank you for having me.

Dan: Do you mind starting off by providing a brief overview of Alpine?

Lucky: We are a Private Equity financial partner that puts up strong results while focusing on treating people well. We focus on investing in exceptional people to create exceptional businesses.

Dan: What are your typical Investment Criteria?

Lucky: We are looking to invest in businesses that produce EBITDA between $1M-$50M with an enterprise value up to $1 billion. Industries we like are software, business services, and consumer services with recurring or reoccurring revenue. We can do deals in the US, Canada, Europe, and Australia.

Dan: What was your outlook for 2022 at the beginning of the year and how has that changed?

Lucky: The year started optimistically, we saw so many deals at the end of Q4 and even into Q1 of this year, but we’ve recently started to see signs of slowdowns. Given the interest rate hikes we have going concerns of how the market can continue performing. We’ve already seen public tech companies take a hit, which naturally leads to concerns about private markets doing the same thing. We are already playing in industries that are recession resistant and will continue to do so.

Dan: What do you think are the current trends in Software valuations?

Lucky: It really comes down to the trends in the estimated exit multiple in the software space. Similar to the public markets, the market has been pumped up for so long, and I think there was a bubble to some extent. Buyers are scared that if they invest X in the business today and the tech markets soften, then the exit will not provide the investment return they are looking for.

The longer we are in a corrective market, the more stable the valuations will get. I’m worried about business owners’ expectations for a sale. Business owners are going to have a hard time adjusting to the new normal and that might take several years. I’ll caveat all this by saying that this also depends on which industry the software caters to. For example, a marketing software versus a CRM that is mission critical to the operations of the business. If the software is ancillary to the business operations the values are likely to see a normalization.

Dan: How has inflation impacted your portfolio companies and how will it impact your future investment perspective today?

Lucky: That has not materially impacted our portfolio companies on a day-to-day basis much, but the real worry is from an investment perspective. When the cost of money was at near zero, everyone was eager to deploy capital and get 5X leverage. That made the initial entry point more palatable because of the cheaper money. Now that money is getting more expensive, it makes it less easy to deploy.

Dan: What interesting trends do you see in the software space moving forward into late 2022 and 2023?

Lucky: Business owners seem to be holding off on going to market right now, because they want to see what is going to happen. However, if you have a pristine asset, you may be one of a very few investment options out there and could see most buyers get very aggressive on that asset. So, it really depends. We are also seeing a lot of other buyers starting to move away from the tier 2 and tier 3 deals. If that trend continues, we will likely go after more tier 2/3 deals because they could be good value buys.

As far as industry predictions, I’d say retail related software will be in the bottom
quartile. We see health tech sector as a very attractive place to be right now. We also think compliance related software will be critical in the short to mid-term. The ultimate value driver is not necessarily the industry the software is in, but the solution that it presents and how critical it is to the success and sustainability of the business it serves.

Dan: Is right now the best time to sell?

Lucky: If you are a mission critical company and will do well through a recession then, now is the time. If you serve an industry that is not as sticky, or recession proof, it’s probably better to hold off for a while to see what happens. How long? We think that things will continue to get worse over the next 6-12 months.

Like I said before, if the business is a pristine asset, for example, it has high growth, solid financials, you know all the value drivers are clicking at a high level, that business would likely garner an attractive multiple, especially in a competitive bidding process.

Dan: What are Alpine Investors top 3-5 value drivers for evaluating software deals?

Lucky: We first look at the Revenue Quality meaning what percentage of revenue comes through recurring means such as a license or subscription. Modernization of the technology is going to become increasingly important, for example cloud vs multi-tenant. The other important factor we consider is how mission critical and recession resistant is the software.

A few KPIs that we see as important:

Dan: Thanks Lucky, I know your time is valuable.

Lucky: Thank you! It’s been a pleasure.

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