Weekly Financial Resources and Capital Markets Roundup: 5/1/2020
Earlier this week investor Gavin Baker identified the irresistible force (government stimulus) and the immovable object (worsening economic, earnings data) at the forefront of investor’s attention. At the end of the week, the S&P 500 posted its best monthly return in over 32 years. Throughout April the irresistible force buoyed investor confidence and was in relative equilibrium with the immovable object. But as the Street digested earnings misses from companies like Amazon to open the month of May the immovable object weighed heavily on investors, who were more uncertain than in weeks about what is to come.
So while last week we said that we see light at the end of the tunnel, we should clarify that we don’t believe the worst is necessarily over as we noted in late March. We’d be remiss not to call out the other word thrown around with volatility per our note last week—uncertainty. It is here that another lesson can be learned from Long Term Capital Management. The firm’s belief that volatility equals risk blinded them to the uncertainty in the markets. Roger Lowenstein wrote “With a pair of dice, for instance, the average roll is 7, and the variation from the average cannot be more than 5…with dice, there is risk—you could, after all, roll snake eyes – but there is no uncertainty, because you know (for certain) the chances of getting a 7 and every other result. Investing confronts us with both risk and uncertainty. There is a risk that the price of a share of IBM will fall, and there is uncertainty about how likely it is to do so. So many variables…can affect the result that the uncertainty all but overwhelms us.” On Friday, fearful investors with itchy trigger fingers let uncertainty consume them, not wanting to be left holding the bag after everyone else dodged serious losses. Should a more severe “risk off” mindset take hold, anything that isn’t a US Treasury bill (or note, or bond – considered to be “risk free”) will sell off, pushing markets lower. The market is aware that every day we’re getting more data – be it economic, earnings, or virus related – and uncertainty persists. While companies like Zoom Video and Carnival Cruises may seem to lack any correlation at present – if the market decides any risk is too much, both are going to suffer and the correlation will go to 1.
On the bright side, Microsoft’s CEO noted on their earnings call, “we’ve seen two years of digital transformation in the last two weeks.” Unlike many industries, the software industry has benefitted from structural tailwinds that have supported sustained growth. And there are new trends supporting the need for more technology. But if risk off pervades investors will flee from growth software. Tailwinds or not—any risk will be too much risk—but remember that this only impacts the valuation we see on the screen. Risk aversion is just another strategy in the market. It is important not to forget that especially for SaaS businesses the value of the underlying assets will be unchanged. Companies must continue to innovate, tackle customer challenges, and deliver value – ignoring the wild swings of the markets.
OpenView’s George Roberts penned a great article this week for Founders and CEOs about making tough decisions around cost reductions in their businesses. If you’re in need of audible content instead, George is also hosting a podcast, “Building to Last,” and speaking with operators including Graham Smith (Former CFO, Salesforce) and Bill Conroy (Former CEO, Initiate Systems) who share their insights on how to build during a downturn and not only survive this crisis afloat, but then thrive coming out on the other side.
As companies have evaluated financing many have asked us how to approach the use of debt—specifically how to think about existing, undrawn credit facilities. Should you pull down as soon as you can in case the bank fails? Banks are far more liquid than they were in 2008 and the risk of failure is low – data and anecdotes support this. So the logic supporting drawing on a facility should be exclusively around your company’s needs. Do you need the cash within the next 12 months even in a downside case? Will you draw and start paying the bank back with their own money? What is the interest rate, and can you refinance on better terms? You neither want to pay interest and principal on cash you’re not using, nor do you want to risk not receiving the funds if they’re necessary. Again, build the business case for pulling down credit. Don’t do so out of fear, but out of necessity after considering all options that may be on the table.
Capital market resources
Private & public market update
On the private side we are seeing and hearing more about unique deals being struck. Given that many individuals don’t expect M&A to return in earnest until Q3, PE firms whose bread and butter is buyouts have shifted strategies so as to continue to find ways to deploy capital—working to build public stock positions, funding pre-IPO companies, and making private investments in public equity (more to come on that next week). As most financial sponsors leverage debt (pun intended), they’re also taking on more risk by offering an equity backstop to financing with given debt markets frozen. On the public side all key indices with the exception of the SaaS index closed the week slightly below last week after rallying through Thursday (SaaS +4.85%, Dow -0.22%, NASDAQ -0.78%, S&P 500 -0.21%).
Consensus has settled on a U-shaped recovery which entails a sharp GDP drop in the second quarter of 2020 and then a modest recovery beginning in either Q3 or Q4. It still does not project real GDP to return to the levels seen in Q4 2019 until 2022. Per the article, even if the economy reopens by June recovery will be more prolonged as some businesses will close permanently, unemployment will still be elevated, and companies will operate with reduced spending plans. Scenario planning beyond 2020 will likely need to account for another year of business impact from the current crisis.
Other financial & capital markets reads (what else we’re reading)
SaaS valuation multiples trended effectively flat, moving from 8.8x to 8.6x 2020E revenues at the median to open the week. PWC’s latest CFO pulse survey. Benchmarking sales prospecting from Tomasz Tonguz. Shifting Your Sales & GTM Strategy in Uncertain Times with Salesforce. Where SaaS Stands from Profitwell.
OpenView Capital Markets Team