Amidst the headline grabbing investment rounds of the leading ecommerce and consumer internet companies, the silent rise of Indian Software as a Service (SaaS) plays has attracted much less attention. Historically, India has been an IT Services led Technology story. However, with SaaS models taking root globally, India has seen the emergence of several globally competitive SaaS players including Zoho, Freshdesk, Rategain, Druva, Pine Labs and Capillary to name a few. This in turn is leading to a strong investor interest in the segment.
To understand this trend better, let’s look at Indian Saas investment activity over the last few years for >$1million investments. Data from VCCEdge and Signal Hill estimates indicate that between 2011 and 2014, SaaS deal volume has jumped from 10 (in 2011) to 22 (2014 YTD basis) with a corresponding jump in total investment amount from $52 million in 2011 to $170 million YTD 2014. Also, compared to an average revenue multiple of 7.7 for 2010-2014, this multiple has based on our analysis, increased to 10.2. Thus on average, 2014 vintage SaaS investments in India have in fact happened at a premium to the prevailing US multiples for listed SaaS companies. Now, this is quite significant given the general perception that price discovery for IP plays in India lags the Silicon Valley.
So what’s really happening here? Why this sudden excitement in the investor community for SaaS offerings? Four things, actually:
1. Globally relevant players – Most of the larger SaaS companies in India are competing globally (and successfully) for clients, talent and product. Given that the top 2-3 players typically end up owning a disproportionate share of market in SaaS, there is a strong investor appetite for these globally relevant companies
2. Attractive underlying metrics – Lifetime Value to Customer Acquisition cost (LTV:CAC), Billings Growth and Churn are the triumvirate that define strength of a SaaS business.
Globally, an LTV:CAC of 3x is considered par and 5+ excellent. A QoQ Billings Growth of 7-8% is a par score and 12-13%+ ranks as excellent. Finally, a <10% churn is industry average and <5% considered outstanding. We are now seeing several Indian businesses reigning in the “excellent” bucket on at least 2 of the 3 metrics outlined above, and a few with all 3 metrics showing green.
3. Compelling cash flow profile with scale – By definition, SaaS models front load customer acquisition cost with a long tail of recurring revenue. Combined with typical gross margins of ~80% and low capex spend, SaaS companies exhibit a hockey stick free cash flow curve and massively expanding operating margins with scale.
4. Exit potential – In recent years there have been many Nasdaq IPO’s of SaaS companies that had revenues of $75-125m at the time of their listing. Hence the scale threshold to IPO a SaaS company is much lower as compared to other areas, making IPO’s a viable exit route for SaaS investments. Additionally, strategic exits for SaaS companies are also quite likely as evidenced by the significant global M&A activity in this space.
These are exciting times for SaaS players out of India. Strong investor interest coupled with attractive valuation multiples make it an ideal time for raising capital. Over the next 3-4 years we see a strong likelihood of several Indian SaaS companies breaking the $1bn valuation barrier. The silent ascent of Indian SaaS players will then be truly complete!
(Nitin Bhatia is director at Signal Hill Capital Advisory India P. Ltd.)
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