Amidst the headline grabbing investment rounds of some of the leading ecommerce and consumer internet companies in India, the silent rise of investor interest in Indian SaaS plays has attracted much less attention. Historically, India has been an IT Services led Technology industry, with globally relevant technology product companies in single digits till 2010. However, with SaaS models taking root globally, India has seen the emergence of several globally competitive SaaS players including the likes of Zoho, Freshdesk, Druva, Rategain, Pine Labs and Capillary Technologies to name a few. Key reason for this is that in SaaS geographical location becomes irrelevant (the product is delivered online) and in particular in the SME space there is increased acceptance of buying SaaS subscriptions online. This in turn is leading to a strong investor interest with larger check sizes at higher valuations becoming more common.
Let’s start off by looking at the overall picture over the last few years. We have focused here on investment quantum of US$ 1mn and above as a proxy for Series A and higher rounds.
As can be seen from the above charts, SaaS deal volumes have increased sharply in 2014 compared to previous years with an even sharper jump visible when one looks at Deal Value. The fact that 2014 data is only till August 2014, makes the uptick even more impressive. This significantly increased deal activity is even more evident if one looks at a rolling 12 month investment activity, as depicted in the charts below.
But the most fascinating aspect of this heightened interest is the valuation multiple expansions that has been seen in 2014 compared to previous years.
Do note that since we are dealing with private companies here, valuation details are available only for a subset of the investments. We have relied on VCCEdge data (and our specific market intelligence, where relevant) and eliminated outliers to make this data more accurate and representative.
As can be noticed, there is a sharp increase in average valuation multiples in 2014 compared to previous years. In fact, based on our tracking of US SaaS valuation multiples, we contend that 2014 vintage SaaS investments in India have in fact happened at a premium to the prevailing US valuation multiples in the same space. Now, this is quite significant given the general perception amongst entrepreneurs that price discovery for IP plays in India lags the Silicon Valley. While this assertion may have been true in the past, evidence is mounting that valuation discounts in India compared to the Silicon Valley have all but disappeared for the SaaS space.
So what’s really happening here? Why this sudden excitement in the investor community for India based SaaS offerings? What are the common threads between SaaS companies which have been able to breach $100mn valuation milestone? Let’s try and distil some common threads from the more successful SaaS players.
- 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 the global market opportunity (for that category) in SaaS, there is a strong investor appetite for these assets. As an example, Freshdesk competes head on with a Zendesk, Fusioncharts with a Highcharts and so on. Two factors are really fanning the strong tailwinds here – Global market access at low cost, and Availability of world-class engineering talent in India. Given most SaaS offerings actively target SMB and mid-sized enterprise customers as primary customer base, significant chunk of sales for SaaS players are increasingly conducted online, supported by phone/ chat based inside sales. Also, with world class product talent from either global product MNC’s (SAP, Intel, Cisco, Facebook, Google) that have large product development teams in India or US based Indian diaspora that want to return to India, India now has the talent ecosystem that has been so fundamental to the success of Silicon Valley.
- Attractive underlying metrics – Lifetime Value to Customer Acquisition cost (LTV:CAC), Billings Growth and Churn are the triumvirate that pretty much define how solid a given SaaS business really is. LTV:CAC is a measure of sales efficiency, and ultimately long term profitability potential of a business. Billings Growth (and not Revenue Growth) is the true measure of growth and momentum of a SaaS business. Finally, Churn (actually measured as Customer Churn or Revenue Churn) measures how well a business is retaining its customers (high churn = leaky bucket problem). Globally, an LTV:CAC of 3x is considered par value and 5+ is considered excellent. A QoQ Billings Growth of 7-8% is pretty much a par score and 12-13%+ ranks as best in class. Finally, a <10% revenue churn rate p.a. is in line with industry average and <5% is considered outstanding. We are now seeing several businesses reigning in the “excellent” bucket on at least 2 of the 3 metrics outlined above, and a number of them with all 3 metrics showing green. Needless to say, these are hotly pursued assets for the investor community.
- 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 as marketing spend as % of sales comes down with scale (because of decline in new sales as % of total sales). They key factor in all of this is, of course, scale. While most Indian SaaS companies are sub US$ 5 mn currently, we are seeing several SaaS players crossing the US$ 10 mn Revenue hump in just the last 12 months and expect at least 3-4 companies to cross the US$ 25 mn Revenue hump over the next 12 months.
- Exit potential – The scale threshold for listing SaaS companies is much lower than for several other segments. Additionally, it is easy to visualize strategic exits for these companies with the likes of Oracle, IBM, Salesforce amongst the traditional software companies and Vertical/ Horizontal SaaS leaders in respective segments being highly active acquirers.
These are exciting times for product companies out of India. Strong investor interest coupled with significantly improved valuation multiples, make it an ideal time for raising growth capital. Aside from Zoho, which if it were to list would already attract a multi-billion dollar market cap, we see a strong likelihood of several other Indian SaaS companies breaking the $1bn valuation barrier over the next couple of years. The silent ascent of Indian SaaS players will then be truly complete!