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He has experience with brick and mortar data centers as well as cloud providers like Digital Ocean, Amazon Web Services, and Rackspace. Download Slide Deck: . Yesterday's debate about public vs. Meanwhile, 9. 4% of enterprises are using some form of Xaa. S - software, platform, and infrastructure as a service. With major technology companies and startups seriously embracing Cloud strategies, now is the perfect time to attend 2.

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Javits Center in New York City, NY, and learn what is going on, contribute to the discussions, and ensure that your enterprise is on the right path to Digital Transformation. Track 1. Enterprise Cloud . Internet of Things . Containers . Midsize and small businesses are also migrating to the cloud in increasing numbers. Companies are each developing their unique mix of cloud technologies and services, forming multi- cloud and hybrid cloud architectures and deployments across all major industries. Cloud- driven thinking has become the norm in financial services, manufacturing, telco, healthcare, transportation, energy, media, entertainment, retail and other consumer industries, and the public sector.

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Why the Pundits Have It Wrong – Andreessen Horowitz. Tune into any cable network stock market channel and the airwaves resonate with one consistent theme: Saa. S companies are simply too expensive. In fact, we might even be in a bubble! The argument goes as follows — high revenue growth coupled with lack of profits means these businesses are fundamentally broken.

Just as we saw in 1. Saa. S companies will be left behind. Andreessen Horowitz. But that line of reasoning conflates the lessons of the 1. The businesses that failed in the last tech bubble were valued on metrics that were both poor indicators of business health (“eyeballs”, anyone?) and were nowhere to be found in generally accepted accounting principals (GAAP).

In contrast, Saa. S companies can be properly valued based on metrics that are both good indicators of financial health and that can be tied directly to the company’s GAAP filings. So why do the pundits have it all wrong? Because we love the simple income statement narrative that makes for great headlines, and we have trained the world to judge company performance based on revenue and earnings per share. Sure, it’s simple and, to be honest, it’s also accurate for a vast majority of publicly traded companies. When it comes to Saa. S, however, such simplicity can lead to bad investment decisions.

Here’s why. The key difference between traditional software and software as a service: Growth hurts (but only at first)In the traditional software world, companies like Oracle and SAP do most of their business by selling a “perpetual” license to their software and then later selling upgrades. In this model, customers pay for the software license up front and then typically pay a recurring annual maintenance fee (about 1. Those of us who came from this world would call this transaction a “cashectomy”: The customer asks how much the software costs and the salesperson then asks the customer how much budget they have; miraculously, the cost equals the budget and, voil.

Because the timing of revenue and expenses are perfectly aligned. All of the license fee costs go directly to the revenue line and all of the associated costs get reflected as well, so a $1.

M license fee sold in the quarter shows up as $1. M in revenue in the quarter.

That’s how traditional software companies can get to profitability on the income statement early on in their lifecycles. Now compare that to what happens with Saa. S. Instead of purchasing a perpetual license to the software, the customer is signing up to use the software on an ongoing basis, via a service- based model — hence the term “software as a service”.

Even though a customer typically signs a contract for 1. Rather, the accounting rules require that the company recognize revenue as the software service is delivered (so for a 1. Yet the company incurred almost all its costs to be able to acquire that customer in the first place — sales and marketing, developing and maintaining the software, hosting infrastructure — up front. Many of these up- front expenses don’t get recognized over time in the income statement and therein lies the rub: The timing of revenue and expenses are misaligned.

The income statement alone therefore can no longer tell us everything we need to know about valuing a Saa. S business. Even more significantly (since cash is the lifeblood of any business), the cash flow timing is also misaligned: The customer often only pays for the service one month or year at a time — but the software business has to pay its full expenses immediately.

Thus, as with many innovative new businesses, cash flow is a lagging not a leading indicator of the business’s financial health. Take a look at the cumulative cash flow for a single customer under a Saa. S model — the company doesn’t even break even on that customer until after a year: Company A, which is spending $6,0.

And as the company starts to acquire more customers, the cash flow becomes even more negative. However, the faster the company acquires customers, the larger it grows its installed base and the better the curve looks when it becomes cash flow positive. The key takeaway here is that in a young Saa.

S business, growth exacerbates cash flow — the faster it grows, the more up- front sales expense it incurs without the corresponding incoming cash from customer subscriptions fees. Because once a Saa. S company has generated enough cash from its installed customer base to cover the cost of acquiring new customers, those customers stay for a long time.

These businesses are inherently sticky because the customer has essentially outsourced running its software to the vendor, making them very predictable to model and more likely to yield high cash flows. Ultimately, we see the reverse of what we saw in the startup phase of the company: all the costs of acquiring that customer were incurred up front and long ago, and now the company gets to harvest nearly all the incoming cash flow from its customers as profits. There is also a really interesting, but often overlooked, long- term cost advantage that Saa. S companies have and that perpetual license businesses don’t: research and development.

In a perpetual license business, the R& D (and support) teams are often maintaining multiple versions of the software, with multiple versions running in the wild. Even Microsoft had to finally — 1.

Windows XP, despite all sorts of customers from ATM operators to federal, local, and international governments mourning the loss. This generally doesn’t happen in Saa. S because all customers are running on the same hosted version of the software: one version to maintain, one version to upgrade, one version on which to fix bugs, and one physical environment (storage, networking, etc.) to support.

Given that software companies at maturity often spend 1. R& D, this cost advantage is very significant and further enables Saa. S companies to be even more profitable at scale — particularly if they use multi- tenant architectures.

Not to mention that this simplified hosting and support model is the very linchpin for long- term Saa. S customer success and retention, especially as compared to the buy- but- don’t- use “shelfware” behavior that characterizes perpetually licensed enterprise software. But there are even more reasons why customers tend to stick to Saa. S. Saa. S customers, by definition, made the decision to have an outside vendor manage the application. In the perpetual license model, in- house IT staff managed all software instances and thus could incur the internal costs to switch vendors if they so chose.

In the past, the top- down technology sales model made it very easy for a CIO to unilaterally replace application vendors. In many cases, the departments forge an even closer relationship with their Saa.

S customer support rep than they do with their own IT. This is why many Saa. S companies today invest aggressively in sales and marketing when adoption is high, even though it puts pressure on current profitability. That early growth is key: In winner- take- all technology markets, it’s a land grab. Manual De Taller Hyundai Accent 2002 Accelerator. The real assessment for investors to make, then, is not whether current revenue and earnings per share multiples are too high — but whether we believe that the investments Saa. S companies are making today (that by their very nature depress near- term earnings and cash flow) are being made appropriately and thus will result in true free cash flow generation over time.

How can we tell whether a Saa. S business is healthy or not?

Given these dynamics, what’s an investor to do in assessing whether an early Saa. S company will yield a good financial return? Thankfully, there are a few key guideposts. We first need to measure Customer Acquisition Costs (CAC); the simple way to do so is to add up the quarterly sales and marketing expense for a company and divide that by the number of new customers acquired in the quarter.