Cloud Insights. Q Investment Banking. SaaS Activity Slows as Valuations Come Under Pressure

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1 Q Investment Banking SaaS Activity Slows as Valuations Come Under Pressure Cloud Insights In This Issue: SaaS index experiences sharp contraction in 2016; IPO market dries up for now Public SaaS companies largely maintaining forward guidance M&A activity recedes from 2014 s record levels 2016 s capital-raising outlook

2 FRONT LINE INSIGHTS SaaS Activity Slows as Valuations Come Under Pressure Crossover funds begin marking down unicorn valuations and pulling back on pre-ipo rounds during fourth quarter. After the late summer surge in market volatility, activity in the SaaS sector contracted significantly during the second half of 2015 across M&A, private placement, and public equity markets. While the slowdown in IPO activity and pre IPO private rounds has limited capital raising options for $1 billion plus companies, the fundraising environment for nonunicorn SaaS companies via traditional VC and PE led investments remains intact. In this issue of Cloud Insights, we examine the trends that shaped M&A, private placement, and public equity markets for SaaS companies in We also examine the capital raising opportunities and challenges that SaaS companies face in 2016 after the rocky start to the year for equity markets. SaaS Index Experiences Sharp Contraction in 2016; IPO Market Dries Up for Now After the third quarter pullback in valuations, the SaaS index performed well in the fourth quarter, gaining roughly 10% between October 1 and December 31. This temporary rebound, however, was not enough to convince companies to pull the trigger on an IPO. After no SaaS IPOs in the third quarter, the only SaaS company to go public in the fourth quarter was Instructure. For the year, there were six SaaS IPOs that raised a total of $558 million, down from 16 IPOs that raised $1.9 billion in The fourth quarter s public equity gains were quickly erased during the first few weeks of As of February 10, the SaaS index was down 24% from where it was at the beginning of the fourth quarter. The market rout so far in early 2016 may have created a disconnect between valuation and performance among SaaS companies. Despite the downward pressure on valuations, as evidenced by the 39% drop in the median revenue multiple between the end of the fourth quarter and February 10, substantial growth opportunities remain. While there is still attractive growth and operating leverage being generated by SaaS companies, the current valuation levels may continue to deter IPO hopefuls and increase the current IPO backlog. Public SaaS Companies Largely Maintaining Revenue Guidance for 2016 Demonstrative of the shifting investor sentiment, SaaS companies endured precipitous price drops despite preliminary SaaS earnings reports indicating group performance in line with consensus estimates. The group s revised fiscal year 2016 revenue estimates are largely on target with consensus estimates and deviate negligibly from prior guidance. Of the five companies that had previously released full year 2016 revenue guidance, not a single company lowered its guidance. Notwithstanding SaaS M&A Activity by Quarter M&A disclosed deal values in the SaaS sector during the second half of 2015 dropped 76% relative to the third and fourth quarters of Challenging leveraged finance markets after the late-summer volatility contributed to this slowdown. ($ in billions) $4.0 $3.0 Source: S&P Capital IQ $ $6.2 $1.8 $ $ $2.8 Q1 '14 Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 M&A Activity No. of Transactions 1

3 this on track performance, the group s price has dropped by over 8% on average one day after earnings announcement. All in all, the current SaaS stock index performance is largely representative of waning investor sentiment and is characterized by extreme market turbulence. M&A Activity Recedes From 2014 s Record Levels In 2014, there were 318 SaaS acquisitions totaling more than $30 billion of disclosed value; both figures were easily the highest levels seen over the past decade. In 2015, disclosed SaaS M&A values dropped 42%, to $17.5 billion, and the number of transactions dropped 16%, to 268. The slowdown in 2015 was attributable to the drop in activity during the second half of the year. Compared with the robust levels seen during the third and fourth quarters of 2014, M&A activity during the second half of 2015 dropped 76% in terms of disclosed deal value and 51% in terms of number of transactions. Broader market volatility that began in late August played a major role in this slowdown. Concerns over China s slowing growth, U.S. interest rates, and falling oil prices that combined to rattle equity markets spilled over into debt markets in the third and fourth quarters. As arrangers and lenders began resetting their risk appetites and tightening underwriting standards, second lien financing particularly in syndicated loan markets became especially challenging. This has served as a significant headwind to LBO activity over the past several months. The market volatility also had a negative impact on interest from strategic buyers in the fourth quarter. Many industry consolidators seem to be using the volatility as justification for taking a wait and see approach when assessing potential acquisitions. In this environment, companies that are exhibiting both strong revenue growth and positive cash flow are in the best position to garner attractive multiples because these companies are appealing to a broader pool of potential buyers. Most financial sponsors are limited in their ability to aggressively value companies that are not generating positive EBITDA. Private Placement Values Rise, but Pre IPO Investing Loses Steam Despite a slight drop in the number of transactions, the total value of disclosed SaaS private placement investments in 2015 increased 18% to a record $6.9 billion. This increase, however, was almost entirely attributable to a surge in activity in the second quarter. During the second half of the year, activity slowed considerably as public equity valuations decreased and crossover funds began marking down the value of their private investments. Fidelity s markdowns of holdings in Zenefits, Dropbox, Snapchat, and other unicorns reflected a widespread downturn in investor appetite for highly valued private companies. Consequently, the quantity of SaaS private placements of over $100 million dropped from four in second quarter and third quarter 2015 to a single transaction in fourth quarter While the pre IPO market has certainly contracted, traditional fundraising routes remain open for high growth, non unicorn SaaS companies. For companies with sub $1 billion valuations, the fundraising environment via traditional VC and PE led investments remains intact s Capital Raising Outlook Large, highly valued private SaaS companies may face some tough decisions in the first half of As long as the IPO market remains shut and investor interest in pre IPO or late stage rounds remains tepid, companies may be forced to either scale back their investment in top line growth or take a private investment at a lower valuation than their previous round. As noted above, however, the capital raising environment is healthier for non unicorns. Highgrowth SaaS companies continue to have meaningful opportunities to raise venture capital through more traditional routes. If you have any questions about these or other trends that are shaping dealmaking and capital raising activity for SaaS companies, please do not hesitate to contact us. William Blair 2

4 MARKET UPDATE AND ANALYSIS SaaS Index Performance The index of SaaS companies performed well in the fourth quarter, but those gains were quickly erased in January. As of February 10, the all-cap SaaS index was down 24% from where it stood entering the fourth quarter while the NASDAQ is down 8% over that same period Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Source: FactSet Small-cap (-24.01%) Midcap (-27.05%) Large-cap (-7.82%) All SaaS (-23.6%) NASDAQ (-7.63%) Cloud Insights Each quarter we look behind the numbers to examine the market dynamics that are driving trends in the deal-making and capitalraising landscape in the SaaS industry. SaaS M&A Activity Broader market volatility and a slowdown in leveraged finance markets served as headwinds to deal-making in the second half of With many consolidators taking a wait-and-see approach, high-growth companies that are generating positive EBITDA margins are in a relatively strong position because they can generate more interest from financial sponsors. ($ in billions) $ Source: Capital IQ $ $22.0 $ $ $ M&A Activity No. of Transactions 268 SaaS IPO Activity Despite strong equity performance in the fourth quarter, SaaS IPO markets remained largely shut with only one SaaS company going public in the second half of the year. Five of the six SaaS IPOs in 2015 occurred during the second quarter. ($ in billions) $1.9 $1.5 $1.3 $1.0 $ $ IPO Activity No. of Transactions Source: Capital IQ and Dealogic 3

5 ($ in billions) $2.2 $1.9 $0.7 $0.6 $1.6 $0.5 $1.9 $1.0 $1.3 $1.5 $0.8 $ IPO Follow-on IPO vs. Follow-on Capital Raised by SaaS Companies While few SaaS companies went public in 2015, companies that were already public continued to raise additional capital at relatively robust levels during the year. Source: Capital IQ and Dealogic Private vs. Public Capital Raised by SaaS Companies Despite a pullback in interest by crossover funds during the fourth quarter, private capital raised by SaaS companies increased significantly in The IPO and pre-ipo markets may be challenging in 2016, but the market for fundraising via traditional VC- and PE-led investments remains intact. ($ in billions) $5.9 $6.9 $1.5 $1.3 $1.0 $2.1 $2.0 $3.4 $3.4 $4.1 $4.1 $ IPO & Follow-on Annual Private Placement Source: Capital IQ and Dealogic LTM Revenue Multiples Publicly Traded SaaS Companies Valuations for publicly traded SaaS companies have contracted dramatically in 2016 year-to-date. Median Multiples Over Time 14.6x 12.4x 12.7x 10.6x 9.8x 9.5x 6.7x 6.7x 5.0x 4.8x 3.1x 3.4x 9.4x 9.7x 9.1x 7.6x 2.5x 2.7x 9.0x 9.4x 7.0x 5.8x 3.0x 1.9x 6.4x 3.9x 1.8x Q1 '14 Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 2/10/2016 Source: Capital IQ Large-Cap Mid-Cap Small-Cap William Blair 4

6 WILLIAM BLAIR SAAS AND CLOUD INVESTMENT BANKING William Blair by the Numbers Drawing on our deep sector expertise and the strength of our relationships with buyers around the world, William Blair has built a leading SaaS and cloud investment banking franchise. Business owners turn to us for outstanding execution for their M&A and capital raising objectives. Recent transactions include: 250+ William Blair technology team completed transactions since SaaS transactions since SaaS companies under coverage 5

7 SaaS Equity Research Coverage Company Ticker Analyst Alarm.com Holdings, Inc. ALRM Bhavan Suri AppFolio, Inc. APPF Bhavan Suri athenahealth ATHN Ryan Daniels Benefitfocus BNFT Adam Klauber Carbonite, Inc. CARB Bhavan Suri ChannelAdvisor Corporation ECOM Justin Furby Connecture CNXR Adam Klauber Cornerstone OnDemand, Inc. CSOD Justin Furby Demandware, Inc. DWRE Justin Furby The Descartes Systems Group DSGX Bhavan Suri Ellie Mae ELLI Brandon Dobell Fleetmatics Group PLC FLTX Bhavan Suri HealthStream HSTM Ryan Daniels MiX Telematics Limited MIXT Bhavan Suri NetSuite Inc. N Justin Furby Ooma, Inc. OOMA Bhavan Suri Opower, Inc. OPWR Matthew Pfau Paylocity Holding Corporation PCTY Justin Furby QAD Inc. QADA Bhavan Suri RealPage RP Brandon Dobell RingCentral, Inc. RNG Bhavan Suri salesforce.com, inc. CRM Bhavan Suri SciQuest, Inc. SQI Matthew Pfau ServiceNow, Inc. NOW Justin Furby SPS Commerce, Inc. SPSC Matthew Pfau Textura Corporation TXTR Bhavan Suri The Ultimate Software Group, Inc. ULTI Justin Furby Upland Software, Inc. UPLD Bhavan Suri Veeva Systems Inc. VEEV Amanda Murphy WageWorks WAGE Robert Napoli Workday, Inc. WDAY Justin Furby Zendesk, Inc. ZEN Bhavan Suri With more than 150 senior bankers around the world, William Blair has completed more than 2,000 advisory and financing transactions totaling more than $200 billion in value for our clients* Cloud Insights Dan Connolly Managing Director dconnolly@williamblair.com Chris Lane Managing Director clane@williamblair.com Scott Mattson Managing Director smattson@williamblair.com Andrew Arno Director aarno@williamblair.com Peter Dalrymple Director pdalrymple@williamblair.com * In the past five years as of January 31, 2016 William Blair 6

8 Disclosure William Blair is a trade name for William Blair & Company, L.L.C., William Blair Investment Management, LLC and William Blair International, Ltd. William Blair & Company, L.L.C. and William Blair Investment Management, LLC are each a Delaware company and regulated by the Securities and Exchange Commission. William Blair & Company, L.L.C. is also regulated by The Financial Industry Regulatory Authority and other principal exchanges. William Blair International, Ltd is authorized and regulated by the Financial Conduct Authority ( FCA ) in the United Kingdom. William Blair only offers products and services where it is permitted to do so. Some of these products and services are only offered to persons or institutions situated in the United States and are not offered to persons or institutions outside the United States. This material has been approved for distribution in the United Kingdom by William Blair International, Ltd. Regulated by the Financial Conduct Authority (FCA), and is directed only at, and is only made available to, persons falling within COB 3.5 and 3.6 of the FCA Handbook (being Eligible Counterparties and Professional Clients). This Document is not to be distributed or passed on at any Retail Clients. No persons other than persons to whom this document is directed should rely on it or its contents or use it as the basis to make an investment decision. About William Blair Investment Banking William Blair s investment banking group combines significant transaction experience, rich industry knowledge, and deep relationships to deliver successful advisory and financing solutions to our global base of corporate clients. We serve both publicly traded and privately held companies, executing mergers and acquisitions, growth financing, financial restructuring, and general advisory projects. This comprehensive suite of services allows us to be a long-term partner to our clients as they grow and evolve. From , the investment banking group completed more than 350 merger-andacquisition transactions worth $95 billion in value, involving parties in 26 countries and four continents, was an underwriter on more than 20% of all U.S. initial public offerings, and raised more than $120 billion in public and private financing.