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Let’s get the bad news out of the way first: On Friday, shares of cloud software companies suffered their worst single-day decline ever, erasing about $28 billion in a matter of hours.
Led by LinkedIn, whose shares fell 43 percent, the flag-bearing names of the cloud software industry as they all posted double digit declines: Salesforce.com fell 13 percent, Workday fell 16 percent, NetSuite fell 14 percent, ServiceNow fell 11 percent and AthenaHealth 13 percent. Atlassian, whose shares debuted in an IPO late last year, fell 16 percent.
And that was just one day. If you include declines begun in late December, publicly held cloud software players have suffered their longest sustained decline in five years. In total, the valuations of 47 publicly traded cloud software outfits tracked by the Bessemer Venture Partners Cloud Index have fallen by $66 billion since a mid-December peak.
So does that mean that the great revolution the cloud companies led to change how businesses buy and use software is over?
Hardly, said Byron Deeter, a Bessemer partner and the creator of its cloud index. Believe it or not, he says there’s good news to be found amid the carnage.
His argument:
First, cloud software companies as a group are still beating the markets: They’re up 97 percent from the start of 2011 versus 49 percent for the S&P 500 and 64 percent for the Nasdaq over the same period. (See the chart below; click to make it bigger.)
“On the fear-to-greed spectrum, I think this is an extreme move toward fear,” Deeter said. “The fear appears to be that IT spending budgets at large companies are being cut and that this will trigger a meaningful pullback cycle for the industry. I don’t think that’s true.”
Second, after their declines, the cloud companies look cheap. As a group, they’re trading at about four times forward revenue, versus their legacy software competitors like Oracle, SAP and Microsoft which until recently have been trading about 3.5 times forward revenue.
“The cloud companies are in a subscription business, and so they have predictable revenue,” Deeter said, noting that investors think they’re fleeing to safety while missing the fact that software as a subscription is a safer business then selling it the old way. “That to me is a position that is dramatically oversold — to me, it seems like a tremendous over-reaction.”
Finally, the cloud companies are still growing faster than the legacy players, even if some of theme (LinkedIn, for example) have pared back their outlook. On average, cloud players are expected to grow their revenue by about 26 percent this year. Compare that to the consensus growth expectations for Oracle, SAP and Microsoft, which range from 3 percent to 7 percent.
But, if they persist, the fears playing out on the public markets will reverberate in interesting ways. Those cloud companies that are already public may face pressure to cut back on their aggressive growth plans and focus on producing a positive cash flow. “Some companies may decide to cut back on their sales and marketing spending, and try to generate meaningful cash flow … if the markets get any worse, some companies will make that trade-off.”
Perhaps the worst reverberation is that private companies shopping for new investments and maybe dreaming of an IPO will have a harder time, Deeter said. “The IPO window is closed for the foreseeable future, and private market valuations are going to suffer,” Deeter said. “The people with the money to invest are going to be much more sensitive to cash consumption.”
That means nowhere to go in the also constricting private capital market, which has been enthusiastic for cloud plays thus far.
No longer. “For every dollar a company wants to raise it will cost them more equity,” said Deeter. “Some won’t be able to raise money at all.”
This article originally appeared on Recode.net.
