fter a decade of fighting on-premise hardware, cloud computing has won, according to a new report that has studied the public and private companies in the sector. And it’s happening faster than technologist and investors might realize.
Longtime investor and cloud expert Byron Deeter is predicting that victory based on a three-month long study he and his venture firm, Bessemer Venture Partners, have recently completed. The report (available here) found that of 42 public cloud companies indexed, total market cap for the group will pass $500 billion by 2020. A sector–Salesforce.com’s customer relationship management–will operate in majority over the cloud by 2016. And with 28 private “unicorn” billion-dollar startups emerging in the cloud and thousands more behind them, IT could see a tipping point that Marc Benioff and other early adopters have spent years preparing.
“The depth and breadth of cloud progress is pretty shocking,” says Deeter, who has invested in cloud companies like Box, DocuSign, Eloqua and Twilio. While companies like Salesforce have succeeded on the public markets and educated Wall St. and the non-technical businessperson about cloud software, more than half of cloud revenue comes from startups, the report found.
Since public cloud companies faced a correction in stock prices in the spring of 2014, many losing as much as 30% off their market capitalizations, those values have rebounded, says Deeter. But this time, the growth is off of revenue growth, the study found. “We think things were overheated last year, but you could almost argue the opposite now,” Deeter says, with multiples off revenue are closer to historical averages today.
But that’s not the case with the big private cloud companies, from Dropbox to Twilio and Slack. Private startups in the cloud sector are valued at about twice the multiple as the index of their public market peers. The reason, Deeter believes: Investors are paying a premium to get into private companies before they go public, and the big ones are taking their time to consider IPO, with subscription revenue often now at least $100 million when a company does go out. “Private valuations are harder to justify, frankly,” Deeter says. “There aren’t opportunities to buy so people are having to be aggressive. We’re getting a little enthusiastic.”
The report also studied a hot-button topic among startups in the current heated investment climate: burn rate. According to the research, a high retention rate can prove as important as a low acquisition cost for a new customer. Cloud companies that take two years to make money off a new customer but retain them at a 115% net retention rate end up in about the same revenue outlook as those that take only one year but retain clients at a net 100% rate.
That could be good news for companies that can’t slow their burn rate any more than they already have–just have a really strong product that more people keep adopting, and you can end up fine–but the report also contains a warning for the slower returns. That extra year to break even on a customer gets a startup to the same place, the research found–but it costs an extra $100 million to get to that point.
“That’s dilution that companies and early investors face,” Deeter says. “That’s why you hear a lot about sales efficiency.” Companies that have taken that route include Box, one of Deeter’s portfolio and a company that went public in January after needing more funding to get across the line.
For startups looking to get venture capital dollars, Deeter’s research found that the best-valued companies can point to 100% forward revenue growth, 125% upsell retention, gross margins of 75% or more with 95% gross dollar retention, and a payback on each new customer of less than one year. At the other end, startups with less than 50% revenue growth and margins with payback of more than two years are much less likely to get funded. “With thousands of businesses in the cloud, a great team is necessary but not sufficient.” Deeter points to Shopify, a Bessemer portfolio company that went public in May. “They’re at a public scale and still growing at almost 100%,” says Deeter. The difference between a high-growth bust and a high-growth winner, the investor argues, is whether the high-growth can come in a sustainable way.
The report taps three areas within cloud as particularly high growth (and areas Bessemer is focusing on for future investments): vertical software-as-a-service, which makes up a dozen of the public index companies; cyber security (“If Salesforce went down for two days, the whole industry would lose 20% off its valuations”); developer-focused services like Stripe and Twilio (one of 10 billion-dollar cloud startups of the current crop that Bessemer has backed).
Deeter also believes that the rise of Amazon Web Services is allowing cloud companies to grow much faster. Struggles as legacy players like Oracle, which just endured a tough quarterly earnings, should spur more acquisitions for startups in the field as well.
As for a bubble in tech valuations? Deeter says that he does expect a pull-back in the next five years among private valuations, which will favor those companies with a lower burn. But he believes that plenty will still go public by 2020, when the public index should pass one half-trillion dollars. “We are running hot now well above the rates to get there,” the investor argues. “Even absorbing some, the overall trend-line will be up and to the right.”
This article was written by Alex Konrad from Forbes and was legally licensed through the NewsCred publisher network.