Enterprise software stocks took a beating last week as the sky-high multiples on the group continued to contract. As Barron's noted on Friday, many names dropped by more than 10% with minimal provocation.
On Monday morning, Jefferies analyst Brent Thill weighed in on last week's selloff, and he cautions that the selloff likely isn't done just yet.
"High growth software valuations are now trading above terminal M&A multiples, suggesting we still have more room for multiple contraction," Thill wrote in a research note. "We expect that the short-term correction will continue given multiples remain elevated even with last week's correction."
See also: Sky-High Software Stocks Are Beginning to Look Like They're Forming a Bubble
"Historically, software companies have traded within a band from 2x to 12x (enterprise value to next 12 month revenues,)" he wrote. "While the lower end of that band has remained the same, the higher end of the band has been pushed to 20x+...For instance, COUP ( Coupa Software ) trades at 20x 2020E EV/Revenue and ZM ( Zoom Video ) trades at 22x 2020E EV/revenue. Even historic terminal M&A takeout multiples do not support these valuations...As such, we believe current valuation multiples for the high growth names are unsustainable and we expect that the correction will continue."
Thill suggests that investors stick to "platform names with attractive growth and reasonable valuations" like Microsoft (MSFT), Salesforce.com (CRM), and Intuit (INTU). He also likes Sailpoint (SAIL), Zuora (ZUO), and Varonis Systems (VRNS) "that have the potential for revenue reacceleration over the next year."
Thill writes that his "most interesting takeaway from last week is no one is immune from multiple contraction -- TEAM ( Atlassian ) beat and raised but saw shares down 9% last week. Workday at its analyst earlier this week cited 'some delays' in deals and its shares were down 16%. We expect to see this valuation pressure on other high growth names as we head into earnings season."
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