Indian ambitions or US pedigree? What SaaS firms aspiring to go public should opt for

For the greater part of the pandemic, investors have been rewarded by the "overweight tech" play as "digital" became central to every interaction, pushing businesses and individuals to move further up the adoption curve almost overnight.

The uptrend is visible in the below graph, both for India (8X and 6X returns generated by emerging tech, i.e. providers of digital transformation services and mid-cap IT respectively) as well as the US (5X and 3X returns generated by loss-making SaaS and profitable SaaS respectively).

Indian IT outperformed US peers majorly due to the ramp-up of mega tech deal wins (25 percent jump in 2021), driven by accelerated digital transformation agenda of enterprises, stepped-up IT spending from North American and European clients, tailwinds from cloud migration, and efficiencies as a result of large-scale reskilling and employee training.

The focus of enterprise tech companies pivoted towards cutting-edge services such as cloud, cybersecurity, and big data analytics.

Exhibit 1: Sharpest growth by Indian tech companies across the 1st and 2nd COVID-19 wave, despite supply-side constraints, on account of a strong deal pipeline and operational efficiencies

Cyclical dynamics

The latter part of the pandemic (November 21 onwards) saw the sector's cyclical dynamics coming into play as central banks turned hawkish to check inflation and tighten liquidity. During a recent hike in interest rates across countries, technology stocks were collateral damage, underperforming the broader market.

Higher prices and wage inflation, along with recent rate hikes, have slowed non-core spending from American and European enterprises, which in turn may potentially slow down revenue growth and put pressure on the margins of tech companies.

However, the decline hasn’t been the same globally, especially when we compare India and the US.

Exhibit 2: Indian IT stayed resilient despite FII's pullout due to domestic institutional support, lesser crowding, and robust client demand, coupled with low churn and INR depreciation

Is the American Dream still worth chasing?

The US SaaS market declined by ~46 percent on an average (November 21 onwards). This can be explained by looking at the US tech market closely. Indices show that investors have flocked to a handful of tech leaders.

Indeed, markets have narrowed, indicating that major technology companies are supporting the overall index. This level of "crowding" endangers the US tech market with a higher downfall risk in the event of relatively minor negative news for any of the tech giants.

As seen from the chart below, around 1,700+ companies are between $1-$10 billion market capitalisation in the US as opposed to only 300+ companies in India, indicating the level of "crowding" in the US market.

Exhibit 3: Massive crowding in the US market as compared to the Indian market

Is the grass much greener in India?

Despite inflation, rate hikes, and FIIs withdrawal, Indian markets remain resilient (downturn of just ~24 percent vs ~46 percent downturn in the US), supported by rupee depreciation coupled with continuous capital inflows from a large domestic investor base.

To explain further, DII’s have been net buyers for 16 consecutive months. Investments crossed the Rs 2 trillion mark (~$25 billion*) till June 2022 with another Rs 1 trillion (~$13 billion*) invested by retail/ HNI investor base (record demat accounts added in the last two years). This was on account of investors having a positive long-term growth outlook towards underpenetrated Indian IT especially, new-age tech companies that are building in India for the world and have a tremendous runway for growth.

This resiliency in the Indian tech market can be demonstrated by the EV/TTM revenue multiples from April 1, 2020–July 12, 2022.

Exhibit 4: Robust performance by Indian tech; significant uptrend in valuation multiples 

EV/TTM revenue multiple for both mid-cap IT India and emerging tech India have shown stellar growth of ~250 percent on an average since April 2020. This is due to the tremendous demand that tech companies enjoy in India, ably supported by the huge investor capital pool (both in terms of DIIs and Retail/ HNI investors) deployed in a lesser crowded market. 

In contrast, their US SaaS peers (both profitable and loss-making SaaS companies) have underperformed with EV/TTM revenue multiple dropping even below their April 2020 mark by ~15 percent on an average.

Exhibit 5: US SaaS market suffered with valuation multiples dropping below pre-COVID levels

Key takeaways: Green Signal to an Indian IPO

We believe SaaS companies (market cap: $1-10 billion) aspiring to go public should prefer the Indian public market over US Stock Markets. Why?

- They can avoid the existing "crowd" as 20 percent of the US market is already captured by the firms with $1-10 billion market capitalisation as compared to just 5 percent in India;

- Less fragmented and underpenetrated tech market in India provides enhanced research coverage to newly listed tech companies; and

- Leverage coverage from top research analysts to get access to India’s marquee long-only mutual funds, global emerging market funds and an emerging base of "new-age" tech retail/ HNI investors keen to invest in industry disrupting models as has been visible in the recent IPO listings.

(The authors are part of JM Financial Limited, a global investment banking powerhouse with deep entrenched investor relationships across the globe with offices in New York and Singapore. It has a track record spanning five decades in executing marquee private equity/M&A and capital market transactions. It has consummated 40+ capital market, M&A, and private markets deals, with a cumulative value of ~$20 billion in the last 12-15 months across digital/technology, consumer and healthcare, among others)