BNP Paribas Equity Research analyzed software-as-a-service, or SaaS, valuations using stock-based compensation, or SBC, in the terminal value framework and noted that investors are “looking for even more bearish scenarios.”
The terminal value framework calculates the estimated value of a business or asset beyond an explicit, short-term forecast period, assuming the business will continue to operate and generate cash flows indefinitely.
Analyst Stefan Slowinski said that, as software stocks have stabilized somewhat, but not yet bounced, they revisited their SaaS Smash terminal value work.
The analysts added that they ran their terminal value framework (0% terminal growth, -2% terminal growth, and zero terminal value), this time applying the analysis to SBC-burdened free cash flow. The goal is to explicitly treat stock-based compensation as a ‘real’ expense, reflecting the growing investor debate around whether software free cash flow is overstated when SBC is excluded, the analysts added.
“Within our SBC-burdened FCF framework, we see some valuation support across our large-cap US software coverage, assuming some residual terminal value exists,” said Slowinski.
The analyst said that under this methodology, they see the most upside in ServiceNow (NOW), Adobe (ADBE), Workday (WDAY), and Intuit (INTU), with companies like Accenture (ACN) and Salesforce (CRM) pricing in some upside as well.
Slowinski sees a downside in companies that are either lower growth or carry depressed GAAP margins — Zoom Communications (ZM), IBM (IBM), and Snowflake (SNOW) — and in large-cap cyber and Electronic Design Automation, or EDA, names — Palo Alto Networks (PANW), Cadence (CDNS), Synopsys (SNPS), CrowdStrike (CRWD), and Cloudflare (NET).
“Investors are hesitant to re-engage as the sector remains susceptible to ongoing headline risk. While we have seen some confidence signals (i.e. mgmt. buying at SAP (SAP), Microsoft (MSFT), and ServiceNow, with Atlassian (TEAM) and ServiceNow (NOW) management pausing share sales), investors may view this as optics-driven especially vs. executive compensation levels; for example ServiceNow’s CEO Bill McDermott’s ~$3m open-market purchase vs. $113m of cumulative compensation since FY22 (NOW has not outperformed the IGV since announcement),” said Slowinski.
The analysts added that investors likely need more forceful signals.