Technology companies are finding a hole in profitability

Image credits: Brian Jackson/Getty Images

Tech companies are getting the hang of making money. At least the losses are much lower than they were when money was cheap and “growth” was attractive. We are seeing this happening across the technology sector, including enterprise software, fintech, and even technology-adjacent digital direct-to-consumer markets.

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It’s hard to know exactly how frugal startups are becoming as they try to save money. But if they are indeed imitating their larger brethren, the entire tech industry could be moving toward increased profitability, and the way we value these companies could change. It should change.

This morning we’re ingesting data and collecting strings from all areas, including Klarna’s recent H1 2023 results, Amplitude, Asana, and GitLab’s quarterly results, recent IPO filings, and more. The resulting situation is that generating cash rather than burning it is an increasingly important factor for the technology industry, especially for companies still building in the later stages of private markets. It shows that.

Once that’s done, take what you’ve learned and put it into context by comparing historical valuations. New data from Altimeter investor Jamin Ball shows that today’s tech startups are more expensive than you might think, but how does that change when you factor in profitability?

Enjoy it!

Profitability is so hot right now

These words from the CEO when Amplitude reported its Q2 2023 results have stuck with me.

The company generated record operating cash flow of $20.4 million and positive free cash flow of $19.3 million. As a result of this result, we expect our free cash flow to continue to be in positive territory.

The swing in which stocks rose sharply near the end of the COVID-19 period, only to see growth slow and get slammed by investors after going public is a near-perfect illustration of what technology companies have been experiencing over the past few years. This is an example. So it’s interesting to see that the company is currently generating a lot of cash. What we have here is a company that has managed to take control of its own destiny by straining its finances so that it can fund its own efforts.

But Amplitude isn’t alone. After Klarna announced its first quarter 2023 results, this column highlighted the company’s significant progress towards radically cutting losses in both the fourth quarter of 2022 and the first quarter of this year. He pointed out that this shows that he is achieving his goals.

Klarna then reported its first-half 2023 results a few days ago, which included a note from CEO Sebastian Siemiatkowski that read:

It’s also very different in the sense that we can now actually talk about Klarna’s return to profitability. Fast forwarding to our promise to return to profitability a year ago, we achieved our first monthly surplus in Q2 223, achieving our goal ahead of schedule.

Everyone loves rebounding. Airbnb quickly entered the public market after demand recovered following the disruption caused by the coronavirus. Apple is recovering to a market cap of $3 trillion because it needed his Microsoft money. . . I understand.

Klarna, somewhat similar to Amplitude, started out as a venture company with a towering valuation into the sun, then became a fintech unicorn that suffered a huge valuation, and now it’s the company it is today. We have become a great company. Still growing. and control its cost profile.

However, two companies do not set trends. Thankfully, we had more data available yesterday. Here’s how Asana discusses its use of cash in its quarterly report.

Cash flow from operating activities was $20.2 million, compared to negative $41.6 million in the second quarter of 2023. Free cash flow was $14.6 million compared to negative $42.3 million in the second quarter of fiscal 2023.

This means that cash flow has dramatically turned positive. Additionally, the company said its GAAP and adjusted operating loss and net loss have narrowed dramatically.

GitLab is also part of the trend. Brian Robbins, the company’s chief financial officer, said in an earnings call yesterday afternoon.

I want to emphasize the importance of driving responsible growth as we achieved more than 2,300 basis points of non-GAAP operating margin expansion. . . . Non-GAAP operating loss was $4.3 million, or -3% of revenue, compared to operating loss of $27 million, or -27% of revenue, in the prior year’s second quarter. . . . We generated positive operating cash flow of $27.1 million in the second quarter of 2024. This compares to cash flow from operating activities of $36.3 million in the prior year period.

Wow, that’s a lot of progress in the past year.

There’s more to consider. Last week, when Instacart and Klaviyo filed to go public, we found out they were making some serious profits. Here are some notes on Instacart’s final improvements:

According to the S-1 filing, the company’s operating income was $204 million in 2021, which rose to +$277 million in 2022. Even better, Instacart’s operating cash flow for the first half of 2022 reached $99 million. This figure increased to $242 million in the first half of 2023.

And here’s Klaviyo’s own journey from our report:

The company’s GAAP net loss in 2021 was $79.4 million, which narrowed to $49.1 million last year. However, the company’s performance has been even stronger recently. In the first half of 2022, Klaviyo reported his net loss of $24.6 million on his GAAP basis, but in his first six months of this year he made a profit of $15.2 million and managed to turn a profit. did.

A good question to ask at this point is: Are we overestimating from this small amount of data? We are not. This is a chart created by Altimeter investor Jamin Ball that tracks his median free cash flow margin over the next 12 months for a basket of publicly traded SaaS companies.

Image credits: Cloudy Judgment, shared with permission.

Why not take a look at it!

What is the problem?

Something had to give, right? Well, we’re seeing revenue growth decline as companies cut costs and increase profits in order to survive longer without raising more capital. Sure, it’s impressive to see all kinds of technology companies finding ways to make money, but they’re no longer making as much revenue at the pace they used to. Don’t just take my word for it. Ball summed up the situation nicely:

As you know, growth has been difficult to achieve in recent quarters. Almost every software company is experiencing a slowdown in growth (and in most cases, that slowdown is dramatic).

The focus on profitability over growth has resulted in growth-adjusted earnings multiples that look a little expensive for many tech companies. However, these numbers look a little more accurate when you factor in the increase in profitability. Ball concludes his discussion of that particular trend by arguing that valuations for software, which makes up the bulk of the technology market, are actually a bit overvalued.

Still, I would argue that once the economy improves, these increasingly profitable and cash-rich companies will not only have a strong base from which to grow, but will also grow from a position of wealth. To do. My expectations for tech companies are a little higher than what the Street thinks. From my perspective, the technology doesn’t seem as expensive as others.

But if you’re not an investor, it’s easy to be an optimist. I just watch, you know?

Finally: Investors demanded that tech companies replace red ink with black ink, or at least free cash flow ink. they got what they wanted. The question now is: How satisfied are investors that technology companies are doing what they’re told? Growth slowed and profits increased. So?