The Pandemic's Beneficiaries: A Reverse-engineered DCF Analysis of Software Companies

Abstract

Since the outbreak of the coronavirus and ensuing restrictions, several Software-as-a-Service (SaaS) companies have reported impressive financial performance and thus seemingly benefitted from the unique market conditions caused by the pandemic. The surging prices of these stocks imply that the market has high expectations regarding future growth. By utilizing a reverseengineered DCF model for 12 of the most prominent players in the SaaS industry, these growth expectations are quantified by extracting the annual growth rate of Free Cash Flow to the Firm as implied by the companies’ respective share prices as of January 1st, 2021. The paper’s ultimate goal is to assess whether or not these growth rates reflect the companies’ true business potential, and if not, apply theories of behavioral finance to explain potential market anomalies and irrational prices. On an industry level, this helps us evaluate if a bubble is forming. With these growth rates as the foundation and reference point for further analysis, the profitability potential of the industry as a whole is assessed through an external analysis. Through a PEST and Porter’s Five Forces analysis, we observe that the SaaS industry is highly attractive and characterized by scalability, with revenue growth serving as an effective proxy for Free Cash Flow growth. Furthermore, the industry appears to have been boosted by the covid-driven digital transition and the need for socially distanced efficiency. However, this has led to fierce competition, challenging the pursuit of profit margins and growth. We found it valuable to differentiate growth- and value stocks for the analysis and experienced the model to be most suitable for growth stocks. Next, Microsoft and Zoom are selected as case studies for further investigation. Internal analyses of the two using a VRIO-analysis aid us in assessing their implied growth rates. Our findings suggest that Microsoft’s implied growth rate of 4,46% is underwhelming, and Zoom’s implied growth expectation of 19,90% is realistic with the implication that they are undervalued and fairly priced, respectively, and as such do not indicate that a SaaS-bubble is forming. On an industry level, we conclude that market saturation and strong competition make some of the high implied growth rates we deduced from the reverse-engineered DCF unattainable. Nonetheless, distinguishing between overpriced individual stocks and a financial bubble, we conclude that we do not have evidence to suggest that a SaaS bubble that is bound to burst is forming.