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Don’t confuse ARR and Forward Revenues

Not all revenue multiples are equal.

99%> of the time EV/ARR multiples should be greater than EV/Forward Revenue multiples, it is therefore very important to understand the difference between the two.

In both of these multiples, the Enterprise Value (EV) remains constant, it is the measure of revenue that is changing. Annualised Recurring Revenue (ARR) is the current Monthly Recurring Revenue multiplied by 12, whereas the Forward Revenue is the total forecasted revenue for the next financial year. Assuming the company is growing, then Forward Revenue will always be higher than ARR and therefore, EV/Forward Revenue will always be lower than EV/ARR.

The relationship between EV/Forward Revenue and EV/ARR is explained by growth. The faster a company is growing the bigger the difference between EV/ARR and EV/Forward Revenue multiples.

A worked example:

A SaaS company has an Enterprise Value of $1,000m and is currently generating $120m in annual recurring revenue ($10m in MRR).

Scenario A – the company is growing at 5% per month, current ARR = $120m, EV/ARR = 8.33x, 12-months forward revenue = $167m, EV/Forward Revenue = 5.98x – ARR multiple is 1.39x higher than Forward Revenue multiple.

Scenario B – the company is growing at 10% per month, current ARR = $120m, EV/ARR = 8.33x, 12-months forward revenue = $235m, EV/Forward Revenue = 4.26x – ARR multiple is 1.96x higher than Forward Revenue multiple grow.

The faster a company is growing the wider the gap between revenue multiples.

The following tables provide more detail for the example above.

growth-rate-to-multiple-difference-exampleThe following table provides a quick reference guide for the relationship between EVARR and EV/Forward Revenue multiples in relation to growth rates. For example, if a company has a 5.1x Forward Revenue multiple and is growing at 8%, an ARR multiple for this company is likely to be 5.1*1.71 = 8.72x

ev-arr-to-ev-forward-revenue-table

A real life example:

Xero currently has an Enterprise Value (EV) of NZD $1,931m. Six months ago the company reported an ARR of NZD $218m. Six months is a long time in SaaS, so say current ARR is closer to NZD $260m – the EV/ARR multiple is 7.43x. The median broker estimate of Forward Revenue for Xero is NZD $318m – providing an EV/Forward Revenue multiple of 6.07x. To achieve this level of Forward Revenue, Xero has an implied month-on-month growth rate of 3.1% and in this example, the EV/ARR multiple is 1.22x larger than the EV/Forward Revenue multiple which aligns with the table above.

And finally, what about the <1%?

There is a scenario where EV/ARR multiples are lower than EV/Forward Revenue multiples. It is not a good scenario. For this to occur a company must have negatively monthly growth, not really an ideal situation for any company let alone a high-growth SaaS company.

Data & Methodology 

All data has been taken from Factset. The Xero estimate of Forward Revenue of NZD $318m is the median value from six brokers forecasts via Factset.

Disclaimer

Clare Capital is not implying that Xero will achieve 3.1% month-on-month growth for the next financial year. It has been calculated on an estimate of what current ARR could be and the median brokers forecast from Factset.

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