It Is Getting Pricier in the Cloud

Staying competitive in the cloud is expensive. The two largest players in the industry aren't making it any cheaper. and Adobe are the largest software companies that derive all or most of their revenue from subscription-based services. It is hardly a zerosum game at this point; analysts from KeyBanc Capital estimate that less than 10% of total enterprise tech spending currently goes toward cloud software. But both companies are richly valued by investors, with stock prices that have surged more than 50% so far this year on the premise that they can continue to fuel annual growth rates of 20% or more.
 That requires both astute management of their core businesses and some aggressive deal making. The latter, in particular, has been on display of late. Last week, Adobe made its largest acquisition ever with its $4.75 billion purchase of Marketo, a provider of cloud-based marketing software services. That came just six months after Salesforce announced its own record deal with the $6.5 billion pickup of MuleSoft, which helps companies build their own cloud-based applications. Neither was a bargain.
 Salesforce paid about 16 times forward revenue for MuleSoft — a price so high that many suspected the company had competition on the deal, though a subsequent regulatory filing showed that wasn't the case. Adobe paid about 10 times Marketo's projected revenue for the coming year, according to analyst estimates.
 It also provided a nice payday for Vista Equity Partners, which took Marketo private for $1.79 billion barely two years ago. For reference, companies in the S&P 500's Software and Services group now average around 5.5 times forward sales, according to FactSet. Future deals aren't likely to be cheaper. Cloud stocks have been on a tear, outperforming the rest of the software industry and the broader tech sector by a wide margin. A group of 55 cloud stocks tracked by KeyBanc is up nearly 69% for the year, compared with 19% for the S&P 500's software group. The average multiple among those cloud stocks is 11 times forward sales, according to FactSet, or double the Software and Services average.
 Investors haven't objected to high-price deals if they perceive them as continuing to drive high growth. Salesforce's shares are up 27% since the MuleSoft deal was announced and have picked up further gains this week as Salesforce's annual Dreamforce conference kicks off. The company told analysts Wednesday that it expects annual revenue in the range of $21 billion to $23 billion for the fiscal year ending January 2022, which would require growth to average at least 20% a year until then.
 Adobe quickly recovered the 2% it lost following last week's Marketo news. But those prices leave little room for error. Even a slight deceleration could put cloudstock prices on the skids.


Run Rate
Annual revenue*

*Salesforce's fiscal year ends in January. Adobe's ends in November.
Sources: S&P Capital IQ; FactSet

By Dan Gallagher


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