A Look at the Software Public Company Playbook

The CEO|Circle + CFO|Circle came together with Paul Kwan, Head of Morgan Stanley’s W. Coast Tech Group, and Melissa Knox, Global Head of Software, to discuss Morgan Stanley‘s software market playbook which they’ve synthesized from scores of public company leadership conversations they’ve held. 

These were the key takeaways:

Morgan Stanley: Plan for a W-Shaped Recovery. Our friends at Morgan Stanley see a “W” shaped economy recovery as more likely than the V-shaped recovery that the public markets are currently pricing in. The projections are largely tied to testing, vaccine development, and herd immunity. In a W-shaped recovery, we will continue to see high volatility in the markets we do not fully reach a stable state until later next year when there is confidence around an effective vaccine or the establishment of herd immunity.

“How Can We Be More Offensive?” The tone in public company board rooms is around how to be strategic and opportunistic in this environment. Many companies felt that they cut too deep, too fast during the ‘08/’09 financial crisis. Well-positioned companies are taking the opportunity to be strategic by balancing cuts in some places with aggressive hiring, acquisitions, and pricing to capture market share.

The Seven-Point Checklist for Software CEOs.

1. 1. Employee Health and Productivity
      • Companies have rightly prioritized taking care of their teams in this environment. The CEO is often overlooked, and this is a time when the board needs to step in and support the CEO – both emotionally and in planning.
   2. BCP and ECP
      • All companies are familiar and well-prepared with Business Continuity Planning.
      • Engineering Continuity Planning is not to be overlooked. How do you continue product building, and how do you map for redundancy within the engineering team if someone cannot work?
   3. Financial Planning
      • Companies are operating under scenario planning frameworks. It is too early to tell the future and you must plan for multiple scenarios.
   4. Customers
      • Take inventory of your customer base: who will have a higher renewal risk? 
      • Be alert and responsive to new use cases for your products that will serve your customers in a work from home environment. 
   5. Go To Market
      • You must evolve to an online and lighter touch sales channel. The market is starting to price companies with a lighter touch, higher velocity sales models at a premium relative to those that are more heavy enterprise direct sales. 
   6. External Leadership
      • How do you think about the government, the community, and your peers? How can you help, and how can you share best practices?
   7. Strategic Opportunities
      • How can you take advantage of M&A and partnership opportunities?
      • How can you be aggressive in hiring talent?
      • How can you use pricing to take market share?

The Public Software Sector. Software has not been hit as hard as the rest of the market. Software overall is trading at 8x forward revenue, higher than where it has been historically around 6x. We saw a steeper, quicker decline and a steeper, quicker recovery than any other crisis, and now some companies are near their all-time highs. At the same time, many companies have pulled guidance for the rest of the year and Morgan Stanley research analyst Keith Weiss lowered revenue estimates across the entire software sector 5% to 7% for the rest of this year and 6% to 8% across 2021. There is certainly a question of whether the sector should be trading at this level.

The Software Haves and the Have Nots. Companies who are closest to a full recovery are capital raising to give themselves flexibility over the next 18 months and to be on the offensive. Companies that are selling work from home/digital transformation enablement, collaboration tools and security, and companies with more of a self-service sales model, are the least affected by the crisis. Companies who have not recovered to early 2020 levels are on the defense, particularly around activist activity. Companies with heavy direct sales models, exposure to SMB and travel and entertainment, and selling more discretionary products have been hit particularly hard. 

Sources of Capital. The convertible debt market is strong, and companies can raise very cheap capital. The investment grade and high yield market have opened up, and companies can quickly raise more permanent capital through this avenue. For private companies, two sources of capital that have been quite active are strategics and sovereign wealth funds. Private equity firms are also active, many of which have credit arms. Fast sources of credit you may consider are drawing on your revolver if available, and an A/R facility.