Some have commented on the strong headline ARR growth and the relatively modest valuation for a SaaS company (5-6 x Revenue). But I wonder how many of the valuations are getting anchored on past share price performance?

(Note: Recognising the recent COVID hit, I have done some of the calculations below over two year periods.)

Overall, revenue growth was OK at the headline level. However, over the last two years, 4 acquisitions have contributed $19m of ARR growth at a cost of $104m including earnouts ($72m excluding). So, without this, organic ARR growth over the last two years has been 18-19% p.a., albeit recognising the COVID hit to this especially in the SME sector. Sub-20% revenue growth is underwhelming for a SaaS firm that is still deep in the investment phase. And clearly there is a lot of investment going on. Beyond the acquisitions, the last two years show cash of $52m going into “Intangibles” (software development).

So, the next question is: will ELO generate strong cash flows? Again, I am not sure about this. Look at FY 2020 and FY 2021, cash from customers was $137m over the two years, yielding almost $7m after paying suppliers and employees. They actually did better in FY 2018 and FY 2019, where they generated $9m from $74m receipts. No sign of operating leverage there.

So, the final hope is can they get big enough in the huge addressable market they now have access to in ANZ and UK? I have serious doubts. I have a lot of contacts who work in small and medium enterprises, and they all seem to use different platforms for HR, most of which I’ve never heard of. I went on to Capterra and found that there are 1233 Cloud/SaaS offerings in the HR space. In terms of both the number of reviews and ratings ELO is nowhere to be seen in the top 40 or 50 (I gave up scrolling). Now many of the competitors do not offer the wide range of modules that ELO offers, but equally, many do. I did a Google trends analysis (image attached) for Australia – and that is also not a good picture.

My conclusion is worrying. ELO has not demonstrated a strong ability to generate cash. It is deep in the investment phase, having invested heavily in functionality and market footprint. They are in a highly competitive market with many SaaS alternatives that customers are turning too. It is unclear that they have a differentiated product, which means they are going to have to spend big on marketing and compete hard on price to build share. (Contrast this to the battle between MYOB and XRO in Australia.)

Generally speaking, when we accept SaaS valuations of 10-20x revenue, these are not the characteristics we expect. Even at 5-6x Revenue, ELO could prove to be highly overvalued.

[Disc: I sold my holding of ELO on 28 June at $4.55 taking a -20% hit. I don’t see anything in the latest results to change my view that the investment thesis for ELO is broken. I will put in a $3.50 valuation as a placeholder on strawman until I re-rerun my numbers.]