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Cloud stock bubble returns, but with less risk

Aaron Pressman
Cloud stock bubble returns, but with less risk

The Internet stock bubble popped in 2000, right after media outlets discovered dozens of newly public companies barely had enough cash to stay in business for another year.

So investors' blood pressure jumped last week after venture capitalist Bill Gurley issued a grave warning that the so-called burn rate of Silicon Valley companies “is at an all-time high since '99 and maybe in many industries higher than in '99.”

But a review of publicly traded companies in the bubbliest tech segment, Internet cloud services, found little reason to worry. While Barron’s found 51 public companies with less than a year of cash left 14 years ago, no publicly traded cloud Internet company has less than two years of cash left now.

In fact, over half of the 38 companies in the Bessemer Venture Partners Cloud Index were generating cash, not burning it, over the past 12 months. Of the remaining 18 that were still in the red, all but four had more than three years of cash left, and none had less than two years.

Yahoo Finance used data from FactSet on free cash flow, which includes cash used or generated in operations, capital expenditures and working capital needs, over the past 12 months and compared it to cash on hand as of June 30. The burn rate exercise assumes companies use as much as cash as they have over the past year and can’t raise any fresh capital.

Companies in the Bessemer index range from larger cloud service providers such as Salesforce.com (CRM) and NetSuite (N) to recently public companies such as Castlight Health (CSLT) and Veeva Systems (VEEV).

Cloud Companies Burn Rate

Yahoo Finance also reviewed seven recent cloud service IPOs that Bessemer leaves out, such as Amber Road (AMBR) and Five9 (FIVN). Five of those companies are still burning cash, but aside from Amber Road, which had a burn ratio of two years, none had less than three years left.

After the financial crisis, many tech companies began raising and setting aside more cash to create “fortress balance sheets” that could survive a future credit crunch. Some of the cloud service companies that had higher burn rates also had substantial cash reserves.

For example, RingCentral (RNG) had negative free cash flow over the past 12 months of $38 million, according to FactSet. But the company had $151 million of cash on its balance sheet, giving it a relatively benign burn ratio of 4.0 years. Workday (WDAY), the third largest company in the Bessemer index by market cap, had negative free cash flow of almost $13 million but cash on hand of $1.8 billion. It could last over 142 years at that rate.

To be sure, cloud Internet companies still trade at high values compared to the average stock. They may not be going out of business, but that doesn’t automatically mean their stock prices will outperform the market.

As of the end of last week, companies in the index were trading at a median price of 6.5 times their 2014 sales, versus companies in the S&P 500 which trade at less than 2 times sales on average. And even though most companies in the index are cash flow positive, almost none are reporting a profit on the basis of generally accepted accounting principles.

Many cloud companies hit a peak valuation in March, highlighted by Castlight’s IPO that month. The company, with only $13 million of revenue, closed on its first day of trading at a valuation of over $3 billion. The entire segment plummeted for much of the next three months, as the Bessemer index lost 30%. Castlight, for example, dropped from its first day close of almost $42 a share to a low of $10.05 in May.

But over the past three months, cloud stocks have clawed back a good portion of the decline. The index has gained 26% since hitting bottom in May, leaving it 12% below the prior peak.

Valuations are still well above the market averages, but less so than earlier in the year. At the peak, cloud companies were trading at almost 9 times their expected 2014 revenue, versus the current figure of 6.5 times revenue.