Cloud stocks are flying in 2018.
Microsoft's $7.5 billion acquisition of GitHub this week only speaks to a bigger theme. From Okta and Twilio, which have more than doubled this year, to Zuora, DocuSign, Smartsheet and Zscaler, which have soared since their recent public market debuts, tech investors are pouring money into emerging software developers at an unprecedented rate.
More than 25 software-as-a-service companies (valued at over $1 billion), including Salesforce, Zendesk, New Relic, Atlassian and ServiceNow, are up at least 40 percent this year, well ahead of the S&P 500 Technology Index's 14 percent gain.
Multiples are rapidly increasing as well, suggesting that investors are getting more bullish on the sustainability of the business models. The 50 companies in the Bessemer Venture Partners Cloud Index now trade for an average of 7.8 times revenue over the next 12 months, up 27 percent from a forward sales multiple of 6.1 at the beginning of the year. The BVP index uses enterprise value to revenue.
Not included in the index are Microsoft and Adobe, which have also experienced extended rallies and are trading near record highs after pushing their businesses from desktop software to the cloud. Even Cisco made a giant bet on cloud early last year, purchasing AppDynamics for $3.7 billion just as the application monitoring company was about to go public.
Here's why so much money is flying into cloud companies.
Subscriptions: The high-level trend that's exciting Wall Street is subscriptions. Unlike the old days of software, when big vendors like Oracle and SAP would charge millions of dollars for multi-year contracts upfront and then tack on maintenance fees, this new generation of companies sell cloud-based services, generating some money initially but getting much more over time as customers renew their deals and demand more features.
"When you buy cloud or subscription software from a vendor, you can buy exactly how much you want: per person, per-employee, pay as you go," said Richard Davis, an analyst covering enterprise software at Canaccord Genuity. "It is a good business model and demand is strong, because everyone wants to buy software to make their companies efficient."
M&A potential: Investors also see big bucks from potential acquisitions.
Microsoft just paid 25 times sales for GitHub, a privately held company that has a relatively small business today but is practically ubiquitous in the developer community. In April, Salesforce made its biggest purchase ever, agreeing to buy MuleSoft for $6.8 billion — that's more than 15 times trailing revenue, which was the most expensive cloud software deal in history for a publicly traded company, based on a multiple of revenue. Cisco's purchase of AppDynamics was also for more than 15 times trailing revenue.