Why Goldman Sachs Is Buying Emerging Software Giants

• Goldman Sachs has initiated coverage on several emerging software names.
• The firm believes that coming cash flow inflection will serve as a catalyst for leading stocks in the space.
• Goldman also anticipates that attractive valuations will lead to a pickup in M&A activity as well.

This week, Goldman Sachs initiated coverage on several names in the emerging software space. Analyst Jesse Hulsing believes that an upcoming shift in the business will provide an opportunity for the leaders in the space.

Cash Flow Inflection

According to Hulsing, Goldman is looking for businesses with improving customer acquisition costs and the potential for multiple years of improving cash flow ahead. Hulsing pointed out that, among the SaaS and infrastructure growth names, those with more than 15 percent operating cash flow (CFO) margins are currently trading at a 40 percent premium to names falling short of that 15 percent CFO margin threshold.

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“We see opportunity in investing in stocks where CFO margins are likely to improve meaningfully over the next two years [...] helping to close this multiple gap,” he explained.

M&A On The Horizon?

Another catalyst in the SaaS space in 2016 could be the return of aggressive M&A activity.

Hulsing noted that mega-cap companies spent $87 billion on enterprise software acquisitions from 2005-2012, but only $9.5 billion in the years since. However, Goldman anticipates that activity will soon pick up now that EV/NTM multiples in the space have once again contracted to within the 4x-8x range seen during the previous M&A boom.

Stock Picks

Goldman has initiated coverage at Buy for Hortonworks Inc HDP, Qlik Technologies Inc QLIK, Demandware Inc DWRE and Zendesk Inc ZEN.

Goldman also initiated coverage of Teradata Corporation TDC at Sell.

Disclosure: The author holds no position in the stocks mentioned.