Snowflake, Zscaler, Cloudflare, Atlassian, Datadog most at risk software names: Jefferies
Warchi

Software stocks have tumbled in recent months as the Federal Reserve looks to combat rising inflation with higher interest rates, putting shivers into the global economy.
And though valuations have come down across the board, investment firm Jefferies believes that "winter came quick" for the software space, with Snowflake (NYSE:SNOW), Zscaler (NASDAQ:ZS), Cloudflare (NYSE:NET), Atlassian (NASDAQ:TEAM) and Datadog (DDOG) having the most to lose.
In a research note, analyst Brent Thill said that software companies have been "slow to get in front of tougher times" as only a few companies have cut expenses. And while there could be certain events that change sentiment, such as continued drops in valuation, mergers and other crowded areas losing favor, it is likely the space is in for "more trims ahead."
"We believe it may take till early 2023 for [companies] to fully reflect in guides," Thill wrote, highlighting comments made by Cloudflare (NET) Chief Executive Matthew Prince at a Jefferies investment conference in June that a storm is coming and it will be fiercer than people think. 
Snowflake (SNOW) trades at 18 times enterprise value to 2023 revenues, while Cloudflare (NET), Zscaler (ZS), Atlassian (TEAM) and Datadog (DDOG) trade at 16, 14, 13 and 13 times, respectively. 
"We believe these names may be more at risk in a continued downdraft," Thill wrote in the note. 
Conversely, Vimeo (VMEO), 2U (TWOU), Sumo Logic (SUMO), Similarweb (SMWB) and Zuora (ZUO) are the cheapest names in his coverage space, trading at 1, 1, 2 and 2 times enterprise value to 2023 revenues, respectively.
Thill added that even software "safe havens" like cybersecurity and infrastructure have "corrected significantly," having fallen 24% and 22% over the past five weeks, while application stocks are down 13%. 
The iShares Expanded Tech-Software Sector ETF (IGV) has declined 20% from the peak of the last rally and it's likely that valuations will "continue to compress as macro headwinds get tougher."
Large cap software multiples have declined 58% year-to-date, while mid-cap and small-cap multiples have fallen 62% and 50%, respectively. 
The amount of pessimism in the market is vastly outweighing the positivity rate, but Thill noted that sentiment could change, but perhaps not anytime soon, if five conditions occur: 

Continued decline in valuations. Software valuations are at 5.8 next 12 months revenue, 28% below the historical average of 8 times. Profitable, large-cap software companies are trading at 19.4 times enterprise value to next 12 months EBITDA and 21.5 times free cash flow, 22% and 24% below the trough of the past 5 years.
Lower expectations. Thill noted that recent channel checks show longer sales-cycles and increased caution and once companies lower expectations and acknowledge the uncertainty, then the healing can start.
Long only investors need to come back "more meaningfully."
M&A activity needs to expand. Overall deal volume for large software is at $194B, higher than it was in 2021, which saw $146B worth of deals. However, the average multiple paid was 7.7 times next 12 months revenue, 21% lower than last year.
Fund flows need to reverse from energy and recessionary trades.

Earlier this month, investment firm Needham started coverage on Snowflake (SNOW), giving the company high marks by saying "data is the new oil."