Elastic adds spring to the fall IPO market

by Scott Denne

Investors clamored for shares of Elastic in the search software vendor’s public debut on Friday as the market for tech IPOs appears ready to bounce back after a slow summer. After pricing at $36 per share, the company’s valuation nearly doubled when trading opened at $70, giving it a market cap that’s just shy of $5bn and the kind of multiple that shows an unflagging faith in growth on Wall Street.

The developer of open source search software for IT log analysis, security analytics and other applications nearly doubled its top line in its fiscal year (ending April 30) to $160m, up from $88m a year earlier, while increasing the share of subscription revenue in its mix. That trajectory propelled the company to a 26.5x trailing revenue multiple – well beyond the $1bn valuation on its last private round, a $58m series D in mid-2016.

Few other unicorns have galloped onto the street with quite as much glamor. This year has now seen 11 enterprise tech companies enter the public markets with valuations north of $1bn, often at heated multiples, although not quite as high as Elastic’s. Zscaler came to market with a similar 26x multiple (it trades just shy of 24x now) and Smartsheet currently commands north of 20x. Longer is the list of 2018 IPOs that trade above 10x, including DocuSign, Zuora and Tenable.

The latter firm was one of just two enterprise tech providers to go public in the third quarter – a dry spell that followed an unusual burst of activity as 10 such companies debuted in the first two quarters (almost the same number that did so in all of 2017). Judging by Elastic’s offering, the dry spell had little impact on investor appetites, setting up a favorable environment for Anaplan and SolarWinds as both look to price this month.

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Two different companies, two different exits

by Brenon Daly

Maybe Anaplan can pull off what its rival Adaptive Insights failed to do: make it to Wall Street. The two corporate performance management (CPM) vendors put in their IPO paperwork just four months apart, but the outcomes for the two companies are looking very different. While Adaptive Insights is probably more at home inside the portfolio of an existing enterprise software provider, Anaplan’s stronger financial profile makes it far more likely to go public and continue this year’s bullish run of enterprise software offerings.

By any number of measures at these two vendors, Anaplan’s financials are more in line with what public market investors want to see. (We would note that measuring financials is essentially what the software from each of these companies actually does.) Anaplan is half again as big as Adaptive Insights, and it’s increasing sales at a more rapid clip (40% growth for Anaplan, compared with 30% at Adaptive Insights.) Anaplan’s scale and trajectory put it more in line with other recent enterprise software debutants such as Pluralsight and Zuora.

The fact that Anaplan has lost roughly twice as much as Adaptive Insights in recent quarters due to comparatively rich sales and marketing spending probably won’t trouble public market investors, who have been focused on the top line of this year’s IPOs rather than the bottom line. Lingering concerns around Anaplan’s red ink will likely be eased if Wall Street looks at the company’s customer retention rate of roughly 120%, which puts it in the top segment for SaaS vendors. For comparison, Adaptive Insights renewed customer contracts each year at only about 100% of their value.

All of that points to Anaplan enjoying at least some premium valuation to its CPM rival. In its dual-track process, Adaptive Insights ended up selling to SaaS stalwart Workday for $1.6bn, or 13.6x trailing sales. That’s also roughly the current trading valuation for recent software debutant Zuora.

Although Zuora and Anaplan serve vastly different markets, they are identically sized ($109m in 1H 2018 revenue, with each putting up a majority of subscription sales combined with a bit of professional services) and share a similar growth trajectory. Putting the mid-teens price-to-sales valuation on Anaplan’s trailing sales of $168m puts the CPM provider in the neighborhood of $2.5bn market value, which would work out to roughly 10x forward sales, based on our estimates. Assuming that’s the case, Anaplan’s IPO exit could well be worth $1bn more than Adaptive Insights’ M&A exit.

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Monkeying around on Wall Street

by Brenon Daly
After closing out a busy first half of 2018 with a lackluster offering, the tech IPO market isn’t looking like it will start the second half much stronger. SurveyMonkey has publicly filed its prospectus on an offering that will test Wall Street’s appetite for money-losing companies that don’t offset the red ink with sizzling revenue growth. The company’s age (19 years old) is higher than its growth rate (currently 14%).

Founded at the tail end of the frothy years of the dot-com bubble, the online survey provider has nonetheless enjoyed a frothy valuation of its own as it collected more than $1bn in debt and equity funding. Private-market investors have put a $2bn price on the company. SurveyMonkey’s ‘double unicorn’ valuation works out to about 8x this year’s projected revenue.

However, our forecast for a quarter-billion dollars in 2018 revenue assumes the company can continue its mid-teen growth. (That may not be a given, since SurveyMonkey increased sales just 6% in 2017.) For comparison, Dropbox – a similarly heavily funded startup that, like SurveyMonkey, also relies on lots of users choosing, at some point, to pay for the service – came to market earlier this year growing 30%. And the online collaboration vendor does more sales in a single quarter than SurveyMonkey does all year.

So Wall Street will undoubtedly scrutinize SurveyMonkey’s financial performance, which shows revenue increasing at just one-half to one-quarter the pace of other software IPOs this year. And they will look even harder at the offering since investors are still underwater from the most-recent tech IPO, Domo. Like SurveyMonkey, the BI specialist had probably drawn in as much money as it could get from private-market investors, so it turned to Wall Street. That’s hardly a compelling pitch for investors.

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A fashionable offering

by Scott Denne

Nabbing a valuation beyond its last venture round will be challenging for Farfetch, the latest consumer company to take a step toward the public markets by unveiling its IPO prospectus. As it bids to join the NYSE, Portugal’s Farfetch flaunts enviable growth and a favorable macroclimate, although its valuation will need a substantial premium above its peer group to have an up-round.

In operating an online marketplace for fashion brands and luxury boutiques, Farfetch generated $481m in trailing revenue. The company’s last venture round valued it north of $2bn, or 5x that amount – a steep hill for an e-commerce vendor, considering that such outlets rarely fetch above 2x from Wall Street. Online furniture seller Wayfair, for example, trades at about 2x – Groupon and JD.com trade below 1x.

Yet Farfetch has several factors working in its favor. For one, there’s a complementary economic environment. According to 451 Research’s most recent VoCUL: Consumer Spending report, in each of the past six months, over 30% of consumers have said they plan to spend more in the next 90 days. And 451 Research’s forthcoming Global Unified Commerce Forecast expects more of that spending to flow online (16% CAGR through 2022) than offline (2% CAGR). (We’ll be hosting a webinar to preview that report in September, readers can sign up here.)

Also, digital retailers specializing in clothing and fashion tend to be valued higher – by both acquirers and public investors – than the broader e-commerce category. According to 451 Research’s M&A KnowledgeBase, online retailers sold in the past 48 months fetched a median 1.1x trailing revenue. In recent sales of fashion-related sites, valuations have come in higher. Younique hit 2.5x in its $600m sale to Coty last year and Farfetch’s more mature rival, YOOX Net-A-Porter, landed 1.7x in its January sale to Richemont.

On the public markets, Stitch Fix, a personalized fashion retailer that went public last year, trades just above 3x. Farfetch would likely pass that marker – its topline expanded 55% compared with 33% for Stitch Fix and it has gross margins barely above 50%, whereas Stitch Fix is closer to 40%. Still, to match its private valuation, the would-be public company would need two full turns above Stitch Fix. That may not be, well, farfetched, but it’s a stretch.

Needs and wants

Thinking big – and spending even bigger – has landed Josh James in a tough spot. That will become clear later this week, when the company that James heads, Domo, prices its IPO. But it’s even more clear when we compare the planned offering by the current company led by James with the mid-2006 offering by the previous company led by James, Omniture. Simply put, it’s the difference between a company going public because it wants to (Omniture) rather than because it needs to (Domo).

The IPO papers show that although the two companies have the same CEO, somewhere over the past dozen years, James lost fiscal rigor. The relatively parsimonious operations last decade at Omniture gave way to a lavish lifestyle at Domo, which has resulted in James having to tap Wall Street to keep the lights on. Consider this: in the final quarter before the offering, Domo is roughly twice the size of Omniture, but is losing 10 times more money, on both an operating and net basis.

Looking closer at the two prospectuses, it quickly becomes clear how Domo’s financials became so deeply stained in red compared with Omniture. Even in its early days, Omniture never really spent more than half of its revenue on sales and marketing. For the two years after its IPO, Omniture spent 44% of revenue on sales and marketing, a level that’s consistent with other hyper-growth SaaS vendors.

Domo, on the other hand, has spent more on sales and marketing than it has taken in for revenue on every single financial period it has reported. And, more to the point, the huge investment isn’t really paying off for Domo, certainly not the way it did for Omniture. Domo, which is reporting decelerating growth, posted just a 32% increase in revenue in its most recent quarter, while Omniture basically doubled revenue every year on its way to creating a $300m-revenue company just two years after its IPO.

Put it altogether, and Domo has piled up a mountainous $800m in accumulated deficit. In comparison, Omniture burned through just $35m on its way to Wall Street. In the current era of mega-fundings and ‘growth at all costs’ business plans, Omniture’s paltry deficit seems almost quaint. So, too, does the fact that just four banks took the company public, half the number listed for Domo and most other software IPOs these days.

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Growth’s rich rewards

With public market investors handing out sky-high valuations for software vendors that are coming public, the debutants are under a fair amount of pressure to start strong on Wall Street. So far in their inaugural reports as public companies, the class of 2018 has delivered. All four enterprise software providers – which are growing, on average, nearly 50% – have kept their businesses humming along as they have stepped onto the NYSE and Nasdaq.

In other words, the newly public software companies (Dropbox, Zuora, Smartsheet and DocuSign) are keeping their end of the bargain they struck with investors during their IPO to post growth that’s well above the market average. In return, Wall Street is continuing to value them at a level that’s well above the market average. Valuations for the quartet range from roughly 10-22 times trailing sales, averaging almost 18x. That’s a richer valuation than virtually any of the existing SaaS kingpins, and three or four times the public market valuations for conventional software vendors.

That run of outsized rewards for above-market growth for enterprise software IPOs appears all but certain to end when Domo comes public in a few weeks. The reason? Domo is decelerating. In its most-recent quarter (ending in April), the BI startup reported 32% growth, down from the high-40% range for both the year-ago quarter as well as the full fiscal year. The slowdown at Domo means the company is now growing at only about half the rate of the two other similarly sized enterprise software providers that have come public in 2018, Smartsheet and Zuora.

Of course, Domo faces a more existential concern than how much revenue it adds each quarter. As we noted in our full report on the planned IPO, the company has spent itself into a hole and needs the money from the offering to get out of it. At current rates, Domo has only enough cash in the bank to keep the business going for two quarters. Wall Street knows that and will price it into offering. Unlike this year’s other software debutants, Domo – with its slowing growth and dwindling treasury – will get discounted when it comes to market.

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Spotify sounds out the street

Contact: Scott Denne

Despite Wall Street’s demonstrated distaste for pricey consumer tech offerings, Spotify intends to go public in the riskiest possible way. The streaming music service has unveiled its registration documents to begin trading its shares directly on the NYSE, bypassing an initial public offering. Spotify posts growth that makes it the envy of many consumer internet businesses, yet its low-margin business model limits its ability to staunch its losses.

The Sweden-based company’s top line jumped 39% last year to €4.1bn ($5bn), although its net loss more than doubled to €1.2bn. Renegotiating of its licensing agreements improved Spotify’s gross margin in 2017, but it still sits at just 21%. Given that it’s facing off against deep-pocketed tech vendors, including Apple and Amazon, it will be challenging for Spotify to negotiate lower rates and as it stands, the company has already had to lower the price of its service to bolster user growth.

Matching its private market valuation will be tough. New consumer tech debuts haven’t received a warm welcome on Wall Street. Snap trades just ahead of its IPO price a year after its debut, while Blue Apron has been decimated amid customer declines. Eschewing a traditional IPO to set a price could make its stock more volatile than it has been in the private markets – in private trades this year, Spotify’s market cap has swung between $15.9bn and $23.5bn.

It’s tough to find a perfect comp that aligns with Spotify. In some ways, it looks like Netflix. Both provide streaming entertainment and post enviable growth. Netflix, however, offers exclusive content to its subscribers, whereas Spotify has largely the same music that its competitors do. Moreover, Netflix, which is twice the size, has a higher gross margin and generated more than $500m in profit last year. Those differences will make it difficult for Spotify to fetch anything close to the 11x trailing revenue where Netflix trades. Still, its growth rate and low churn will likely keep it well above the 0.8x where Pandora trades. When Spotify enters the NYSE, we anticipate that it will be priced on the low end of its private market valuation, around 3x trailing revenue.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

What to look for in tech M&A in 2018

Contact: Brenon Daly

As we look back on 2017 and ahead to 2018, 451 Research has published its annual forecast for tech M&A, highlighting the trends that we expect to shape deal flow and the markets that we think will see much of the activity. The 2018 Tech M&A Outlook – Introduction serves as an overview of the broad M&A market, setting the stage for the upcoming publication of our comprehensive report that features analysis and predictions for eight specific IT markets on what deals are likely in 2018.

The full report, which we think of as an ‘M&A playbook’ for the enterprise IT market, has insightful forecasts for activity in application software, information security, mobility and other key sectors. The 80-plus-page 2018 Tech M&A Outlook report will be published at the end of January. It will be available at no additional cost for subscribers to 451 Research’s M&A KnowledgeBase Professional and Premium products, and will be available for purchase for 451 Research clients and others that don’t subscribe to our M&A KnowledgeBase products. (If you’re interested in purchasing the full 80-plus-page report, contact your account manager or click here.)

In the meantime, our introduction provides insights on some of the overall dealmaking trends that are also likely to shape activity and valuations in sector-specific transactions. Key highlights in our overview of the broader M&A market include:

  • After tech M&A spending in both 2015 and 2016 topped a half-trillion dollars, what happened that knocked the value of deals in 2017 down to just $325bn?
  • Many of the tech industry’s biggest buyers printed only half as many deals as they have in recent years. Is that the new pace of M&A at these serial acquirers, or will they rev up again in 2018?
  • The pending tax overhaul will likely add billions of dollars to the treasuries at major tech vendors. Why don’t we think that will necessarily lead to more M&A? If they don’t spend it on deals, what are tech companies going to do with the windfall?
  • Which tech markets are expected to see the biggest flow of M&A dollars in the coming year? Enterprise security tops the forecast once again, but what about emerging cross-sector themes such as machine learning and the Internet of Things?
  • How did private equity (PE) move from operating on the fringes of the tech industry to become the buyer of record? PE firms accounted for an unprecedented one out of every four tech transactions last year. Why do we think their share of the market will only increase?
  • VC portfolios are stuffed, as the number of exits in 2017 slumped to its lowest level since the recession. What challenges loom for startups and the broader entrepreneurial community without the return of billions of dollars from those investments?
  • For startups, will venture capital be flowing freely in 2018? Or will the polarized VC market (fewer rounds, but bigger rounds) continue this year?
  • Despite nearly ideal stock market conditions, why don’t we expect much acceleration in the tech IPO market in 2018? What needs to happen – to both supply and demand – for the number of new offerings to take off?

For answers to these questions – as well as other factors that will influence dealmaking in 2018 – see our just-published 2018 Tech M&A Outlook – Introduction.

Bull market bypasses tech IPOs

Contact: Brenon Daly

Although there’s still a month remaining in 2017, most startups thinking about an IPO – even those already on file ‘confidentially’ – have already turned the calendar to 2018. The would-be debutants want to have results from the seasonally strong Q4 to boast about during their roadshow with investors, as well as toss around a bigger ‘this year’ sales figure to hang their valuation on. There’s no compelling reason to rush out an offering right now.

That’s true even though the tech IPO market has been pretty active recently. By our count, a half-dozen enterprise-focused tech vendors have come public in just the past two months. (To be clear, that tally includes only tech providers that sell to businesses, and leaves out recent consumer tech companies such as Stich Fix and CarGurus.) The total of six enterprise tech IPOs since October is already higher than the full Q4 2016 total of four offerings.

While there has been an uptick in IPO activity, shares of the newly public companies haven’t necessarily been ticking higher, at least not dramatically so. There hasn’t been a breakout offering. Based on the first trades of their freshly printed shares, not one of the recent debutants has returned more than 20%. Half of the companies are trading lower now than when they debuted. Meanwhile, investors who aren’t interested in these new issues can’t seem to get enough of stocks that have been around a while, bidding the broad market indexes to record high after record high this year. The much-desired IPO ‘pop’ has gone a little flat here at the end of 2017, which might have some startups slowing their march to Wall Street in early 2018.

 

SailPoint sets sail for land of unicorns

Contact: Brenon Daly

In what would be one of the few private equity-backed tech companies to go public, SailPoint Technologies has put in its paperwork for a $100m IPO. The identity and access management (IAM) vendor, which has been owned by buyout shop Thoma Bravo for three years, should debut on Wall Street with a valuation north of $1bn. That is, unless SailPoint gets caught up in the current M&A wave that has seen a number of big buyers pick up identity-related security firms.

SailPoint reported $75m in revenue for the first half of 2017, an increase of 32% over the same period last year. Assuming that pace holds, the Austin, Texas-based company would finish this year with about $175m in sales. Depending on the product, SailPoint sells both licenses and subscriptions to its software. Subscriptions to its cloud-based offering, IdentityNow, are outpacing on-premises software sales, and currently account for some 42% of total revenue. License sales generate 34% of overall revenue, with the remaining 24% coming from services.

Transitioning to more subscription sales will undoubtedly boost SailPoint’s valuation. (Wall Street tends to appreciate the predictability that comes with multiyear subscriptions. In the case of IdentityNow, SailPoint indicated in its prospectus that the standard contract lasts three years.) That’s not to suggest that SailPoint will get the same platinum valuation as a pure SaaS provider such as Okta. That cloud-based IAM vendor, which went public in April, currently commands a $2.75bn market cap, or 11x this year’s sales. Of course, Okta is larger than SailPoint and growing at twice the pace.

Instead, we would look to some of the recent M&A pricing in the active IAM market to inform SailPoint’s valuation. For example, we understand that SecureAuth traded at more than 6x revenue in its sale in September to buyout firm K1 Investment Management. Ping Identity – which, like SailPoint, was in transition from license sales to subscriptions – also sold for about 6x sales last year. SailPoint is substantially larger than either of these fellow IAM firms, and is growing solidly. That should garner it a premium. But even using a conservative valuation multiple of 6x sales gets SailPoint into the land of the unicorns.

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