Cloudflare looks to stoke a flickering IPO market

by Scott Denne

Cloudflare, a network control specialist that unveiled its IPO prospectus this week, will need an enthusiastic reception to get over an already-rich private valuation and an uncomfortable comp. Through 2019, Wall Street has greeted new offerings from enterprise technology vendors with enthusiasm, extending double-digit valuations on the opening days of all new issues. And while there still seems to be plenty of appetite, the enthusiasm has tapered a bit with recent declines in the equity markets.

As Cloudflare looks to debut, it boasts 48% year-over-year topline growth through the first half of the year. And like all startups, that growth comes at a cost. In cranking out $234m in trailing revenue, the company chalked up a $91m loss, with few signs that it will be approaching profitability anytime soon. Unusually, it’s a surge in Cloudflare’s G&A expenses, not only sales and marketing costs, that’s eating away at profitability. In the first half, its G&A expenses were roughly equal to its R&D costs, each of which is about half of the $67m it spent on sales and marketing.

As we noted in a recent report on B2B tech IPOs, all recent issues have come to market with valuations north of 10x trailing revenue. And although most still trade well into double digits, the market has cooled a bit. Of the eight such offerings this year, five are down 10% or more from their opening prices. Even so, the valuations are still generous. Take Slack, for example. It’s down about 20% from its first day and trades at 38x trailing revenue.

For Cloudflare, though, the least generous valuation from this year’s crop belongs to a fellow networking services firm. Fastly, Cloudflare’s competitor in the CDN sector, is one of the few that trades with a multiple that’s in single digits after a 35% decline since its opening day in May. While Fastly trades at 7.5x, Cloudflare will need to get above 12x to top the valuation from its series D round. Despite a 5% dip in the S&P 500 this month, it should still get there. Cloudflare is about 40% larger than its rival, growing 10 percentage points faster and targeting a larger slice of the networking market.

B2B tech IPO activity

Dynatrace’s dynamic debut

by Brenon Daly

Dynatrace’s IPO represents the third major transition in recent years for the application performance management (APM) company. Like the other two, today’s shift has proved wildly lucrative. Dynatrace created more than $7bn in market value as it moved from private equity to public trading.

Although not unprecedented, Dynatrace’s partial swapping out of financial sponsor Thoma Bravo for Wall Street investors is still somewhat unusual. (Post-offering, the PE firm still owns about 70% of Dynatrace.) By our count, just three of the two dozen enterprise-focused technology vendors, including Dynatrace, that have gone public in the US since the start of 2018 have come from PE portfolios. Dynatrace raised roughly $570m in its offering, some of which will go toward paying down its nearly $1bn in debt, which, again, stands in contrast to the typical VC-fueled growth for most tech IPO candidates.

In many ways, the partial change in ownership for 14-year-old Dynatrace is the culmination of the other two changes, the first being a technology overhaul followed by a shift in business model. As we noted in our full report on the IPO, Dynatrace revamped its product a half-decade ago, integrating all of its monitoring into a single platform. (It no longer sells its legacy product, which it refers to as ‘classic,’ except to existing customers.)

As part of the transition to a platform, Dynatrace also changed how it sold its product, as well as how it accounted for those sales. Gone were licenses, in favor of subscriptions. And while the company has undeniably made progress in its transition to a new, more valuable business model, it has also been undeniably aided in its efforts by a rather expansive definition of ‘subscription’ revenue.

Accounting purists might have a hard time signing off on Dynatrace’s practice of including term and perpetual licenses, as well as maintenance and support revenue, all as subscription revenue. Basically, the company lumps all sales of its non-classic product – regardless of whether it is true SaaS or license-based – into the subscription line on its income statement.

Our quibbles about accounting are rather minor, and certainly didn’t stand in the way of professional investors, who have long since given up on GAAP, from rushing to buy newly issued shares of Dynatrace. The stock surged 60% shortly after its debut on the NYSE. With roughly 286 million (undiluted) shares outstanding, Dynatrace began life as a public company with a value of $7.4bn. That’s one-third more than the current value of APM rival New Relic, which has been public since Dynatrace first started its product transition some five years ago.

Europe’s increasingly global M&A ambitions

by Brenon Daly

As economic growth slows across Western Europe, tech acquirers there are increasingly looking to do deals outside their home market. The 451 Research M&A KnowledgeBase indicates 2019 is on pace for fewest number of ‘local’ deals (with both Western European acquirers and targets) in a half-decade. Based on our data, this year will see one-third fewer Continental transactions than any of the previous three years.

The slump in shopping comes as Western Europe weathers a broad slowdown that the International Monetary Fund recently said would rank the region as the slowest-growing of all the major economic regions around the globe this year. The IMF forecast that European economic activity would increase a scant 1.3% in 2019, half the comparable rate of the US.

We have noted how that has cut the overall tech M&A activity by acquirers based in the once-bustling markets of the UK, Germany and elsewhere. Collectively, Western Europe is the second-biggest regional buyer of tech companies in the world, accounting for roughly one of every four tech acquisitions announced globally each year, according to our data.

What’s more, the decline comes through sharpest in those deals that are closest. Western European acquirers have picked up fellow Western European targets in just 29% of the tech deals they’ve announced so far this year, our M&A KnowledgeBase indicates. That’s down from the five-year average of 32%.

Granted, the shift in shopping locations isn’t huge, but it is significant. Decisions on where to buy can swing hundreds of millions of dollars into and out of a local tech scene. Further, there’s a rather ominous implication about the politically fractured and economically sluggish Western Europe.

If we make the economically rational assumption that M&A dollars get spent where they can generate the highest return, then Western European tech acquirers don’t appear to be finding anything too attractive around home. On both an absolute and relative basis, they are shopping locally less often right now than at any point in the past half-decade. Instead, the M&A strategy for Western European acquirers is taking them more and more on the road.

PE, not just VC, joins the IPO parade

by Brenon Daly

The tech IPO parade continues, but with a twist. Rather than having its journey to Wall Street backed by truckloads of venture dollars, the first enterprise-focused company in the second half of 2019 to put in its S-1 is coming from a buyout portfolio. Dynatrace is a private equity-backed spinoff, not a VC-backed startup.

The planned offering by Dynatrace would be the latest move in a rather unconventional journey to the public market by the application performance monitoring (APM) vendor. Founded far from Silicon Valley, Dynatrace got its start in the sleepy Austrian town of Linz in 2005, taking in only $22m in funding before exiting to Compuware in July 2011 for $256m, or 10x invested capital.

Compuware itself was taken private by buyout firm Thoma Bravo three years later for $2.5bn, which, at the time, represented Thoma’s largest single transaction. Shortly after, Thoma spun off Dynatrace from its one-time parent and consolidated its new stand-alone APM holding (Dynatrace) with an existing one (Keynote Systems, which Thoma took private for $395m in June 2013).

After all that addition and subtraction, Dynatrace now looks to debut on Wall Street. That’s a trick that rival AppDynamics wasn’t able to pull off because Cisco Systems snapped the venture-backed company out of registration. Assuming Dynatrace does make it public, it would mark the first IPO in the fast-growing sector since New Relic went public in December 2014. (New Relic currently sports a $5bn+ market cap.)

But it certainly won’t be the last. Dynatrace’s sometime rival Datadog, which has raised $148m in venture backing, is thought to be eyeing an IPO of its own. (Subscribers to the Premium edition of the 451 Research M&A KnowledgeBase can see our full profile of Datadog, including our proprietary estimates for revenue for the past two years.) Meanwhile, subscribers to 451 Research’s Market Insight service can look for our full report on Dynatrace’s proposed offering on our site later today.

Quality, not quantity, in the IPO market

by Brenon Daly

With Medallia’s paperwork closing out tech IPO activity for the first half of 2019, it’s worth taking a look back at the new listings so far this year. 451 Research will have a full report next week on the unusual flow in the IPO market, but our quick take is that Wall Street got back to business (as it were) with tech IPOs, and that the focus has been on quality, not necessarily quantity.

Not a single B2B tech company went public in Q1, a rare quarterly shutout for startups in a segment that typically finds a warm welcome on Wall Street. The slow start to this year for enterprise tech IPOs left the total number of completed offerings at just six for the first half of 2019, down from 10 offerings in the first half of 2018.

To be clear, we are tallying only B2B tech vendors listing on the two major US exchanges, so our count excludes this year’s IPOs by Pinterest and Uber, for instance. We would note, however, that these consumer tech names, unlike their enterprise brethren, received a rather bearish reception on Wall Street. The high-profile offerings of both Lyft and Uber are currently underwater.

More significant than the number of enterprise tech startups coming public this year, however, is the stunning market value they are creating. Collectively, the six B2B companies that debuted in 2019 are valued at over $60bn, as of the end of Q2. For comparison, the 10 enterprise tech vendors that went public in the first half of 2018 created slightly more than $40bn of market value at the end of Q2 2018.

451 Research will have an in-depth report early next week on the stunningly rich valautions being awarded across the board to IPOs so far this year, as well as which startups from our coverage areas might be looking to cash in on Wall Street’s lucrative interest in enterprise tech right now.

Medallia heads toward NYSE listing

by Scott Denne

Medallia is looking to become the latest software vendor to test Wall Street’s appetite for new enterprise tech offerings as it unveils its IPO prospectus. The experience management software provider, however, lacks the growth of recent debutants and isn’t likely to come to market with the kind of extravagant multiple that many of the year’s offerings have fetched.

The customer and employee experience software developer’s sales rose 20% to $314m in its most recent fiscal year. Its topline expansion accelerated to 32% in the last quarter, yet that’s still behind the numbers put up by many other enterprise companies to enter the public markets this year. CrowdStrikePagerDutySlack and Zoom Video, for example, are all growing around or above 50% annually and boast valuations ranging from 20-70x trailing revenue.

Medallia isn’t likely to garner a price in that range when it comes public. Still, the offering will likely push its valuation well past the $2.4bn it commanded in a February fundraising. Its main competitor, Qualtrics, sold to SAP for $8bn – or 21.5x – on the eve of its own IPO. Medallia is likely to fall short of that multiple when it begins trading on the NYSE, although it could fetch a premium if it follows Qualtrics’ lead and sells the whole business.

As we’ve noted in the past, there are many potential acquirers, such as Adobe or Salesforce, of customer experience management vendors and a paucity of potential targets with Medallia’s scale. Would-be buyers may have difficultly finding other targets with the breadth of Medallia’s experience management and analytics software. Wall Street investors, on the other hand, have many options for investing in faster-growing software providers.

Slack ropes in premium valuation

by Scott Denne

An unusual route to the public markets didn’t stop Slack from capitalizing on soaring prices for new offerings. In its direct listing on the NYSE, Slack, like recent enterprise IPOs, commanded a scorching valuation, catapulting it well past what it fetched as a private company.

The workplace communications vendor’s stock quickly ran up to $41 per share, more than 3x the price of its series H round less than a year ago. The company currently trades above 50x trailing revenue, with a market cap that’s just north of $20bn. Still, that valuation falls a bit shy of fellow workplace tech provider Zoom Video, which fetches over 70x trailing revenue. Although both valuations are exorbitant, Zoom doubled revenue last quarter, while Slack rose 86%. Both are roughly the same size, but only Zoom is profitable. Slack still puts half its revenue toward sales and marketing.

Slack’s multiple matches what infosec vendor CrowdStrike garnered in its IPO last week. And PagerDuty, a firm that’s one-quarter of Slack’s size, with a topline that’s expanding at less than 50% annually, boasts a 35x multiple following its April IPO. The premium valuations for enterprise companies come as confidence in the stock market is leveling out after a turbulent end to 2018. In each of the last four months of 451 Research’s VoCUL: Consumer Spending survey, 20% or more of all respondents have claimed to be more confident in the stock market than they were 90 days ago, the highest level since last summer.

Instant gratification in CrowdStrike’s IPO

by Brenon Daly

Other recent high-flying debutants in the information security (infosec) market have had to take some time to grow into their multi-unicorn status on Wall Street. Not so for CrowdStrike. The endpoint security vendor smashed all pricing expectations on its way to creating a stunning $12bn of initial market value in its IPO.

To put that number into perspective, CrowdStrike’s valuation is roughly equivalent to the M&A spending across the entire infosec market for any given year, according to 451 Research’s M&A KnowledgeBase. Or, sticking to comparisons in the IPO market, CrowdStrike’s debut market cap is twice the initial value created in IPOs by two other recent fast-growing cloud security startups:

Okta came public in April 2017 at a valuation of $2.4bn, and now commands a $14.5bn market cap.

Zscaler came public in March 2018 at a valuation of $3.7bn, and now commands a $10bn market cap.

In its most recent fiscal year, CrowdStrike posted revenue of $250m. Revenue more than doubled last year, helped in part by an astonishingly high dollar-based retention rate of roughly 140%. Although not yet profitable, the company showed some leverage in its model by holding its net loss at the same level over the past two years, even as it doubled revenue.

In the IPO, Wall Street is valuing CrowdStrike at nearly 50 times trailing sales. That’s a heady multiple, significantly eclipsing the current mid-30x price-to-sales multiples for both Okta and Zscaler.

CrowdStrike is, however, still looking up at the current trading multiple of Zoom Video Communications. Zoom shares have tacked on roughly 50% since debuting in April, giving the profitable and fast-growing videoconferencing startup a price-to-sales multiple of nearly 70x. If CrowdStrike could replicate Zoom’s trading in the aftermarket, the infosec startup would be tracking to nearly the same astronomical trading multiple later this summer.

A quick double for Fastly

by Brenon Daly

Even as other VC-backed unicorns have stumbled recently in ‘down round’ IPOs, Fastly more than doubled its private-market valuation as it came public Friday. The CDN startup priced its offering at the top end of the expected range and then surged some 50% in aftermarket trading.

Fastly’s strong debut continued the recent bull run of enterprise tech IPOs, a sharp contrast to several high-profile consumer tech offerings that have sunk underwater. It also sets up a rather rich valuation for the company compared with its primary rival, which went public two decades ago.

With its newly issued shares changing hands on the NYSE at about $24 each, Fastly is valued at more than $2bn. That’s a significant step up in value from its final venture funding, which came last summer. Although a bit deep in the alphabet, the series F round had Fastly’s investors paying slightly more than $10 per share.

The company posted $145m in sales in 2018 and is likely to bump that up to roughly $200m this year, assuming it holds its current high-30% growth rate. That means Wall Street is valuing it at a mid-teens price-to-sales multiple, on a trailing basis. Or another way to look at it: on a relative basis, Fastly is worth three times more than CDN industry stalwart Akamai, which trades at almost 5x trailing sales.

Back to business

by Brenon Daly

After a brief but unprofitable dalliance with a popular consumer tech name, Wall Street is getting back to business. CDN startup Fastly is set to debut later this week, while business communications provider Slack and endpoint security specialist CrowdStrike have lined up expected offerings next month. All of those IPOs – which are built on more durable businesses than ride-sharing, for instance – should help put Uber‘s underwater offering in the rearview mirror.

Wall Street tends to run on a ‘what have you done for me lately?’ business. Uber’s offering didn’t do much for investors, except cost money to those who bought shares at the open. Of course, a week is a ridiculously short period to judge a company that will likely be public for years. But for now, with Uber shares still in the red, investors will shift their attention to where they can make money.

In IPOs, it’s been the offerings from tech vendors that sell to other companies that have generated returns. PagerDutystock is currently changing hands at twice where it priced its offering last month. Zoom Video Communications has also seen its shares double from their offer price, on a much larger scale. The firm has created an astonishing $19bn in market value.

Of the trio of enterprise-focused tech startups that are slated to come public soon, not one of them has figured out how to make money. But their losses are a fraction of the $3-4bn operating loss that Uber has posted in each of the past three years. When it comes to enterprise tech IPOs, companies don’t have to be profitable to be profitable bets for investors.