Category: IPO

Startups stuck in a billion-dollar backlog

Brenon Daly

Contact: Brenon Daly

Startups are increasingly stuck. The well-worn path to riches – selling to an established tech giant – isn’t providing nearly as many exits as it once did. In fact, based on 451 Research calculations, 2017 will see roughly 100 fewer exits for VC-backed companies than any year over the past half-decade. This current crimp in startup deal flow, which is costing billions of dollars in VC distributions, could have implications well beyond Silicon Valley.

First, the numbers. So far this year, 451 Research’s M&A KnowledgeBase reports just 439 VC-backed companies have been acquired, putting full-year 2017 on pace for roughly 570 exits. That’s 16% fewer deals than the average number of VC exits realized from 2012-16, and the lowest number of prints since the recession year of 2009, when startups were mostly focused on survival rather than a sale.

The reason for the current slowdown in the prototypical startup-sells-to-brand-name-buyer transaction that has generated hundreds of billions of dollars in investment returns over the years is that the buyers aren’t buying. (We would note that’s only the case for the bellwether tech vendors, the so-called strategic acquirers. Rival financial buyers – both through direct investment and acquisitions made by their portfolio companies – have never purchased more VC-backed firms in history than they have in 2017, even as the overall number of venture exits declines. Private equity now accounts for 17% of all VC-backed exits, twice the percentage the buying group held at the start of the decade, according to the M&A KnowledgeBase.)

Parked in VC portfolios, startups can, of course, build their businesses, along with the accompanying value. What they can’t do as long as they are still owned by venture investors is realize that value, at least not tangibly or completely. That takes either a sale of the company outright or an IPO. (Wall Street hasn’t provided many exits at all for VC-backed companies since 2000, and isn’t ever likely to be a primary destination for startups.)

And although we’re talking about small companies, there’s already been a pretty big impact. Even if we take a conservative average exit price of $50m for startups, multiplying that across the 100 exits that won’t happen this year means a staggering $5bn won’t get distributed in 2017 that would have in previous years. Without capital once again flowing from corporate acquirers back to startups and VCs, the entire ecosystem runs the risk of stagnation.

ForeScout looks ahead to Wall Street

Brenon Daly

Contact: Brenon Daly

For all the ‘next generation’ hype throughout much of the information security (infosec) market, 17-year-old ForeScout represents a bit of a throwback. For instance, ForeScout has been around twice as long as the other infosec company to make it public this year, Okta. Further, its business is primarily tied to old-line boxes, while Okta and other startups of a more-recent vintage have pushed their businesses to the cloud.

That comes through in the numbers. At ForeScout, sales of products (physical appliances, mostly) still accounts for about half of the company’s revenue. The remaining half comes from maintenance fees, with just a sliver of professional services revenue. There’s no mention in ForeScout’s IPO paperwork of ‘bookings’ or ‘billings’ or any other business metric favored by companies delivering their offering through a newer subscription model

While not flashy, ForeScout’s business model works. (There aren’t too many startups that are generating a quarter-billion dollars of revenue and increasing that by one-third every year.) ForeScout posted $167m in sales in 2016, and $91m in the first half of 2017. (Growth over that period has been consistent at roughly 33%.) Assuming that pace holds through the end of 2017, ForeScout would put up about $220m in revenue, or roughly triple the amount of sales it generated in 2014.

However, in our view, much of that performance has been more than priced into the company, which secured a $1bn valuation in the private market. That said, we also don’t imagine that ForeScout will be one of those unicorns that stumbles when it steps onto Wall Street. (Post-IPO valuations for recent offerings from Snap, Blue Apron, Cloudera and Tintri are all lingering below the level they secured from VCs.)

ForeScout likely won’t enjoy anywhere near the platinum valuation that Okta commands. (The cloud-based identity vendor currently trades at a market valuation of $2.7bn, or 11x this year’s forecast revenue of $245m.) Instead, to value ForeScout, Wall Street might look to another product-based infosec provider, Fortinet.

The two companies don’t exactly line up, either in terms of strategic focus or scale. (Fortinet generates far more revenue each quarter than ForeScout will all year, while ForeScout is growing about twice as fast as Fortinet.) Nonetheless, Wall Street currently values Fortinet at roughly 4.3x current year’s revenue. Slapping that valuation on ForeScout would get the company to a $1bn valuation, but not much higher.

451 Research subscribers can look for a full report on ForeScout’s filing later today.

A private equity play in the public market

Brenon Daly

Contact: Brenon Daly

In a roundabout way, private equity’s influence on the technology landscape has also spilled over to Wall Street. So far this year, one of the highest-returning tech stocks is Upland Software, a software vendor that has borrowed a page directly out of the buyout playbook. Shares of Upland – a rollup that has done a half-dozen acquisitions since the start of last year – have soared an astounding 150% already in 2017.

Investors haven’t always been bullish on Upland. Following the Austin, Texas-based company’s small-cap IPO in late 2014, shares broke issue and spent all of 2015 and 2016 in the single digits. For the past four months, however, shares have changed hands above $20 each.

Upland’s rise on Wall Street this year essentially parallels the recent rise of financial acquirers in the broader tech market – 2017 marks the first year in history that PE firms will announce more tech transactions than US public companies. As recently as 2014, companies listed on the Nasdaq and NYSE announced twice as many tech deals as their rival PE shops. (For more on the stunning reversal between the two buying groups, which has swung billions of dollars on spending between them, see part 1 and part 2 of our special report on PE and tech M&A.)

Although Upland is clearly a strategic acquirer in both its origins and its strategy, it is probably more accurately viewed as a publicly traded PE-style consolidator. The company has its roots in ESW Capital, a longtime software buyer known for its platforms such as Versata, GFI and, most recently, Jive Software. Upland was formed in 2012 and, according to 451 Research’s M&A KnowledgeBase, has inked 15 acquisitions to support its three main businesses: project management, workflow automation and digital engagement.

Selling into those relatively well-established IT markets means that Upland, which is on pace to put up about $100m in revenue in 2017, bumps into some of the largest software providers, notably Microsoft and Oracle. To help it compete with those giants, Upland has gone after small companies, with purchase sizes ranging from $6-26m.

However, the company has given itself much more currency to go out shopping. Early this summer – with its stock riding high – it raised $43m in a secondary sale, along with setting up a $200m credit facility. Given Upland’s focus on quickly integrating its targets, it’s unlikely that it would look to consolidate a sprawling software vendor. But it certainly has the financial means to maintain or even accelerate its rollup of small pieces of the very fragmented enterprise software market.

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

Roku’s next episode will stream on smart TV 

Scott Denne

Contact: Scott Denne

Roku has withstood an onslaught of competition from the world’s largest tech companies, yet it faces challenges on a new front as it readies its initial public offering. The maker of appliances for streaming video devices was able to flourish as Apple, Amazon and Google entered its market, but now faces a threat from smart TVs.

Amid a bevy of streaming alternatives, Roku expanded its topline by 25% in 2016 to $399m. According to 451 Research’s Voice of the Connected User Landscape survey, Roku leads the market for streaming media devices – 41% of respondents that own such a device use one from the company. It also sits ahead of the competition in daily usage and customer satisfaction rankings.

Most of Roku’s revenue comes through sales of its hardware ($294m in 2016), although most of the growth and profit margin comes via its advertising, licensing and revenue-sharing activities, which (at one-third the size) generated nearly twice the gross profit as the hardware segment. While Roku remains in the red, losses have decreased through the first half of the year, and modest increases in marketing spend – atypical of a venture-backed IPO – have fueled its gains.

Roku’s IPO heads to Wall Street as the market for streaming video accelerates. More than 21% of people in that same 451 Research survey said that they pay for three or more streaming services – double the number from two years earlier. Yet, much of that content is being consumed on smart TVs, which obviate the need for separate streaming devices, like Roku’s, and whose use ticked up by one-quarter over the last year, per our survey.

The company has begun to license its Roku OS software to TV makers, and needs to do so to continue to scale its audience reach – the lifeblood of the most profitable part of the business. While Roku showed that it can last through a heated battle with the biggest in tech, the company’s next phase will call for a subtler mix of partnership and competition with and against TV manufacturers.

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

Private equity does a number on the public markets

Brenon Daly

Contact: Brenon Daly

Private equity (PE) is doing a number on the public markets. No longer content with siphoning dozens of tech vendors off the exchanges each year, buyout shops are now moving earlier in the IPO process and targeting companies that may only be thinking about someday going public. These rapacious acquirers are not only harvesting the current crop of tech vendors on the NYSE and Nasdaq, but also snapping up the seeds for next season’s planting as well.

Consider the recent activity of the tech industry’s most-active PE shop, Vista Equity Partners. Two months ago – on the same day, as a matter of fact – the firm ended Xactly’s two-year run as a public company and snagged late-stage private company Lithium Technologies, a 16-year-old vendor that had raised some $200m in venture backing. (Subscribers to 451 Research’s M&A KnowledgeBase can see our estimates of terms on the Vista Equity-Lithium deal here.) And just yesterday, Vista Equity once again went startup shopping, picking up software-testing firm Applause.

To be clear, neither Lithium nor Applause would have been considered dual-track deals. Both startups undoubtedly needed time to get themselves ready for any eventual IPO. And while it might seem like a PE portfolio provides a logical holding pen for IPO candidates, buyout shops don’t really look to the public markets for exits. As far as we can tell, Vista Equity hasn’t ever taken one of its tech vendors public. The same is true for Thoma Bravo. Instead, the exit of choice is to sell portfolio companies to other PE firms or, to a lesser degree, a strategic acquirer. (Buyout shops prefer all-cash transactions rather than the illiquid shares that come with an IPO so they can speed ahead raising their next fund.)

The PE firms’ expansive M&A strategies – directed, effectively, at both ends of the tech lifecycle on Wall Street – aren’t going to depopulate the public markets overnight. However, those reductions aren’t likely to be offset by an increase in listings through an uptick in IPOs anytime soon. That means tech investing is likely to get even more homogenized. It’s already challenging to get outperformance on Wall Street, where passive, index-driven investing dominates. With buyout shops further shrinking the list of tech investments, it’s going to be even harder for money managers to stand out. With their latest surge in activity, PE firms have made alpha more elusive on Wall Street.

To see how buyout shops are reshaping other aspects of the tech industry and the long-term implications of this trend, be sure to read 451 Research’s special two-part report on the stunning rise of PE firms. (For 451 Research subscribers, Part 1 is available here and Part 2 is available here.) Additionally, a special 451 Research webinar on the activity and outlook for buyout shops in tech M&A is open to everyone. Registration for the event on Thursday, September 7 at 1:00pm EST can be found here.

Unready to step on the stage, Blue Apron is unlikely to step off

Brenon Daly

Contact: Brenon Daly

Welcome to Wall Street, Blue Apron, but what are you doing here? That’s a question making the rounds among a few investors Thursday as the meal delivery outfit publicly reported financial results for the first time since its IPO. And how were Blue Apron’s numbers? Well, suffice to say that the company’s shares, which have been underwater since the offering in late June, sank even further. In roughly six weeks as a public company, Blue Apron has lost nearly half of its value.

Rather than specifically look at the top line or the mess of red ink that Blue Apron reported for its second quarter, it might be worthwhile to focus on a broader point that might have been lost in the quarterly song and dance: Blue Apron probably should have never come public in the first place. The five-year-old company was simply not mature enough to join the NYSE.

But since Blue Apron — needing the cash — went through with the offering, it finds itself in the very awkward position of casting around to find a way to be a sustainable business, and doing it in front of the whole world. Everyone gets to see all of the missteps: the sequential decline in customers and orders, the costs rising faster than sales, the employee layoffs. It’s a bit like a teenager going through the clumsy, fitful process of growing up while on a stage.

However, the company doesn’t appear to going anywhere, with CEO Matt Salzberg saying Blue Apron is committed to building ‘an iconic consumer brand.’ And he’s taken steps toward that goal. Although the IPO very much represented a ‘down round’ for Blue Apron, it nonetheless adds nearly $280m to its treasury. That buys a fair amount of time, as does the company’s dual-class structure of shares, which effectively makes it impossible for shareholders — who, don’t forget, are the actual owners of Blue Apron — to force it to consider any strategies from outside.

For both financial and philosophical reasons, an imminent sale of Blue Apron is unlikely. Nonetheless, we would hasten to add that at its current valuation, shares are priced to move. Wall Street currently values the company at about $1bn, which we could use as an approximate enterprise value (EV) for any hypothetical transaction. (By our rough-and-tough math, we assume that backing out Blue Apron’s cash from the purchase price would be offset by an acquisition premium.)

At roughly $1bn, Blue Apron’s net cost would be less than the $1.1bn it will likely put up in sales this year. That’s a smidge below the average EV/sales multiple of nearly 1.3x in the handful of internet retailers that have been erased from Wall Street since the start of 2015, according to 451 Research’s M&A KnowledgeBase. As those exit multiples suggest, merely becoming an iconic consumer brand doesn’t necessarily pay off.

Competition cools appetite for new offerings

Scott Denne

Contact: Scott Denne

Competition, not cash flow, has become a leading indicator of a successful IPO. Wall Street rallied behind Redfin’s mission to take on the staid real estate market but was far less enthusiastic about this year’s other consumer tech IPOs – Snap and Blue Apron – as both vendors pursue markets where the largest tech companies already tread.

Redfin seeks to grab share in the real estate brokerage market by developing technology that it claims enables it to find customers and deliver services at a lower cost. In that way it’s similar to Blue Apron, which brings a tech-driven business model to the sedate grocery market. After more than a decade in market, Redfin posted $285m in trailing revenue, up 42% from a year earlier. Blue Apron is three times the size of Redfin and has been around for one-third the time. Yet when the two comparable firms began trading shares publicly, they went in opposite directions.

Redfin priced its shares at $15 before it began trading on Friday and closed the day up 45% from there. It added another 15% in early trading on Monday and was flirting with $25 for a market cap that’s just shy of $2bn. Blue Apron cut its initial price range as Amazon struck a deal to acquire Whole Foods and move further into Blue Apron’s grocery market. Shares priced at the bottom of its revised range and have been sinking since, with some help from a trademark filing by Amazon that suggests that it’s launching a competing meal delivery service.

To be clear, competition isn’t the only difference. Blue Apron faces questions about the ability of its business to generate a profit. Both companies lose money, but the ratio of revenue to losses has shrunk at Redfin and gone the other way at Blue Apron. Snap provides another example of the challenges of going public under the shadow of a larger adversary. While Snap faces a tough road to reaching 200 million monthly users, Facebook’s Instagram has roared past 250 million, fueled in part by selective borrowing of Snap’s features, helping send the upstart social media company’s shares down by half since its first day of trading.

The contrast between Redfin’s successful offering and the struggles of Blue Apron and Snap highlights the towering impact that the largest tech vendors have on the ability of younger businesses to raise capital and generate liquidity. And while risks posed by larger competitors aren’t new, the scale and scope of their impact will increase as a few tech firms expand their resources and spread into more consumer markets.

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

No more high-rolling in infosec M&A

Brenon Daly

Contact: Brenon Daly

Casinos, which are always looking to have patrons spend more money, are notorious for making exits difficult to find. For that reason, the Mandalay Bay was the perfect setting for this week’s trade show for the information security industry, Black Hat. Why do we say that? Infosec companies — at least the big ones — are having difficulty in finding exits, too.

Not to overstretch the metaphor of the host city for Black Hat, but the infosec industry has stepped away from the high-roller tables. So far this year, just one infosec company (Okta) has made it public, while those that have headed toward the other exit haven’t enjoyed particularly rich sales. This year’s small bets are reversing the recent record run for M&A spending on infosec transactions.

Spending on overall infosec acquisitions in the first seven months of the year has put 2017 on pace for the lowest annual total in a half-decade, according to 451 Research’s M&A KnowledgeBase. This year’s paltry total of just $2.3bn in aggregate deal value means that 2017 will snap three consecutive years of increasing infosec M&A spending. Our M&A KnowledgeBase shows that in 2016, infosec buyers spent $15bn, more than any other year in history, while 2015 also came in as another strong year in 2015 with $10bn in transaction value.

To put the current dealmaking decline into perspective, consider this: The largest infosec print so far in 2017 wouldn’t even make the list of the 10 biggest infosec transactions of 2015-16. And while this year’s largest acquisition – CA’s $614m purchase of Veracode – represents a decent exit, it’s fair to say more was certainly expected from the application vulnerability startup. (Veracode had filed its IPO paperwork several months before the sale on the quiet, according to our understanding.) Similarly, this year’s second-largest VC exit saw TeleSign agree to a sale that valued it lower than its valuation in its previous funding round.

The reason why so few sizable infosec startups are looking to exit is mostly because they don’t have to exit. Thanks to ever-increasing CISO spending, venture capitalists are back writing big checks to subsidize infosec startups. And when we say ‘big checks,’ we mean the size that used to come in IPOs or the rounds that got announced during the 2014-15 boom in late-stage investing, when single rounds of $100m were announced from across the startup landscape. While those growth rounds were relatively plentiful across the IT scene two or three years ago, infosec is the only industry where the big checks are once again rolling in. In just the past three months, a half-dozen infosec startups have each raised rounds of about $100m.

Tech IPOs need to take the summer off

Brenon Daly

Contact: Brenon Daly

In the tech IPO market, as with most trends, it’s better to be early than late. That’s not always the case, of course, but typically the first few startups that emerge from a prolonged pause for new offerings do so with a ‘bankable’ story for Wall Street. It’s as if they are going public out of desire, rather than necessity. By the end of the cycle, however, the motivations for IPOs don’t often reflect that same confidence, a fact that investors tend to sniff out and discount accordingly.

As we ease into a summer break for new issues, it’s worth noting that we have certainly seen that cycle in the IPO market so far this year. By and large, the handful of enterprise-focused startups that have been first to (public) market in 2017 have raised more capital, created more market value and rewarded shareholders more than the companies that have followed. MuleSoft, Alteryx and Okta all emerged onto Wall Street with solid offerings in the spring, representing the first enterprise tech IPOs following last November’s US election. (New offerings had been on hold as investors assessed the impact of the unexpected election results on their existing portfolio of companies before placing more speculative bets on IPOs.)

On the other side, the companies that have emerged from the pipeline more recently haven’t found Wall Street to be such a welcoming place. The most recent tech offerings — storage startup Tintri and online meal delivery vendor Blue Apron — both cut the pricing of their IPOs, but even that hasn’t been enough. (The discount for Tintri was particularly sharp, leaving the company, which had raised $260m in the private market, with just $60m in proceeds from public-market investors. Built on some $320m in total funding, Tintri currently has a market value of slightly more than $200m.)

The valuation declines for both companies have continued uninterrupted on the stock market, leaving Blue Apron and Tintri underwater from their IPO prices, never mind the much higher valuations they received as private entities. In contrast, MuleSoft and Okta are both roughly twice as valuable as they were when they last received funding as private companies. For the tech IPO market to get back on track in the second half of 2017, it might be well-served to take the summer off and look to restart in the fall, rather than dragging out the current cycle.

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

Despite the jumpstart, the tech IPO market still sputtering

Brenon Daly

Contact: Brenon Daly

Though undoubtedly well-intentioned, the Jumpstart Our Business Startups (JOBS) Act has nonetheless turned out to be a bit of a misnomer. When it was originally signed into law in April 2012, the JOBS Act was heralded as a way to remove some of the perceived obstacles that kept young companies from pursuing an IPO. Over the past half-decade, however, the law has come up way short in jumpstarting the tech IPO market.

Undeterred by that, the authors of the JOBS Act have expanded the law, opening the way for all companies — rather than just the ones that met the original ’emerging growth’ criteria — to go public while limiting the amount of information they disclose. The change goes into effect today.

However, we can only imagine that the expanded JOBS Act will have as negligible impact on the tech IPO market as the original law had. That’s generally the case when bureaucrats introduce regulation to solve a market-based problem, and that goes double for when regulators focus on the wrong problem in the market. To be clear, the lingering problems in the tech IPO market are due to a breakdown of the fundamental components of any market: supply and demand. (See our recent full report on the tech IPO market.)

Crucially, the JOBS Act only really addresses the ‘supply’ portion of the equation by, ostensibly, making it easier for companies to go public. But once companies make it to the NYSE or Nasdaq, they soon discover the real problem: Wall Street doesn’t particularly want them. Sure, tech vendors such as MuleSoft and Okta have both put up strong offerings so far in 2017. But we would argue that startups that can raise a quarter-billion dollars from private-market investors hardly need help raising capital through a public offering. (Indeed, both Okta and MuleSoft raised more as private companies than they did in their upwardly revised public offerings.)

Without increased demand from investors for newly issued equity from the hundreds of tech startups that have the financial profile to go public, the tech IPO market will continue to sputter. Paperwork from Washington DC won’t change that.