Category: IPO

For PE, secondaries become primary

Brenon Daly

Contact: Brenon Daly

In many ways, the tech buyout barons have themselves to thank for the record run of private equity (PE) activity so far in 2017. The number of so-called ‘secondary transactions,’ in which financial acquirers sell their portfolio companies to fellow financial buyers, has increased for three consecutive years, according to 451 Research’s M&A KnowledgeBase. The pace of PE-to-PE deals has accelerated even more this year, with an unprecedented 64 secondary transactions already in 2017 — more than twice the average number in the comparable period over the past half-decade.

The fact that secondaries have become primary for PE shops represents a fairly noteworthy change in both the buyout shops and their backers, the big-money limited partners (LPs) of the funds. In years past, LPs have frowned on the practice because, in some cases, they might be investors in both the PE funds that are doing the buying as well as the ones doing the selling, which doesn’t really reduce their risk in that particular holding — nor do they truly exit that investment. The practice has been criticized by some for being little more than buyout shops trading paper among themselves.

For that reason and others, our M&A KnowledgeBase indicates that the number of PE-to-PE deals in the first half of the years from 2002-10, when the tech PE industry was relatively immature, averaged only in the mid-single digits. In others words, PE shops are currently doing 10 times more secondary transactions than they did in the first decade of the millennium. Recent tech deals that have seen financial buyers on both sides include Insight Venture Partners’ sale of SmartBear Software to Francisco Partners after a decade of ownership, TA Associates’ sale of Idera to HGGC, and Summit Partners’ sale of most of Continuum Managed Services to Thoma Bravo.

These types of transactions appear likely to remain the exit of choice for PE shops, as both the number of funds and the dollars available to them continue to surge to new highs. The increasing buying power of buyout firms stands in contrast to the diminished exits provided elsewhere for portfolio holdings. The tech IPO market has never provided much liquidity to PE shops. (For instance, neither Thoma Bravo nor Vista Equity Partners has seen any of their tech holdings make it public.) Meanwhile, corporate acquirers — the chief rival to financial buyers — have dialed back their overall M&A programs, and in some cases have found themselves outbid or outsprinted in PE-owned deals by ultra-aggressive buyout shops.

The one and only exit for infosec’s unicorns

Brenon Daly

Contact: Brenon Daly

In just the past month, four different information security (infosec) startups have all pulled in single rounds of funding that typically would have only been available from an IPO. In addition to filling company coffers, however, the roughly $100m slug of capital raised by each of the quartet — CrowdStrike, Tanium, Netskope and Illumio — may also influence company strategy, at least when it comes time to seek an exit. Rather than pursue a sale of the business, which is the most likely outcome for any startup, these infosec unicorns will likely eye the door that leads to Wall Street.

In other words, when it comes to the two exit options available to these security startups, they should be modeling themselves more on Okta than on AppDynamics. The reason? Of the 17 sales of VC-backed vendors valued at more than $1bn since January 1, 2014, not a single startup has come from the infosec market, according to 451 Research’s M&A KnowledgeBase. Mandiant came close to a 10-digit exit in its early 2014 sale to FireEye, but the announced value of that deal stands at $989m. (Of course, FireEye paid for the vast majority of that in stock, which lost half of its value within four months of the transaction and has never regained its early-2014 level.)

Infosec is conspicuous by its absence among the big-ticket purchases of venture-backed companies. Virtually every other major tech sector has realized some unicorn exit, including mobility (WhatsApp, AirWatch), e-commerce (Jet.com), storage (Cleversafe), the Internet of Things (Jasper Technologies) and cloud (Virtustream). The largest sale of a VC-backed infosec firm over the past three and a half years, according to the M&A KnowledgeBase, is Trustwave’s $810m sale to Singtel in April 2015. (Although Trustwave did raise venture money, notably from FTV Capital, it hardly fits the classic definition of a startup. Instead, it is more accurately viewed as a rollup, having consolidated 16 other businesses since its founding in 1995.)

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

 A taste of the unexpected 

Scott Denne

Contact: Scott Denne

Blue Apron has taken the lid off its burgeoning food-delivery business, and uncertainty is on the menu. The company publicly unveiled its IPO prospectus on Thursday night, showing a rapid rise in annual revenue for the quasi-subscription grocery supplier but a lack of clarity on customer retention that Wall Street might not be able to stomach.

Last year’s annual revenue popped 2.3x above 2015’s total to $795m. And its improving gross margins already outperform traditional competitors. The 31% it posted last quarter puts it on par with its high-end cousin, Whole Foods, while traditional grocers are typically in the 20% neighborhood.

But other costs – administrative, development and technology – moved in tandem with revenue. In that way, it looks like a typical tech offering. Yet on a quarterly basis, its expenses – particularly marketing – are lumpy, which will likely be scrutinized.

Marketing costs jumped 63% sequentially in Q1 after a 25% decline in Q4. Even on a year-over-year basis, the growth of its marketing doesn’t fit a discernable pattern. On top of that, the returns on that investment are diminishing. Blue Apron’s revenue grew just 42% last quarter and for every dollar it spent on marketing, it notched $4.04 in revenue, the lowest return of any quarter in its history and $2 less than the previous average.

Declining ROI would be digestible if it were temporary. Blue Apron runs a no-commitment subscription service, so high upfront marketing costs to land customers with large lifetime value is part of its model. The company claims that 92% of Q1 revenue came from repeat orders. But it’s not clear how many of those already are, or will continue to be, regular clients. It’s also not clear whether Blue Apron faces rising retention costs or rising acquisition costs, or both. Any way you slice it, Blue Apron could struggle to build the kind of predictable business that won’t give investors heartburn.

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Will the ‘Appian way’ lead more startups to Wall Street?

Brenon Daly

Contact: Brenon Daly

With Appian’s debut on the Nasdaq earlier this week, the tech IPO market has hit an early summer vacation. Right now, there are no tech companies on file, at least not publicly. So with no offerings (officially) to look ahead to, it’s worth taking a look back on what we’ve already seen from recent new listings.

The first impression is that there aren’t very many of them. By our count, just five enterprise tech vendors have made it public so far this year. Further, the pace for the remainder of 2017 isn’t expected to accelerate. Respondents to a recent survey from 451 Research and law firm Morrison & Foerster predicted just 15 tech IPOs this year. (451 Research subscribers can see our full report on the current IPO market, as well as a few of the firms that we think could be in Wall Street’s ‘class of 2017.’)

But to even hit that number of IPOs, we might suggest that Wall Street look to more companies like Appian rather than the other four tech vendors that also made it public this year. (See our full report on Appian’s offering.) What we mean by that is Appian is far more representative of the broader startup universe than high-profile unicorns such as Okta, Alteryx, MuleSoft or Cloudera. Certainly, more startups can relate to Appian’s capital structure than any of the other recent debutants. Appian raised just $48m as a private company, compared with $163m for Alteryx, $220m for Okta, $259m for MuleSoft and more than $1bn for Cloudera. In fact, all four of the unicorn IPOs raised more in a single round of private-market funding than Appian did in total VC funding.

Not having done an IPO-sized funding in the private market meant that Appian could come public with a more modest raise. (It took in just $75m, compared with this year’s previous IPOs that raised, on average, $190m for the four unicorns.) And, probably most importantly, the Appian offering showed that these types of IPOs can work, both for issuers and investors. (Appian created about $900m of market value, and saw its shares finish the first day of trading up about 25%.) So when it comes to IPOs for the second half of this year, the ‘Appian way’ could help a lot more startups make it to Wall Street.

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

The dried-up startup exit

Brenon Daly

Contact: Brenon Daly

The quintessential Silicon Valley deal is drying up. Sales of VC-backed tech startups, which once provided a steady flow of money to entrepreneurs and their backers, are down sharply so far this year, compared with recent years. And while the impact of the narrowing of that exit will be primarily felt along Sand Hill Road, the cause of the slump traces back to Wall Street.

So far this year, just 235 VC-backed tech companies have sold, according to 451 Research’s M&A KnowledgeBase. That paltry level represents the fewest startups sold in the first five and a half months of any year since 2010, even as the overall tech M&A market has broadened and increased the current number of total tech transactions by nearly 15% since the start of the current decade. Year to date, M&A volume for VC-backed vendors is running 13% lower than the average number of deals over the past five years, according to the M&A KnowledgeBase.

The sharp decline in exits comes as the ranks of the startups are swelling, with thousands of businesses receiving venture investment each year. So if the slowdown isn’t coming from the supply side, that leaves only the demand side. And indeed, we can narrow the cause of the recent slump to one particular set of startup buyers: US public companies.

For the first half of the current decade, according to the M&A KnowledgeBase, NYSE- and Nasdaq-listed vendors accounted for more than 40% of the purchases of VC-backed companies. In some years, that approached nearly half of the transactions. So far this year, the tech industry’s big fish have gobbled up the minnows in only slightly more than one-third of the deals. If the classic startup-sells-to-tech-giant transaction isn’t playing out as often as it once did, that’s primarily because many of the tech industry’s one-time biggest buyers have themselves been bought.

Some behemoths have been consolidated by fellow behemoths, with the net effect that the combined entity – perhaps still struggling with integrating a business that does hundreds of millions of dollars, or even billions of dollars, of revenue – doesn’t have the capacity to do anywhere near as many deals as the two stand-alone companies did. Consider the relative M&A rates for Dell and EMC on both sides of that blockbuster pairing. In other cases, tech giants have gone private, with buyout shops that tend to focus on financially optimizing existing businesses, rather than trying to bump up revenue growth through potentially costly acquisitions of shiny new startups. For instance, BMC has done only three purchases since its leveraged buyout four years ago, down from an average of four acquisitions in each of the three years leading up to its take-private.

Source: 451 Research’s M&A KnowledgeBase

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The unicorn trend looks ready to Snap 

Scott Denne

Contact: Scott Denne A debacle of a first earnings report sent Snap shares down 20% this week, making the mobile app company the latest high-value startup whose private investors are taking a haircut. Silicon Valley spent the past few years building an unprecedented number of alpha startups. Now that they’re delivering beta exits, the funding that propelled their rise is drying up.

Snap’s last private round carried a valuation of $25bn, compared with its $21bn market cap today. Cloudera’s public debut valued it just beyond half of the $4.1bn that Intel assigned to the company in a 2014 investment. On the M&A front, storage provider SimpliVity came up shy of its $1bn-plus private valuation in a $650m sale to HPE; and Turn, an ad-tech vendor that reached near-unicorn status with a $750m valuation, sold to Singtel for $310m. All of those outcomes should be the envy of investors in LivingSocial, which literally gave itself away to daily-deals rival Groupon last fall.

That’s not to say there haven’t been any positive returns this year from heavily funded and highly valued venture-backed firms. AppDynamics’ investors came out ahead when Cisco paid $3.7bn for the company and with its $2.8bn market cap, MuleSoft has held up as a public entity, as have Okta and The Trade Desk.

Nonetheless, some of the newest and largest late-stage venture investors are scaling back as they find that the returns aren’t making up for the lack of liquidity in startup investing. T. Rowe Price, a backer of Snap and LivingSocial, has only announced one new investment in a private tech vendor this year. That’s the same number that BlackRock and Fidelity Investments, which both invested in Turn’s last round, have made so far. Investors that believe in unicorns are becoming as hard to find as the mythical beast itself.

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

Tech’s ‘usual suspects’ are back in the market for startups

Brenon Daly

Contact: Brenon Daly

After a prolonged period of restructuring and refocusing their own businesses, tech bellwethers are once again in the market for startups. Many of the industry’s biggest names are putting their record levels of cash and record-priced equity to work as they return to paying significant valuations for largely unproven companies. This year’s return of the recently rejuvenated ‘usual suspects’ of tech M&A comes after a few years when the big names were somewhat overshadowed by unconventional buyers rolling the dice on technology vendors.

For instance, the list for 451 Research’s M&A KnowledgeBase of who has printed significant acquisitions of VC-backed companies this year includes Cisco, CA Technologies and Hewlett Packard Enterprise. In 2017, there aren’t buyers like General Motors, as there was in 2016, or Delivery Hero, as there was in 2015. To generalize broadly, we might suggest that the driver in the startup M&A market has swung from fear to greed. What we mean by that is several of the 2015-16 big VC exits appear to be motivated by fear, specifically – as kids these days say – fear of missing out. The threat of being disrupted by technology appears to have driven earlier transactions such as Unilever’s $1bn purchase of Dollar Shave Club last July and old-line Ritchie Bros. Auctioneers’ $759m pickup of online platform provider IronPlanet last August.

This year’s resurgence of the well-known tech giants, which have both the means and the need to acquire faster-growing startups, has helped boost the number of significant VC exits in 2017 to almost as many transactions as the same period of the two previous years combined. According to the M&A KnowledgeBase, buyers so far this year have announced six deals valued at more than $500m. (That total includes transactions for which 451 Research has a proprietary estimate of the unannounced terms.) For comparison, the same period in 2016 and 2015 produced a total of just seven VC exits valued at more than a half-billion dollars.

Probably no group is happier to see renewed demand from these tried-and-true acquirers of startups than the main supplier of startups, Silicon Valley. VCs overwhelmingly rely on sales of their portfolio companies to generate returns and, thus, keep their firms in business. The acceleration in the pace of big deals for startups is helping to offset a rather lackluster IPO market, which offers the other exit for their portfolio companies. Not that many startups are taking that exit, as we detailed in our special report on the fertile, but barren, tech IPO landscape.

No ray of sunshine from Cloudera IPO

Brenon Daly

Contact: Brenon Daly

As far as Wall Street is concerned, the outlook for the tech IPO market is still cloudy after Cloudera’s offering. Sure, the data analytics platform vendor priced shares higher than its underwriters expected and investors pushed the freshly minted stock about 20% higher in aftermarket trading on Friday. But that solid start isn’t likely to necessarily draw other startups to the public market because Cloudera’s capital structure got so uniquely inflated.

Few startups could even imagine – much less collect – an investment of three-quarters of a billion dollars from a single investor in a single round, as Cloudera did from Intel three years ago. The chipmaker paid up for the privilege, putting a ‘quadra unicorn’ valuation of $4.1bn on Cloudera. Altogether, Cloudera raised more than $1bn from private market investors, making the $225m raised from public market investors seem almost like lunch money.

And then there’s the small matter of valuation. In its debut, Cloudera is only worth about half of what Intel thought it was worth when it made its bet. (As we noted in our full preview of Cloudera’s IPO, Intel’s investment appears even more bubbly when we consider that, at the time, Cloudera was generating less than half the quarterly revenue it currently puts up and its operating loss actually topped its revenue.)

As a longtime corporate investor, Intel can chalk up the overpayment for the stake of Cloudera to ‘strategic’ considerations. (Much like the chipmaker effectively wrote off its massive bet on security, unwinding half of its underperforming acquisition of McAfee at roughly half the valuation it initially paid in the largest infosec transaction in history, according to 451 Research’s M&A KnowledgeBase.) Besides, Intel can afford it: the day that Cloudera priced its IPO – thus confirming Intel’s overpayment – the chipmaker reported that it earned $3bn in the first quarter of this year alone.

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Okta’s growth-story IPO finds an audience on Wall Street

Brenon Daly

Contact: Brenon Daly 

The unicorn parade on Wall Street continued Friday as security vendor Okta nearly doubled its private market valuation in its debut on the Nasdaq. The subscription-based identity and access management provider initially sold shares at $17 each, but investors bid them to about $24 in midday trading. With the surge, Okta is valued at some $2.4bn. (See our full preview of the offering.)

Okta becomes the third enterprise IT startup to come public so far this year, and it extends the strong performance of these new issues. It also joins the two previous IPOs – MuleSoft and Alteryx – in sporting a rather stretched valuation. Based on a market cap of $2.4bn, Okta is trading at about 15x trailing sales.

Granted, Okta’s sales are growing quickly, having nearly quadrupled in just the past two fiscal years to $160m. Still, the company is commanding quite a premium compared with fellow secure identity specialist CyberArk, which also just happens to be the last information security startup to create more than $1bn of value in its IPO. (To be clear, CyberArk, which went public in 2014, also sells identity-related products in the form of privileged identity management, but doesn’t really compete with Okta.)

Wall Street currently values CyberArk at about 8.2x trailing sales, or just slightly more than half the level that investors are handing to the freshly public Okta. Bulls would argue that Okta merits the premium given that it is growing twice as fast as CyberArk. But others might counter with a question about what that growth is costing each of the companies. Okta lost a mountainous $83m on its way to generating $160m in sales last year. In contrast, CyberArk, which has run in the black for the past four years, netted $28m from its 2016 revenue of $217m.

If nothing else, the valuation discrepancy underscores that growth is still the key metric for investors. Okta’s IPO is simply supply meeting demand, same as it ever was on Wall Street. Indeed, CyberArk has also experienced that. Shares of the company reached an all-time high – nearly 50% higher than current levels, roughly Okta’s current valuation – in 2015, when revenue was increasing north of 50%, compared with the mid-30% level now.

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

An earthbound IPO for Cloudera

Brenon Daly

Contact: Brenon Daly 

Looking to extend the current bull run for enterprise software IPOs, Cloudera has taken the wraps off its prospectus and put itself on track to hit Wall Street in about a month. Assuming the debut follows that schedule, the heavily funded Hadoop vendor would be the third infrastructure software provider to come public in six weeks, following MuleSoft and Alteryx. Unlike the debuts of those two other software firms, however, Cloudera’s IPO will almost certainly be a down round.

Three years ago, when Cloudera’s quarterly revenue was less than half its current level, Intel acquired 22% of the company at a valuation of $4.1bn. Since then, both the company and other equity holders agreed that ‘quadra-unicorn’ valuation got a little ahead of itself and have priced Cloudera shares below Intel’s level of just less than $31 each. (In contrast, MuleSoft has more than doubled its final private market valuation on Wall Street.) Cloudera – along with its nine underwriters, led by Morgan Stanley, J.P. Morgan Securities and Allen & Co – should set the inaugural public market price for shares in about a month.

Because Wall Street likes to use a ‘known’ to help assign value to an ‘unknown,’ investors will look at Cloudera’s future trading valuation relative to the current trading valuation of fellow Hadoop provider Hortonworks. However, that comparison won’t particularly help Cloudera get any closer to its previous platinum valuation. Hortonworks currently has a market capitalization of just $650m, or 3.5x its 2016 revenue and 2.7x its forecast revenue for 2017.

The two Hadoop-focused companies actually line up fairly closely with one another, financially. Cloudera and Hortonworks hemorrhage money, largely because of huge outlays on sales and marketing. (Both firms spend roughly twice as much on sales and marketing as they do on R&D.) Cloudera is nearly one-third bigger than Hortonworks, recording $261m in sales in its most recent fiscal year compared with $184m for Hortonworks. Both are growing at about 50%.

Within that revenue, both Cloudera and Hortonworks wrap a not-insignificant amount of professional services around their product, which weighs on their margins and, consequently, their valuations. Both are consciously shifting their revenue mix. Cloudera is further along in moving toward a ‘product’ company, with professional services accounting for 23% of revenue in its latest fiscal year compared with 32% for Hortonworks. That progress is also reflected in the fact that Cloudera’s gross margins are several percentage points higher than those at Hortonworks, although both are still low compared with pure software providers. (For instance, MuleSoft, which also has a professional services component, has gross margins in the mid-70% range, about seven percentage points higher than Cloudera.)

With its larger size and more-efficient model, Cloudera will undoubtedly command a premium to Hortonworks. (That will come as a relief to Cloudera because if Wall Street simply valued the company at the same multiple of trailing sales it gives Hortonworks, Cloudera wouldn’t even be a unicorn.) We’re pretty sure Cloudera will come to market with a ‘three-comma’ valuation, but it won’t be near the $4bn valuation Intel slapped on it. Perhaps Cloudera can grow into that one day, but it certainly won’t start out there.