April 12, 2018 | Blog

Pivotal Software IPO: Successful Offering May Trigger More Open Source Software IPOs

Summary: Pivotal, the cloud software company spun out of Dell-EMC and VMware, plans to go public next week. At the high-end of its price range, Pivotal’s IPO would net $700 million at a $4 billion valuation. It would be the second largest IPO of 2018 behind Dropbox. (We excluded Spotify from this analysis because its IPO did not include any primary share sales.) Pivotal’s IPO could pave the way to a public offering from other Unicorns with open source software business models such as Docker and SugarCRM. Or, it could inspire SaaS firms such Palantir to also consider a large public offering.

Pivotal’s IPO is particularly noteworthy for two reasons:

  1. Litmus test for open source software: Pivotal’s IPO could validate that open source software can evolve from an innovative technology to a sustainable, successful business model valued by Wall Street. That could bode well for comparable software unicorns such as Docker and SugarCRM. We continue to believe that open source software technology is a crucial component of modern cloud infrastructure, and we expect to see more such open source software-based unicorns. Investors view Red Hat (which Pivotal most closely resembles) as one of the most successful open source software businesses. Over the past two years, Red Hat’s stock has more than doubled to $150 per share. On the flip side is Cloudera. Since going public in April 2017, Cloudera stock has dropped 30 percent after a 50 percent down-round IPO.
  2. Valuation test for SaaS-Services combo businesses: The Pivotal offering could also set a positive precedent for companies evolving from a pure services or consulting-based business model to a SaaS or subscription-based business. That could bode well for software unicorns such as Palantir.

Private Tech Valuations Continue To Rise In Public Markets: Recent IPO activity among VC-backed tech companies has been quite encouraging. Cybersecurity firm Zscaler upped its IPO at $16 per share after an initial range of $13 to $15 per share. Zscaler’s IPO was effectively valued at 99 percent above its most recent private funding round. Dropbox and Spotify have also enjoyed warm receptions on Wall Street. Pivotal’s proposed $4 billion valuation in the public markets (assuming the high-end of its IPO pricing range) would compare favorably to its $3.3 billion private valuation.

Because tech IPOs can serve as a key indicator of investor sentiment, the ongoing uptick in valuations as private companies seek public valuations is a promising sign for the more than 200 unicorns waiting to go public. We could very well see another wave of IPOs, as well as significant value creation for institutional and individuals investors and employee shareholders.

Including Pivotal, we’ve tracked 25 VC-backed tech IPOs over the past 24 months in the chart below. According to our data, 17 companies enjoyed IPOs that exceeded recent private valuations, while eight companies suffered down-round IPOs. Year to date, we haven’t had a down-round IPO.

Source: Google Finance; SharesPost Research; Spotify IPO valuation assumed at $28.5 billion; Pivotal IPO valuation assumed at $4.0 billion; Chart excludes Stitch Fix IPO which implied a 595 percent estimated premium.

Background: Rob Mee founded Pivotal in 1989 as a software consulting and services shop. The San Francisco company was acquired by EMC in 2012. By April 2013, it was spun out into a new business, Pivotal Software. The company has raised $1.7 billion in venture funding since 2013, including investments from General Electric, Ford, and Microsoft. Pivotal offers two ways to generate revenue: services and a “Pivotal Cloud Foundry” (PCF) for companies that want to build native cloud software using open source code. The PCF is essentially a platform that integrates all the components necessary to create software to run on both public and private clouds. This includes an operating system, security framework, networking engine, and data services. Companies pay Pivotal a subscription fee to access the PCF. This kind of business model is much more stable than services.

The Upside Scenario

Ongoing shift toward subscription revenues: In fiscal year 2015, more than two-thirds of Pivotal’s annual revenues came from services, compared to 34 percent for the PCF business. Today, PCF subscriptions make up 51 percent of its annual revenue.

Gross margin trending higher: Pivotal generated a 43.1 percent gross margin last year, a significant jump from 33.3 percent in fiscal 2015.

Big corporate backer: Dell continues to own 70 percent of Pivotal. Dell’s controlling ownership will likely mean lower volatility in share price.

The Downside Risk

A very crowded market: Competition includes large incumbents like Oracle, IBM, SAP, as well as an evolving list of niche players.

Child needs to grow up: Pivotal remains heavily dependent on Dell-EMC, VMware, and Dell Technologies. Pivotal initially received back-office and administrative services from DellEMC and VMware. Today, Pivotal relies on DellEMC and VMware to market and sell its products and services. We will wait and watch how Pivotal operates as an independent public company going forward.

Ongoing operating losses: Pivotal lost $168.3 million from operations last year. That’s a big number but still a significant improvement over fiscal year 2015, when it reported a $272.7 million operating loss.

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This report does not contain a complete analysis of every material fact regarding any issuer, industry, transaction, or security. The opinions expressed in this report reflect the judgment of the analyst at a specific point in time and are subject to change. The information contained in this report has been obtained from sources the analysts consider to be reliable; however, there is no guarantee the any of the information is accurate.

Securities referenced in this report may be offered by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions.

Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative, involving a high degree of risk, and investors should be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and investors should conduct their own, independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or investment advice.

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Alejandro Ortiz

Alejandro Ortiz

Alejandro is a Research Analyst, Private Investment Research for SharesPost Research LLC. Prior to joining SharesPost, he was a Valuation Analyst at Duff & Phelps with a focus on TMT industries.

PLEASE READ THESE IMPORTANT LEGAL NOTICES & DISCLOSURES

CONFLICTS

This report is distributed by SharesPost Financial Corporation, a member of FINRA/SIPC. SharesPost Research LLC, SharesPost Financial Corporation, and SP Investments Management, LLC, an investment adviser registered with the Securities and Exchange Commission, are wholly owned subsidiaries of SharesPost, Inc.

Recipients who are not market professionals or clients of SharesPost Financial Corporation should seek the advice of their own financial advisors before making any investment decisions. None of the information contained in this report represents an offer to buy or sell, or a solicitation of an offer to buy or sell, any security, and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation, or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation do not (1) advise any member on the merits or prudence of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax, or transactional advisory services.

ANALYST CERTIFICATION

The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about the subject matter therein, including all of the subject securities or issuers, and that no part of such analyst compensation was, is, or will be during their employ directly or indirectly related to their specific views contained in this report.

Analyst compensation is indirectly based upon the growth and success of SharesPost, Inc., including the overall performance of its subsidiaries, the individualized performance of any such analyst, and the development and progression of the overall research effort. SharesPost, Inc. earns revenue from, among other avenues, brokerage sales, and therefore the analyst may indirectly benefit from research reports that have the ultimate effect of increasing trading activity, either through SharesPost Financial Corporation and/or with SharesPost Investment Management, LLC.

DISCLAIMER

This report does not contain a complete analysis of every material fact regarding any issuer, industry, transaction, or security. The opinions expressed in this report reflect the judgment of the analyst at a specific point in time and are subject to change. The information contained in this report has been obtained from sources the analysts consider to be reliable; however, there is no guarantee the any of the information is accurate.

Securities referenced in this report may be offered by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions.

Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative, involving a high degree of risk, and investors should be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and investors should conduct their own, independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or investment advice.

Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment.

SharesPost, the SharesPost logo, My SharesPost, the SharesPost Index, and SharesPost Investment Management are all registered trademarks of SharesPost, Inc. All other trademarks are the property of their respective owners.

Copyright SharesPost, Inc. 2019. All rights reserved.