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:
- 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.
- 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.
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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