Denver-based email software company SendGrid recently revealed details about its upcoming IPO in an amended S-1 filing. In the offering, SendGrid plans to list 7.7 million shares on the NYSE at a price as low as $13.50 and as high as $15.50 per share. In total, the company hopes to raise over $100 million in working capital. An IPO at $14.50, the mid-point of the anticipated price range, would peg the company’s implied valuation at over $700 million – more than 20% higher than the company’s most recent private valuation of $582 million in November 2016. This is good news for existing investors, including Founders Fund, Bain Capital, and Bessemer Venture Partners. But, this also raises two basic questions: Is SendGrid an attractive investment for new investors as well? And, what does this IPO tell us about the state of the IPO market in general?
Expect More Enterprise SaaS IPOs
Heading into 2017, our year-end 2016 Investor Sentiment Survey highlighted a clear bias among investors for Enterprise Software companies. The majority of the 600 accredited investors in our survey liked the long-term prospects of Enterprise Software companies as a group. SendGrid will be the ninth after AppDynamics, MuleSoft, Alteryx, Okta, Cloudera, Yext, Appian, and MongoDB. We continue to see an affinity for Enterprise Software companies heading into 2018. While large, successful consumer-oriented unicorns continue to get the bulk of media attention, the less glamorous Enterprise Software companies remain the unsung heroes of the Private Tech Growth asset class. Year to date, these IPOs have provided encouraging signs that other such cloud workhorses will deliver returns over the longer-term.
Why Invest in SendGrid Now? SendGrid was founded in 2009 to solve the problem that developers had with managing email delivery. The company built a robust API in which developers could, in minutes, integrate their email and deliverability platform into any application. Two key points: 1) SendGrid operates within a large and growing market. While companies may be switching to messaging services for internal communications (e.g. Slack, Skype), email remains a critical medium for businesses to interact with their customers for things such as purchase receipts, shipping notifications, account information, social media updates, reservations, etc.; and 2) SendGrid has moderate top-line growth but profitable cash flows. SendGrid enjoys high gross margins – over 70%. Like many successful SaaS companies, the company has also attained profitability on an adjusted net income basis. Additionally, SendGrid has been producing positive operating cash flow since 2015. Overall, these financials are healthy and a step ahead of the majority of pre-IPO software companies. These metrics will also likely appeal to investors in the public market and protect the company from some of the speculative volatility associated with some recent IPOs, such as Snap.
Finally, SendGrid has A-list VC backers and remains a potential acquisition candidate. From a valuation standpoint, assuming a reasonable 30% growth in top-line over the next 12 months, Sendgrid’s IPO valuation implies a 6.5x to 7.5x EV/Revenue multiple, a reasonable valuation for a profitable small-cap SaaS company.
What about SendGrid has us worried? The first concern is SendGrid’s size. As one of the smallest software companies to go public this year, SendGrid is less mature than peers such as Tintri and Cloudera when they went public. This is likely to increase its sensitivity to fluctuations in the market and inhibit its ability to weather headwinds in the short-term. Furthermore, the company will likely feel the burden associated with its transition to operating as a public company more heavily than more developed businesses.
Adding to these concerns is the company’s modest revenue growth rate. At 36% year-over-year for 2016, it lags behind the high expectations investors often have for young growth companies. To improve its fortunes, SendGrid should strive to increase revenue growth rates while maintaining its high gross margins.
Another factor that makes us marginally more concerned about SendGrid is the replicability of its software offerings and business model. Unlike other Enterprise Software companies, SendGrid has an extremely limited IP portfolio. As a result, its flagship offering, SendGrid API, can largely be reproduced by others. This liability, coupled with the fact that email solutions present relatively low switching costs for customers, means that SendGrid is more vulnerable to copycat competitors than other Enterprise Software offerings.
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