Zendesk’s Stellar IPO And The Current Tech IPO Climate

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Gillmor Gang Live 05.16.14

Following a nearly 50% pop on its first day of trading on Thursday, Zendesk is up double digits again today, rising more than 11% in midday trading. For tech companies and their investors, it’s a sign that the IPO window, recently worried to be either closed or rapidly closing, isn’t, for the right kind of company.

And investors are not as closed minded to the intricacies of cloud-based businesses and the fickle, long-odds nature of tech startup metrics, as some might have thought. “I’m impressed by the quality of the investors that we’ve met on our roadshow,” said Mikkel Svane, co-founder and CEO of Zendesk, in an interview after the company’s debut on the NYSE. “These are sophisticated investors and they understand what it means to invest in growth. The public market investment is as sophisticated as the private market investment.”

In case you missed the run-up to Zendesk’s offering, here are the brass tacks: Zendesk priced at $9 per share, in the middle of its expected (but lowered) range, bringing in $100 million. According to Google finance, after its gains, its market cap is nearing the $1 billion mark. Revenue expanded from $38.28 million in 2012, to $72.04 million in 2013. Most importantly, the company’s net loss declined from $24.15 million in 2012, to $21.83 million in 2013. So, as Zendesk grew its top line from 2012 to 2013, its net loss decreased.

That’s the key difference, looking at yearly data, between Zendesk and a few other companies — from a GAAP perspective — that are looking to go public.

Here’s Box’s two most recent years:

Fiscal year ending January 31st, 2013:

  • Revenue: $58.79 million
  • Net loss: $112.56 million

Fiscal year ending January 31st, 2014: 

  • Revenue: $124.19 million
  • Net loss: $168.55 million

And Good Technology’s most recent full calendar year periods:

2012:

  • Revenue: $116.60 million
  • Net loss: $90.43 million

2013:

  • Revenue: $160.38 million
  • Net loss: $118.43 million

As you can see in both cases, their losses are expanding quickly, staying stubbornly over revenue in the case of Box, or in the case of Good, falling from a high to mid 70s percentage of revenue.

Box and Zendesk are SaaS plays, and the most quickly growing component of Good Technology’s revenue is its “recurring” column, so they share much in common, even if each offers a different kind of enterprise-focused product.

There are two camps of people who look at the S-1s of SaaS companies: People who fret, and people who love the burn rate. A crop of non-GAAP financial metrics are useful to understand why normal accounting doesn’t do a great job at showing off future growth, and profits, of companies that spend heavily to acquire customers, and then earn revenues off that customer in regular intervals for the future.

These methods compare the cost to acquire a customer (CAC), with the average lifetime value of a customer (LTV). Conventional wisdom is that you want to have an average CAC that is no more than a third of your average customer LTV. Why? Because your CAC doesn’t take into account a host of costs that you will endure, and, of course, you want to have a net profit margin at some point.

How does this apply to the above? If you have up-front CAC costs, and LTV spread out over time, with a break-even period, of say, 12 months, you burn heavily in the short-term to buy annual recurring revenue (ARR) that will, provided your unit economics work out over the life of a customer, more than pay back those earlier expenses. So, in the case of Box, say, it’s willing to pay heavily for ARR up front, because it will continue to enjoy the fruits of those losses for quarters to come.

It’s a reasonable idea. Here’s the sticking point: In Box’s S-1, for example, here are the number of mentions of ARR, LTV, and CAC: 0, 0, 0. So, we’re discussing abstract accounting principles, with little in the way of handles to get our arms around Box’s performance in this regard.

Returning to Zendesk, its sales and marketing costs rose 65% from 2012, to 2013, while its revenue expanded 88% in the same period. Sales and marketing is Zendesk’s largest line-item cost, so this comparison, practically, allowed the company to reduce its net loss while quickly growing its top line.

While Zendesk’s financial performance did improve on a GAAP basis from 2012 to 2013, in its updated S-1, Zendesk’s first 2014 quarter showed a steeper loss than in its first 2013 quarter. Revenue grew from $13.91 million to $25.09 million on a year-over-year basis, while its net loss grew from $5.35 million to $10.20 million. Comparing single quarters is less compelling than comparing full years, but it seems that Zendesk isn’t afraid to pick up larger losses.

Speaking with Zendesk, the company seems to understand that a very careful approach to spending is the order of the day right now.

“We’re going to be prudent about spending our money,” Svane said. That means no more acquisitions for now — even though the company noted in its S-1 that it would be investing “aggressively” in its growth. “We have had long and organic development. The opportunity to acquire Zopim out of Singapore was a little love affair that we had a hard time ignoring… but we’re not in any acquisition considerations.”

A wrinkle from Zendesk’s S-1: “subscriptions to our customer service platform and live chat software are shorter than most comparable SaaS companies.” That could impact its expected CAC repayment periods, decreasing the short-term impact of its sales cycle, lowering its short-term net losses. A good thing? Not if shorter contracts lead to more customer churn at the expiration date, and thus less total gross profit per customer. But, again, we’re speculating.

To sum up, Box and Good’s financials look scary as heck from a GAAP perspective, while making more sense from a potential perspective. But in the case of Zendesk, it differs from its SaaS brethren because it has delivered a full-year period of revenue growth with a smaller recorded loss. That’s compelling. Its wider Q1 2014 loss could be indicative of a change in strategy, but proving that you can lose less while growing is worth something.

The above may help explain why Zendesk’s IPO has performed as well as it has, and why Box and Good may have a harder time convincing investors that yearly nine-figure GAAP losses are reasonable investments in future cash flows.

IMAGE BY FLICKR USER Antonio Morales García UNDER CC BY 2.0 LICENSE (IMAGE HAS BEEN CROPPED)