The Pure Storage IPO In Context

Pure Storage has been one of the hottest Silicon Valley enterprise startups for the past several years, sporting a world-class team and having raised capital from some of the top enterprise investors on the planet.

When the company filed its S-1, Pure’s historical top-line growth left many speechless. In the years ending January 2013, 2014 and 2015, the company grew from $6 million to $43 million to $174 million, respectively, topping the growth rates of prior enterprise speed demons such as Riverbed, DataDomain and GGV-backed stars such as Nimble Storage and Isilon.

Pure has maintained torrid growth this year, posting revenues of $159 million for the six months ended July 2015, versus $59 million in the year-earlier period. Despite this rapid growth, Pure’s IPO wasn’t meteoric. The company priced its IPO at $17 per share, the mid-point of its filing range, and traded down over 5 percent on its first day of trading, then fell a bit further on its second day before rallying at the end of the week to close at $16.60, still below its IPO price.

The company seems to be doing great, so why wasn’t there a big pop from the last private round and from the IPO? Does it matter? What lessons can we draw from this?

The Private Market “Winner’s Curse”

In mid-2012, Pure’s VCs plowed nearly $40 million into the company, at $3.77/share; and in mid-2013, investors put in another $172 million at $6.93/share. Versus the close price at the end of the first week, these deals represent a three-year multiple of 4.4x and a two-year multiple of 2.4x, which are respectable returns, given the durations. If these were Pure’s last private rounds, its pre-IPO funding history would look like countless other now-public tech companies.

But rather than IPO in 2014, the company raised a final private round, a whopping $225 million, in April 2014 at $15.73/share, or nearly flat to today’s current price. Investors in this round, including the likes of Wellington Management, T. Rowe Price and Tiger Global, obviously know the public market very well and were likely hoping for a greater IPO pop than they’ve gotten.

Part of the issue may be with how private deals are priced versus how public stocks tend to trade. As I’ve written before, financings in hot private companies are a scarce commodity — these companies rarely raise money. The investors who lined up for the April 2014 Pure round knew this would be their last chance to invest prior to an IPO.

Given the huge influx of capital into the pre-IPO asset class, fierce competition to be the winning bid can ensue in these situations, driving high prices. This may have helped drive up Pure’s last pre-IPO round.

IPO Fickleness: Does it Really Matter?

While financings in hot private companies can look like rare art auctions, with multiple would-be buyers driving up the price for the auction’s eventual winner, IPOs are priced very differently. A book of investors is built, with the IPO’s book-running underwriter(s) attempting to find a price that will attract meaningfully sized orders from deep-pocketed, respected and seemingly committed public investors.

Rather than the most excited investor with the highest willingness to pay setting the price, as would occur in a private-market round, in an IPO, the price is more likely set to appeal to less zealous investors, whose willingness to pay falls further down the curve (think of Econ 101’s supply and demand curves crossing at a market-clearing price).

Post-IPO trading action is very hard to predict. Underwriters will try to set the IPO price so that there is a price bump, usually 10-20 percent, in early trading to help reward IPO investors for taking the risk. But anticipating early trading in a stock like Pure can be very tenuous, even for the most experienced underwriters. Nowhere can you see the fear and greed pendulum swing more rapidly or violently to unexpected stimuli than in an IPO.

While I hear that Pure’s IPO order book was very solid, and the company conservatively opted to price its IPO in the middle of its initial filing range rather than at the high end or above, obviously public investors have behaved less aggressively than anticipated, with some of the larger IPO investors likely cycling out of the stock rapidly. Hence, the early drag on Pure’s stock price.

A company’s long-term stock-price trajectory has everything to do with results and almost nothing to do with initial public market perceptions.

While the press tends to obsess over the IPO and early trading patterns of companies like Pure, I believe early trading action doesn’t really matter. One has to look no further than the opposite cases of Facebook, which had a disastrous IPO but whose stock has since rocketed, and Twitter, which had a white-hot IPO and a very tough stock chart since, to recognize that a company’s long-term stock-price trajectory has everything to do with results and almost nothing to do with initial public market perceptions.

Pending Private Market Re-Set?

Although there have been many large and high-priced private financings like Pure’s April 2014 round over the past few years, IPOs of these unicorns have been few and far between. With data points like the Pure IPO, expect to see prices in private company rounds start to re-set. Signals from IPOs like Pure’s suggests that public-market pricing is being set by more traditional valuation metrics such as Price / Revenue.

Top public enterprise tech companies such as Workday, ServiceNow and Palo Alto Networks are all trading below 10x forward revenue. Public investors have these stocks as alternatives, so newly issued public companies are likely to be valued lower in this context.

Another possible driver should we see private valuations re-set will likely be underlying unicorn performance. As in Pure’s last round before IPO, public long-only and hedge fund investors have dominated many unicorn rounds. These investors need to mark their portfolio to market frequently.

With time-to-IPO elongating, one can assume many private unicorns eventually fall short of the aggressive plans they presented at the time of financing. As a result, I’m hearing of mark downs in the private portfolios of many of these investors.

Although late-stage financing rounds in hot private companies will still exhibit auction-like dynamics, dropping multiples of high-quality public comps and the sting of recent write-downs should conspire to lower the flame on the heat in these auctions.

Back to Pure. Let’s not forget that the company still has roughly a $3 billion valuation, a success by any measure. Although the company has posted healthy losses to date, public investors have a long history of trading high growth for profitability in IPOs, at least for a few years. Should Pure continue to grow fast and begin to show progress toward a path to profitability, the future is likely to look bright.