1) To those who think sell-side analysts don't play a role in the investment banking process, it's interesting that Jason Maynard's firm got the lead. Maynard has been way out in front of the SaaS world, including publishing a meaty research primer on the sector which has long been a prerequisite for firms that want to prove their mettle and expertise in a given space.
2) The selection of WR Hambrecht is a coup and undoubtedly relates to their expertise handling the Google auction. You see, NetSuite is taking a page out of Google and will hold an auction instead of the traditional IPO listing most are familiar with.
As you can imagine, this long-awaited offering garnered a ton of press in the last few days. Many of the mainstream stories are fixated on Larry Ellison's majority stake, yet few that I've seen have bothered to articulate why that's of any consequence.
Dissecting Ellison's Majority Stake
I was well aware of the fact Ellison and his family owned a majority position in the company, but even I was surprised at the magnitude of his position. As of March 31st, Larry Ellison and related parties owned 74.1% of the company:
- Larry Ellison -- 649mm shares (61.1%)
- Trustee for David Eillson (Larry's son) -- 69mm shares (6.5%)
- Trustee for Margaret Ellison (Larry's daughter) -- 69mm shares (6.5%)
Why does this matter?
- Post IPO, Ellison will retain majority control. As a result, public shareholders will not have a material say in the governance of the company. Larry will still be able to make quasi-unilateral decisions and is under no obligation to create a truly independent board of directors. From the S-1:
- As a result, Mr. Ellison and entities with which he is affiliated will be able to exercise control over most matters requiring approval by our stockholders, including:
• the election of directors;
• amending our Certificate of Incorporation;
• approval of significant corporate transactions, including a change of control;
• executive and director compensation plans, including equity compensation plans;
• issuing additional shares of capital stock; or
• commencing a liquidation.
- As a result, Mr. Ellison and entities with which he is affiliated will be able to exercise control over most matters requiring approval by our stockholders, including:
- While not a certainty, historically companies have been afforded a lower valuation than their comparable peers when they are captive
- The ties to Oracle, itself with grand designs on the On Demand software market, will be hard to ignore as a real risk factor as long as Larry has controlling interest (imagine if you will Larry deciding to sell a major piece of the company in a privately negotiated transaction to Oracle, for example)
Nuggets from the S-1
- One Data Center -- I was surprised to learn that NetSuite currently operates its entire business out of one 3rd part data center in California. We host our services and serve all of our customers from a single third-party data center facility located in California. We do not control the operation of this facility. [cont]...[cont] We do not currently operate or maintain a backup data center for any of our services or for any of our customers’ data, which increases our vulnerability to interruptions or delays in our service. They have no redundancy which astounds me when you consider the company has 5,300 customers and $67mm in 2006 revenues and runs a utility computing model
- Staged Releases -- Unlike other SaaS companies that deploy major new releases to all customers at once, we roll out all major releases and many upgrades of our application suite to a portion of our customer base at any one time. This “phased release process” is designed to allow us to mitigate the impact of major changes and new releases, ensuring that any potential issues affect only a portion of our customers before they are addressed. Quite the contrast from SfDC, which prides itself on simultaneous release cycles.
- Principal Competitors List -- It's always fun to see who a company lists as its principal competitors. Lest you think this is a random sampling, I can assure you that every admission and omission is carefully calculated. So who does NetSuite list as its competition? Our principal competitors include Epicor Software Corporation, Intuit Inc., Microsoft Corporation, SAP, The Sage Group plc and salesforce.com, inc. The omission of Oracle is amusing and inaccurate (if SAP is a competitor, so too is Oracle). I give the company credit for listing Intuit, which I maintain is their most direct competition. Of course, NetSuite and the investment community are more likely going to compare the company to Salesforce, for obvious reasons.
The Inevitable Comparisons to Salesforce.com
Back in March of last year, I profiled NetSuite and handicapped its potential IPO, comparing it to salesforce.com. I'm pleased to see that many of my suppositions have proven accurate. Regardless of whether NetSuite and salesforce are really competing for deals (they don't very often), it's inevitable that from here on out, the two companies will be compared and contrasted against one another by the investment community. Many investors have been waiting for another pure-play SaaS vendor to hit the market, and now we're finally going to get what we asked for.
- Revenues at time of filing -- NetSuite reported 2006 revenues of $67.2mm, representing 85% year-over-year growth. March '07 results were $23.2mm, representing 72% growth. Compare that to Salesforce's numbers in 2004 when it files its S-1. It was coming off a $96mm year representing 88% growth. Don't underestimate the importance of NetSuite's June quarter results (which we will see in a subsequent S-1 amendment I'm sure). Although the company is growing incredibly fast, Q1 hinted at deceleration and investors will want to see that June results don't show further deceleration.
- Net profitability at the time of filing -- NetSuite is decidedly unprofitable. The company posted a 16% operating loss margin in March, and a 34% loss margin in 2006; compared to Salesforce.com's 3.9% operating profit margin.
- Current metrics -- It's hard to ignore the disparity in size between the two companies.
- 2006 Revenues: SfDC -- $497mm (60% YOY) vs. NetSuite -- $67mm (85% YOY)
- 4Q Annual Run Rate (As of most recent Q): SfDC -- $648mm vs. NetSuite -- $93mm
- Customers: SfDC -- 32,300 vs. NetSuite -- 5,300
The size disparity is particularly interesting when you consider that NetSuite was founded in 1998 versus salesforce.com, which was founded in 1999.The fact that Marc Benioff's firm has been able to grow to be 7x larger over a similar time span raises broad questions:
- Does being a publicly traded company make that much of a difference? NetSuite will argue as much, and certainly the ability to compensate talent with stock options and restricted stock grants is a factor in driving a growth company, but by itself this wouldn't seem to argue for the size disparity
- Is this evidence of the more entrenched nature of on premise back office ERP functionality? Does the fact that NetSuite is 7x smaller than SfDC indicate demand for back-office SaaS pales in comparison to front-office SaaS? In aggregate, back-office ERP is several orders of magnitude larger than front-office SFA, yet uptake of SaaS appears far less pervasive.
- Is the size disparity an indication of customer size? According to NetSuite's filing, they target the SMB channel, defined as companies with up to 1,000 employees. While that's an important part of SfDC's market, as well, they have been successful winning deals in larger enterprises, too. Does NetSuite need to prove an ability to scale in order to close the revenue gap?
Important metrics we've yet to be provided with:
There are variables to the NetSuite equation that we've not yet been provided with. I'm sure they will fill in the blanks in subsequent S-1 amendments, and will do the obligatory IPO deal roadshow when the time is right. In the meantime, here are a list of metrics that I would like to see from the company:
- Net new customer additions
- Net subscribers (we know they have 5,300 customers, but how many users?)
- Average revenue per customer (either annualized or quarterly)
- Pricing (e.g., per module? incremental pricing for platform? higher pricing for better SLAs?)
- Average contract length (the company has said it's been focusing more on 1-year deals of late)
What's NetSuite Worth?
I won't presume to tell you what NetSuite will, or should be worth at IPO. We have no idea what overall market conditions will be like at listing, what the institutional demand will be, how the auction process will alter the IPO pricing, or what NetSuite's forward-looking guidance will be. For the sake of comparison, here are a sampling of enterprise value/revenue estimates for publicly-traded SaaS companies, provided by Brent Thill's team at Citigroup:
- Concur (CNQR): $860mm market cap, 6.8x '07E revenues, 5.3x '08E revenues
- Salesforce.com (CRM): $5.0b market cap, 6.3x '07E revenues, 4.6x '08E revenues
- Omniture (OMTR): $1.1b market cap, 7.6x '07E revenues, 5.1x '08E revenues
- RightNow (RNOW): $540mm market cap, 3.9x '07E revenues, 2.9x '08E revenues
- Ultimate (ULTI): $725mm market cap, 4.5x '07E revenues, 3.8x '08E revenues
- Average '07E revenue multiple: 5.8x
- Average '08E revenue multiple: 4.3x
Remember, NetSuite is an entirely different company with a different growth rate (both historically and going forward), a different addressable market, and we have yet to see how NetSuite will approach margins and cash flow generation. Investors may opt to value NetSuite on entirely different metrics, and may also choose to assign a different multiple that lies outside the bounds of this theoretical analysis.
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