Zendesk v. Box: The downward pressure on enterprise IPOs was actually one VC's gain

By Michael Carney , written on July 10, 2014

From The News Desk

Normally public and private market investors are two very different beasts. Recently, though, traditional public investors like hedge funds and mutual funds have been moving further downstream to make large bets into growth stage private companies amid a search for both returns and market intelligence.

So who's to say that things couldn't go the other way too?

One largely overlooked recent example of such a situation occurred as part of Zendesk’s May IPO. Traditional growth stage VC firm Institutional Venture Partners (IVP) made its its first ever investment into the SaaS help-desk company as part of its initial public offering.

To understand why the firm departed from its usual playbook, it’s essential to understand the market environment in which this deal took place. I caught up with IVP's Jules Maltz recently and asked him about that very deal. He told me:

We’re looking for the fastest growing, later-stage technology companies and are indifferent to whether they are private or public. The Zendesk IPO was attractively priced and allowed us to back an exceptional company. Typically, private companies trade at a discount to public comparables – but in this market we are seeing the opposite.
Zendesk had the bad fortune of timing its IPO with a dramatic correction on Wall Street in the revenue multiples granted to enterprise SaaS companies, a change that saw category darlings like Salesforce and Workday hand over large chunks of market cap flesh overnight. At the time, private market SaaS valuations were still heady -- but the expectation was they too would soon fall back to earth.

This environment combined to mean that, in IVP’s eyes, the Zendesk IPO was the best deal going in the enterprise SaaS category, regardless of stage.

Maltz wrote in a blog post at the time:

Although it never worked out for us to invest in the company privately, we were able to purchase a significant position in the company’s IPO a few weeks ago. Ever since IVP started in 1980, we’ve been able to invest a meaningful amount of our fund in select public stocks – and have executed on this strategy particularly in times when public market valuations have been below valuations in the private market. We believe we are now in one of those times and were thrilled to establish a long-term position in a company that we’ve always admired.
VCs that get into hot companies late in the game routinely get lambasted as logo hunters, a critique that implies being associated with the deal is more important for optics reasons than the underlying return the firm is able to earn for its LPs. In the overwhelming majority of cases this is a fair characterization, but in the case of IVP's Zendesk deal it's anything but -- at least if you buy into Maltz's assessment of the company and its terms.

He writes in the same blog post, “Given some of the recent changes in public market valuations, we believe companies will need to exhibit both strong revenue growth and cash efficiency to achieve premium valuations – and Zendesk exemplifies both of these characteristics.”

Best of all, as an IPO investor, the firm wasn't subject to any of the traditional insider lock up provisions that come in growth companies ahead of their IPO.

So, it bears asking, does IVP's thesis hold water?

Zendesk's stock is up more than 78 percent in its first seven weeks, closing trading yesterday at $16.05 (down 2.1 percent on the day). After pricing its IPO at $9 per share, the company opened trading on May 15 at more than $13 per share and traded as high as $18.49 within the first month. It would seem that IVP’s confidence in the company is being rewarded by Wall Street. That said, Zendesk has yet to post its first quarterly earnings as a public company so we’ll see if it can live up to the early excitement.

As for how IVP looks at this investment going forward, Maltz tells me, “We're long term holders and generally look for a 3- to 5-times return over 3- to 5 years in all of our private and public investments." He later added, "We're looking at high growth companies, we're not buying Apple and Google.”

So, should Zendesk start knocking on $30 per share – a value that will give it nearly a $2.2 billion market cap – we may see IVP reevaluate its position. Then again, should that be the case in the next three years, we might see a major uptick in traditional private market investors taking a closer look at buying into future tech IPOs.