Pando

A bunch of cloud companies you've never heard of are reviving the tech IPO market

By Kevin Kelleher , written on June 4, 2018

From The IPOs Desk

You may or may not have heard of Zuora, but it's emerging as the poster child for the 2018 tech IPO market.

Tech IPOs are having their best first-half in several years, and it's largely thanks to companies like Zuora – enterprise-cloud companies with little brand-name recognition among consumers but a steady stream of recurring revenue, an impressive growth rate, and the kind of path to profitability that has eluded many recent consumer-tech IPOs like Snap and Blue Apron.

Like those companies, Zuora isn't yet profitable. It reported an operating loss of $46 million in its fiscal year ended Jan. 31, although the loss as a percentage of revenue has declined to 28% from 52% a year ago. Meanwhile, revenue growth has been accelerating: to 49% last fiscal year from 23% in the previous year. In the last quarter alone, revenue grew by 60% year over year.

Moreso Snap and Blue Apron, it's somewhat easy to imagine Zuora becoming profitable in coming years. Nearly three-fourths of the company's revenue comes from subscriptions to its cloud-based service (the rest mostly comes from training new clients). And a key reason for its accelerating growth is that Zuora subscribers are companies that themselves are hoping to transition to subscription business models. Zuora's platform helps them get there.

The tech market is, after three sluggish years, making a modest comeback. Through the first five months of 2018, 77 companies have raised $24.2 billion. Barring any major shocks in the second half of the year, that puts it on pace to be the best year for IPO proceeds since 2014, when 275 companies raised $85.3 billion.

The technology sector has emerged as a leader, not just in successful IPOs, but in post-offering performance. According to IPOScoop, 18 of the IPOs that have listed so far this year are in the technology sector, 14 of them coming since mid-March. Of those 14, 10 are companies that mostly or entirely rely on subscriptions for revenue. Those 10 are trading between 22% and 142% above their offering prices.

During the past year, nearly every tech IPO that has managed to land in public waters has been well received by investors, a contrast to the general trend of the previous several years. According to the New York Stock Exchange, of the 35 tech companies that went public in the past year on U.S. stock exchanges, 33 are trading at or above their offering prices.

The recovery in tech IPOs took root last fall with the successful IPOs of Roku, which has seen its shares rise 165% above its $14 a share offering price. StitchFix followed with a more modest success – share are trading 27% above the $15 a share offering price. After a market selloff threatened to derail the nascent recovery in February, enterprise-cloud plays like Dropbox and Zscale emerged with their own IPOs. Their stocks are trading 41% and 76%, respectively, above their offering prices.

A number of others have since followed, each with a post-IPO performance that is more eye-catching than their brand names are. Smartsheet (cloud collaboration) is trading 75% above its offering price, Docusign (digital signatures) is 72% higher, Ceridian (cloud HR platform) 57% higher. HUYA, a Chinese live-gaming sight that relies heavily on subscriptions, is up 133%.

For its part, Zuora has risen 89% since its IPO, having somehow anticipated this trend toward cloud subscriptions before most others – and then created a meta business model of a subscription service that builds subscriptions services. Its prospectus says it foresaw a decade ago what the company calls a “subscription economy” in which companies transition from selling products as units to a pay-as-you-go model.

For at least the last hundred years, companies have operated primarily under a product-centric business model, where the goal was to make, ship, and sell more units—more cars, more clothes, more computers.... Ten years ago... we foresaw a new business landscape in which traditional product or service companies shift toward subscription business models. Our vision redefines subscriptions in a broader context than a simple monthly fee.

That broader vision encompasses things like upselling and add ons that extend a customer transaction beyond a one-time purchase. Even most of the giants dominating Silicon Valley have gravitated towards this kind of subscription model. Amazon was the first with Prime in 2005, fearing that shipping costs would place an early ceiling on its growth curve. Apple moved into subscriptions, which have helped Services to become its second largest product category, growing 38% last quarter (or more than twice the iPhone's growth rate). Netflix has been pure subscriptions all along.

Google and Facebook, by contrast have either been slow to move into subscriptions or avoided them entirely, favoring ad revenue instead. Not only have Google and Facebook struggled more with privacy and data-collection issues, their stocks have lagged those of Apple, Amazon, and Netflix over the past two years.

In coming weeks, more tech companies are expected to enter the IPO market, many of them offering cloud services through a subscriptions model: Adaptive Insights, which makes business planning software; Avalara, which focuses on tax compliance; and Domo, which filed for an IPO for its business-intelligence platform on Friday.

Still absent from the IPO pipeline are many of the brand-name companies like Airbnb and Uber, which for several years now have been kicking the IPO can down the road. Their lesser-known brethren toiling in the cloud have been braving the public markets instead. If the tech IPO markets recover this year, it won't be a Netscape or a Google that ignites it, but a bunch of little Zuoras.