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Analyzing a Hot SaaS IPO: the Box.com S-1 Filing

April 16, 2014 Ho Nam 

When I heard that Box.com had filed for IPO, I was excited to look through their S-1 filing as the company could be the first big hit of a new generation of SaaS companies that are riding the “consumerization of IT” wave. SaaS companies such as Box.com, Dropbox, Evernote, Github and Hubspot look more like consumer software companies compared to companies like AthenaHealth, Conerstone, ExactTarget, SuccessFactors, Veeva and Workday that have professional services staff and account managers to help make customers successful. The first generation of enterprise SaaS companies had lower gross margins, higher ASPs and longer sales cycles compared to newer ones with more low-touch, high-velocity sales models.

In analyzing the financials, I also thought this was a good opportunity to revisit the series of blog posts I had been intending to write about the 40 enterprise SaaS companies that had gone public over the past 10 years (the first post which describes the analysis and database of SaaS companies is here).

By analyzing data from Box.com’s S-1 filing and comparing it to our SaaS IPO database, we will share some data/charts which may be useful for analyzing any SaaS company against the benchmarks set by the Top 40 SaaS IPOs from the prior decade.

Growth and Size

In looking through the S-1, the first metric that stood out was impressive growth at large scale. Even before filing, Box.com was already labeled a “unicorn” with a $100M round completed a few months ago. We expect this trend of larger IPOs to continue as the top VC-backed companies seem to be able to attract very large amounts of capital at increasingly higher valuations.

Box.com grew 111% and posted $124M in revenues in its most recent fiscal year. Two interesting facts stand out when Box.com is compared to other SaaS companies in our database:

  1. Only four companies were bigger in the year prior to IPO – ExactTarget, Intralink, Workday and Veeva. All of those companies except Intralink, reached $2B+ market values after IPO.
  2. Only three companies grew faster in the year prior to IPO – Success Factors, Salesforce and ServiceNow. All of these companies reached $3B+ market values after IPO.

Each datapoint in the graph below represents one company in our database in the year prior to IPO. The horizontal axis is the growth rate for the year and the vertical axis is revenues.

Revenue vs Growth

The graph of all SaaS companies shows that 100%+ growth rates were very rare for companies larger than $50M in revenues (4 of 41 companies). Out of all companies in the history of the SaaS industry, only Veeva was comparable to Box.com in size and growth rate. The three companies that were growing even faster were far smaller in the year before IPO.

The Cost of Growth

While Box.com’s growth at scale is impressive, so were the staggering losses, driven by very high sales and marketing expenses. Total accumulated deficit prior to IPO was $361 million which sets a new record (previously held by E2Open) and is more than 5x higher than the median accumulated deficit of $71M.

Whenever we see aggressive sales and marketing expenses, we look to the SaaS “Magic Number” to see if the investment to fuel growth is yielding satisfactory results. The Magic Number for SaaS companies is typically calculated using quarterly data. However, we use the available annual financials provided in IPO filings to calculate an annual magic number (AMN) as a way to compare companies.

The AMN formula is as follows:

AMN = (Revenue Yr2 – Revenue Yr1) / (Sales+Marketing Expense Yr1)

Box reported two full years of financials which showed AMNs of 1.04 and 0.66 (Fiscal Years ending January 2013 to 2014). These are both below the average AMN in our database of 1.11. However, because the average is brought up by several outliers (companies that had very high AMNs in certain years), the median of 0.91 and is a better benchmark. As a general rule of thumb, it makes sense to “step on the gas” when the Magic Number is above 0.75.

The scatter plot below shows the AMNs for all companies in our database (each data point is the AMN for one year for each company). Including Box.com, there are 41 companies represented with an average of seven years for each company (pre and post-IPO). The blue diamond dot represents Box.com’s FY 2014.

Distribution of Annualized Magic Numbers

Most AMNs fit between the top and bottom quartile of 0.58 to 1.35. Box.com’s AMN of 0.66 in the most recent fiscal year would rank around the 31st percentile.

For illustrative purposes, if your SaaS company has an AMN of 1, the graph above would show that the year would rank around the 57th percentile. AMN of 2 should be considered exceptional at 90th percentile (I would guess 90th percentile among the best SaaS companies would mean that an AMN of 2 would be 99th percentile against the industry).

Gross Margins

As important as AMN is for judging SaaS companies, that number can be misleading when comparing companies with dramatically different gross margins.

SaaS companies that require professional services tend to have lower gross margins. For example, Workday’s blended gross margin was only 51% in the year prior to IPO compared to 79% for Box.com, which is consistent with our expectation that the next generation of SaaS companies will be more like consumer software companies with higher gross margins.

To account for gross margin differences, we created another scatter plot based on gross margin growth relative to Sales and Marketing expenses. The chart below shows the Gross Margin AMN for all companies.

Distribution of Gross Margin AMN

When adjusted for gross margin, Box.com’s year before IPO would move up from 31st to the 39th percentile (Box.com’s GM AMN = 0.54, compared to median of 0.64).

Proving the SaaS Model

While Box.com’s AMN and GM AMN are below average, those metrics put the company ahead of many successful companies in the industry. For example, companies such as Cornerstone, Eloqua, Netsuite, Responsys, RightNow, Salesforce, Success Factors and Taleo all had one or more years in which their GM AMN was worse than 0.54. Eventually, every company reached cash-flow break-even as it reached critical mass.

A good example of a company that proved the SaaS skeptics wrong was Success Factors. The company had many skeptics at the time of its IPO due to an unprecedented level of spending, losing more than a dollar for every dollar of revenue. What most people did not realize was due to the highly predictable nature of its business, Success Factors was “profitable” from a customer life time value (LTV) perspective long before the business as a whole became profitable.

The LTV story was critical to Success Factors’ IPO. However, at the time, it was just that – a “story” not yet proven. Not long after the IPO, many investors abandoned ship and sold at a loss (below IPO price of $10/share). The company became somewhat of a favorite among shorts. However, as the company continued to grow, the business started generating cash – more than $30 million in free cash flow per year around the time the business reached $200M run-rate. Before it was acquired, Success Factors had more than $300 million net cash. When the company got acquired for 4x its IPO price many shorts got burned while the faithful got handsomely rewarded.

Key Takeaways

Not yet knowing the final pricing of Box.com’s IPO shares it’s hard to judge whether or not the stock will be a good buy. We also don’t know key metrics that are not reported in public filings (for Box.com as well as other companies, so it’s hard to compare key metrics other than basic reported financials).

All that said, given the large Total Available Market, an exceptional founder CEO, lots of cash (soon to be raised in its IPO) and what looks like “good enough” AMN metrics, I would not bet against the company based on what looks, on the surface, like a hugely money losing business.

Going forward, I would want to continue to track the company and try to understand how it plans to increase switching costs, maintain a low churn rate and grow its per account revenue through a “land and expand” strategy to drive more efficient growth. The stock price will eventually follow the direction of the underlying metrics.

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