The Path to IPO – What does it take to go public in 2022?
Written by Vivian Guo | February 16, 2022
Each year, the ICONIQ Growth Analytics team produces an in-depth analysis of historical SaaS IPO performance, with a focus on the most recent cohort of IPOs that went public in the previous year1. Below is a summary of some of our findings2. You can access the full study here.
For software companies, 2021 was a historic year in many ways. Pent-up demand from robust private markets and a frothy public market led to a record number of SaaS companies going public. At the same time, they were met with changing macroeconomic conditions that led to a dramatic contraction in the public tech equity markets.
Driven in part by faster-than-expected quantitative tightening by the Federal Reserve in response to heightened inflation risks along with the impending rise of interest rates, the BVP NASDAQ Emerging Cloud Index (which tracks the performance of emerging cloud public companies) is down 18% YoY as of 1/31/22, with some high growth software stocks trading ~40-50% off 52-week highs3.
Looking forward, we can reasonably expect continued market volatility as investors grapple with various economic indicators, inflationary concerns, a tight labor market, and shifting geopolitical dynamics.
However, as growth partners, we strongly believe in the fundamental value creation opportunity for “best in class” software companies to grow and generate exceptional returns over time, even through shifting and sometimes difficult market environments. Despite the recent pullback, some of the highest multiple software companies have continued to trade well above historical averages.
Defining IPO success
So what does a “best in class” software IPO look like? Our annual study dives into the detailed profile of both average and top performing software IPOs by analyzing the business performance of SaaS companies that went public between 2013 and year-end 2021 as reported in their 424B4s.
As outlined in our first post on IPO performance, we use three distinct metrics to measure an IPO’s “success”:
Indication of success at IPO: A company’s forward revenue multiple (EV / NTM Revenue) at IPO.
Indication of success post-IPO: The current forward revenue multiple (as of 1/31/22).
Indication of value creation: The ratio of the change in stock price (from Day 1 close to 1/31/22) divided by the percent change in S&P over the same time period.
Methodologies for assessing IPO success have historically varied. However, we believe our approach is a somewhat holistic and objective way to assess a company’s performance beyond the traditional method of looking at a company’s first day “pop.”
Examining the top quartile companies across each of these metrics, a group of 21 companies rose to the top in this year’s analysis.
Driving Ongoing Performance
A variety of factors spanning scale, growth, retention, and profitability will drive initial IPO performance. (In this case, we looked at forward multiple at time of IPO.) However, revenue growth and net retention have historically been most closely correlated to IPO performance. When refreshing our analysis this year, one of the most interesting findings was that while revenue growth remained the leading indicator of IPO performance, profitability did become slightly more correlated to IPO performance. This was perhaps driven by volatile markets and the rising importance of business predictability to investors.
Looking at what differentiates top software performers from their peers, we find that they are not always larger than their peers at time of IPO, but they typically have stronger growth in the years leading up to IPO and are also able to maintain healthy growth trajectories post IPO. While software companies see a median growth rate of ~40% YoY prior to IPO, these top performers saw a median growth rate of ~73% with certain companies seeing as high as 138% YoY growth in the last twelve months prior to IPO.
Operational efficiency ranges widely across recent IPOs, but top performers typically also have a higher OpEx spend than peers, with total operating spend as a percentage of revenue ranging from 53% to 194%.
Lastly, at the time of IPO the majority of software companies are not profitable. In fact, only four top performers were profitable at time of IPO. However, within two fiscal years of IPO, half of the public software companies we analyzed expected to be free cash flow positive, indicating that a clear line of sight into profitability is still important.
So how is the most recent cohort of 2021 IPOs doing post public market debut? While valuations continued to increase and the growth and profitability of companies going public remained consistent with 2020, the average stock gains of 2021 IPOs were notably lower for both average and top performing companies. It is also important to note that there has been a degradation in the business performance of companies going public in recent years compared to historical SaaS IPOs, with median LTM revenue growth and Rule of 40 significantly lower than pre-2020 cohorts.
The most striking and heavily reported fact is that ~70% of companies that IPO’d in 2021 are now trading below their issue price (as of 1/31/22).
Given the current market conditions, it will be interesting to see where 2022 IPOs end up pricing. As always and especially during these next few months where it will be hard to predict results based on past performance, we welcome any questions and discourse on these topics.
Notes and Sources:
1. The universe of companies included in this study consists of certain major enterprise SaaS IPOs from ~2H2013-2021, including all software IPOs across all ICONIQ Growth portfolio including co-investments as of the time period indicated above. IPOs that have since been acquired are excluded from this report. For more information, please see full study.
2. All statements included in this post and companion study contain opinions and/or estimates of ICONIQ and its personnel that constitute its and their best judgement as of the date of the materials.
3. Data from Factset and NASDAQ as of 1/31/22.