WORTH A LOOK #5 “Durable Growth in Market Turbulence: IPO Returns”

Worth a Look

October 24, 2022

“Investing in the eye of the market storm and the role that Durable Growth plays – not growth rate – for the highest returning stocks since IPO”

 

What is Worth a Look?

As part of our research process we are continuously reading, watching and listening to a wide range of content related to business trends affecting our portfolio companies. We often come across underfollowed material that might be of interest to our investors from the perspective of:

  1. highlighting an important transition happening within in a sector we cover
  2. help explain changes affecting the way you do business or consume life
  3. general curiosity

Planet MicroCap host Robert Kraft’s interview with Jeremy Deal about Meritech Capital’s recent memo “Durable Growth”

 

Listen on Spotify  |  Listen on Apple  |  Listen on Substack

 

Key excerpts from the Durable Growth memo

Background: How have the successful SaaS companies (based on shareholder returns) created value? Meritech models the factors that contribute to total shareholder return over time. (Although the paper focuses on public SaaS companies the idea can be applied across sectors)

  • Even after the recent massive market correction, the returns of public SaaS companies over the past 20+ years have been staggering, the top 25 have averaged 13.7x IRR with an average return of 5.3x for all 100 companies in the research,
  • It doesn’t matter how big (revenue scale) you are when you go public, the most important factor is how much you actually grow revenue from IPO,
  • The absolute revenue growth rate has no impact on share price return or share price growth,
  • Staying public is very important. The longer you are public, the more returns you’ll likely generate,
  • Absolute share price at IPO is not important to returns,
    Conclusion: durable growth, i.e., the persistence of revenue growth over time, matters more than the absolute pace of growth or changes in valuations due to market conditions
  • It’s about time in market, not market timing
  • There is a level of efficiency required to stay public and generate strong returns; companies cannot burn a lot of money to frow in the publics markets [for long] without being forced to slow growth or eventually fall out of the index by acquisition or insolvency (durable growth and profitability converge)

Case Study examples

Salesforce

  • Salesforce stock up 69.5x since IPO in 2004 despite growth declining materially over time from 100%+ annually pre-IPO to ±20% today. ARR (revenue) has grown from $37 million in April 2002 to $30+ billion today while the valuation multiple has generally declined from a peak of 12x NTM revenue to ~5x today.
  • Salesforce stock is up 60x from the 2008 bottom because the company was able to balance cutting costs, maintaining margins, and growing market share

ServiceNow

  • ServiceNow stock is up 28x from IPO in 2010. Revenue has grown roughly 49% annually since IPO in 2010 from $66 million to over $7 billion today while the valuation multiple has traded between 21.5x NTM revenue and 5.5x.
  • Durable revenue growth and strong free cash flow margins has driven significant gains

Five9

  • Since IPO in 2012 Five9’s has returned 17x with revenue growing from $57 million to $760+ million today. The rate of growth was slower than the other top-quartile performers in the study at 23% annually until the pandemic temporarily accelerated the rate.
  • The paper points out that “you don’t need growth at a super high rate (even at a smaller scale) to create significant value, but that your growth rate must be durable.

“One important caveat”

  • This analysis does not include associated margins, cash burn, or overall efficiency of the group of companies in relation to their multiples,
  • Efficiency and strong unit economics are, of course, required if a company is to remain in the public markets for a long time,
  • If you’re not efficient; cash will run low, you’ll be forced to raise dilutive primary capital and/ or growth will be forced to slow, stock price can fall, and you may ultimately be acquired, removing you from the public markets and likely capping return potential in the process.

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About JDP: JDP is a private investment partnership that makes long-term investments in public companies with significant unrealized potential.  www.jdpcap.com

Disclaimer
This content is for informational purposes only and should not be considered legal, tax, investment, financial, or other advice. Nothing contained in this document constitutes a solicitation, recommendation, endorsement, or offer by JDP or any third-party service provider to buy or sell any securities or other financial instruments in any jurisdiction. This document is intended only for investors in JDPI, LP and its affiliated entities, and prospective investors who have attested to qualifying as an “accredited investor”, also referred to as a “professional” or “qualified” investor based on the country of domicile. Funds managed by JDP might maintain positions in companies discussed in this document.