S-1 IPO breakdown | Sprout Social
This is a close look to the S-1 prospectus of Sprout Social, a Chicago, Illinois based venture capital-backed founder-led company. It will be traded on the NASDAQ on December 13, one day after the Bill.com IPO, under the symbol SPT, and it will be the last company to go public in the decade after a year with a number of (un)successful IPOs.
Last week, it set the price range between $16 and $18 dollars a share for a valuation of approximately $1 billion for an offering in excess of $180 million.
COMPANY OVERVIEW
Sprout Social, founded in 2010, is one of the go-to social media management platforms for SMBs to pull data, monitor, analyze and communicate with their social media audiences. It benefits from the secular tailwind of social media adoption around the world as the number of users has increased over 200% from 2010 to 2020E, an implied CAGR of 12% during the period.
As people adopt and share their preferences, location, interests, and their social graphs among various social media platforms, this specific and valuable data is used by SMB and enterprises alike that aim at promoting their products to targeted online audiences as opposed to traditional offline advertisement to achieve better return on their investments.
To have an effective online presence, organizations build online marketing teams to oversee marketing budgets, measure performance of online posts and engage with its customers. And companies pay for the convenience of managing all platforms in a centralized software as opposed to managing each individual platform.
Sprout Social has built a SaaS model in which customers pay monthly fees per user depending on several tiered functionalities, from $99/month per user up to $249/month per user with an efficient 30-day demo option that funnels the majority of its new customers at an average of 9,000 new trials per month. In 2018 alone, more than 90% of new customer revenue resulted from these trials, a predicted outcome of best-in class SaaS companies that Tomasz Tunguz summarized:
Once a demo is converted to a paying customer, Sprout Social will lead its salesforce to upsell new functionalities and add additional users (e.g. more users with approval permits and new social media platforms).
From 2017 to 2018, the organization increased in 80% the number of customers with Annual Contract Value (ACV) of $10,000+, from 772 to 1,391, at a much higher rate than the 12.4% of total customers that went from 18,802 to 21,135. Another closely looked metric is the dollar-based net retention rate — or the rate at which consumers are retained and incentivized to expand their subscription plans –that went from 108% and 106% in the same period. Excluding SMBs, the dollar retention rate is significantly higher at 118% and 115% rates, respectively.
LEADERSHIP
The company has 11 members on its leadership team including all four original co-founders with significant operational roles, and four women. On Glassdoor, the company has a 99% CEO approval and a 4.8 approval rating. Also, there are no new hires in the leadership group since Jamie Gilpin came on board as CMO in April 2018. Of note, both SVP of Operations and VP of Engineering are with the firm since 2010 (the year the company was founded) and I believe it is a good indication that the firm promotes from within even in high-growth mode.
The board has an unusual par number (6) of members, comprised of co-founders CEO Justyn Howard and CTO Aaron Rankin and four directors, including one woman. In August 2019, the company added two new members for the board in anticipation for its IPO, Steven Collins and Karen Walker.
Co-founders Justyn and Gil Lara were long-term friends prior their shot at Sprout Social and Justyn met Aaron through their wives. Peter joined the group as a former colleague of Aaron and soon after that the company was founded.
There is a good video from SaaStr Annual 2018 in which the former CMO of HubSpot Mike Volpe interviews Justyn. There isto hear about the business model, from its sales model to cohort, conversion rates and pricing models. Some relevant numbers and data points:
a) Enterprises have on average 3 to 4x higher ACV compared to SMBs.
b) In the early 2010s the market was primarily offering free social media monitoring tools and Sprout was the first to add a paying layer at approximately $200/year. Going from $200/year to $150/month in less than ten years shows how price inelastic this market is as a result of the value Sprout adds.
c) There is room for price increases in the enterprise segment with new and more sophisticated features.
The exact numbers of the interview are less important than the opportunity of listening how their business model was shaped overtime and how informal and engaged Justyn is.
FINANCIALS & COMPARABLES
Considering that the Venture Capital industry has raised record-level funds with accompanying unprecedented rounds of financing across all stages, Sprout Social has been very efficient in its capital raise, with nearly $100 million in the private market from key venture capital firms Lightbank and NEA, as well as Goldman Sachs across six rounds of valuation.
Sprout Social has over $26m in revenues over the last quarter and $199m in the last twelve month with gross margins in the mid-to-high 70%. It is still unprofitable on a GAAP basis with operating expenses representing over 100% of gross margins.
For a company that is pricing its shares in the public markets, it is common to determine its performance against others that share similar structure, business model, and growth trajectory. For Sprout Social, I will compare it against companies that are in high-growth mode whose business models are primarily related to the social media industry for there is no true competitor in the public market. The companies for this analysis are Yext (YEXT), HubSpot (HUBS) and Cardlytics (CDLX).
Sales and Gross Margins
The company main source of income is the subscription plans it charges with an immaterial line of professional services that represent less than 1% of its total revenue.
Its growth QoQ has rapidly decelerated from 57% (4Q18 vs 4Q17) to 29.5% (3Q19 vs 3Q18), primarily as a result of law of large numbers with potential investors keeping a close eye in its momentum to keep and attract customers.
Revenue growth is primarily driven by revenue from new customers and expansion within existing customers. Revenue from new customers accounted for nearly two thirds of the increase in subscription revenue from 2018 to 2017, while expansion within existing customers accounted for less than 10%. The remaining was related related to an acquisition completed in 2017.
Among its peers, Cardlytics has tremendously accelerated its revenue over the last two quarters, when it grew at 37% and 63.1% compared to the quarter of the previous year (Q219 vs Q218 and Q319 vs Q318, respectively). As a result, its shares grew more than 460% in 2019 alone after a struggling IPO 2018 year.
SaaS companies consistently post gross margins in excess of 70% and SproutSocial is no different, with 71%+ margins over the last 8 quarters. One important point of concern, however, is the sequential reduction in margin over the last 4 quarters. Cardlytics is once again the outlier for their focus in the purchase of advertisement inventory. HubSpot is among the best in class among all the SaaS stocks with 80%+ margins and Yext has accelerated its gross margins from 73.7% in Q318 to 76% in the last quarter by benefiting from greater scale of operations.
OPEX (OPERATING EXPENSES)
According to accounting standards, Opex are the costs related with running the operation of a company and include Research and Development (R&D), Sales and Marketing (S&M and General and Administrative (G&A).
Sprout Social spends 24.1% of total revenues in R&D, in line with its peers. It is worth mentioning that this expense has decreased sequentially over the last 6 semesters as a result of better operations expenses and increased scale of economy.
As mentioned previously, Sprout Social captures the majority of its new customers through a free demo sales channel and it should be expected to have S&M as a percentage of revenues lower than the average SaaS tech company. And indeed, it has lower S&M expenses as a % of revenues when compared to both HubSpot and Yext, that are clipping its expenses in excess of 50% for HubSpot and 70%+ to Yext.
Lastly, G&A consist of personnel expenses for teams in the finance, legal, HR and other administrative functions. Personnel costs increased in the last quarter primarily as a result of a 37% increase in headcount as the company continues to grow and costs related to stock-based compensation in preparation for its IPO. The G&A ratio is in line with the other companies, with HubSpot having the lowest for its relative larger scale.
CONCLUSION
SproutSocial will be the last tech company to IPO in the decade of high-flying tech companies posting strong long-term performances after much hyped — and in some cases contentious — IPOs. Companies such as Facebook, Alibaba, and a number of enterprise B2B tech companies delivered multiples of return over invested capital to investors that are betting in secular trends in the industry.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
