NetSuite Ponders IPO

Back in December when I profiled NetSuite, I pondered whether the company would pursue an IPO or become the latest in a ever-growing line of software acquisitions.

Well, to no one's surprise NetSuite now appears set to pursue an IPO later this year. Earlier this week, NetSuite executives acknowledged the company's plan to come public, citing the success of SaaS vendors salesforce.com (CRM) and RightNow (RNOW) since listing their shares.

"We're hoping to see something in the ballpark of what Salesforce got in terms of valuation," said NetSuite CEO Zach Nelson.

"Those are the two most similar companies in terms of the way we offer product in the market," said NetSuite CFO Jim McGeever. Their high stock valuations "certainly put a company like us in a high demand. Every single bank on the planet has probably called here."

Given the dearth of attractive software IPOs, there's little question that NetSuite will be a sought after issue and get banked by the top bulge bracket banks. But is it reasonable to expect investors to pony up a valuation similar to what CRM received?

Points to consider relative to NetSuite versus salesforce.com (at the time of its IPO):

• Comparative financials -- When salesforce.com filed is S-1 in June 2004, the company's was coming off a $96 million revenue year (88% growth) and was marginally profitable (3.9% operating margins). According to public statements made by NetSuite (we won't have concrete numbers until they file a registration statement), the company generated $40mm in 2005 and are on pace to double that in 2006, reaching profitability by year end. While NetSuite's growth profile is exciting, the company will be held against the CURRENT state of other SaaS vendors and, by that token, NetSuite is a smaller company with a less mature operating model. Verdict: Negative for NetSuite
  

• SaaS is no longer a "show me" concept among public investors -- When CRM came public, software-as-a-service (SaaS) was a largely unproven concept among public investors. Now, thanks in no small part to what Marc Benioff and his company have accomplished, SaaS is THE buzzworthy software model. If anything, the currently public SaaS vendors are being afforded a scarcity premium. Verdict: Positive for NetSuite

• The "Ellison" Factor -- Larry Ellison is a shareholder in salesforce.com, but has been quoted as saying he hopes his investment gets written down to zero. But that remains a far cry from his position as NetSuite's co-founder and majority shareholder. The bottom line is Ellison owns more than 50% of NetSuite and, if he maintain his majority position at IPO, the Street will discount NetSuite because of the captive nature of the company. Verdict: Negative for NetSuite

• SMB versus Enterprise Focus -- salesforce.com was largely viewed as a departmental SFA offering at the time of its IPO, but the customer base had a healthy dose of larger companies in hand. According to the S-1, CRM had 9,800 customers, 147,000 subscribers and 30% of its customers were companies with more than $500mm annual revenues. NetSuite is a more downmarket solution...competing on the low end against Intuit Quickbooks and Act!/Goldmine...while on the high end competing against the likes of Microsoft Dynamics [formerly Navision/Great Plains], Epicor and Lawson. In other words, small- to mid-sized enterprises that are looking to move beyond point products into a loosely integrated solution set. Typically, investors don't assign comparable multiples for lower end solutions because the marginal contribution per sale cycle is smaller (you have to close a lot more deals to scale the business). Verdict: Negative for NetSuite

• Breadth of functionality -- salesforce.com has grand designs to become the hub for all types of functionality via AppExchange, but at the time of its IPO, it was squarely a CRM vendor with offerings in sales force automation (SFA), marketing automation, and call center. NetSuite, while playing downmarket, offers a broader range of ERP-esque functionality that spans CRM, ERP and financials/accounting. Verdict: Positive for NetSuite

We'll all know a lot more when NetSuite actually files its registration statement. Clearly, if they are on pace to double revenues and reach profitability, the company seems well positioned to have a successful IPO particularly given the rabid appetite for SaaS plays. However, expecting NetSuite to be afforded a valuation similar to that of salesforce.com may be a tad aggressive. Meanwhile, I still contend NetSuite could get scooped up by Oracle before it ever sees the light of the public markets.

Related Posts:

• Phil Wainewright also blogs about the proposed IPO
• Private Company Spotlight: NetSuite
• Nostradamus or Nostra-dummy, You Decide
• Private Company Spotlight: Rearden Commerce
• CRM OnDemand: Evaluating the Takeout Premium

Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained a long equity position in ORCL but did not maintain a position [long or short] in CRM or RNOW.

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Comments

[Thomas Otter]

Jason,
I'd be interested in your take on marketing spend. Some folks endow SaaS with mythical powers of viral adoption and short sales cycles, but looking at the numbers of both SFDC and Netsuite I just don't see it. It is rather odd that those that knock SAP and Oracle for high SG&A havent applied the measure to the SaaS darlings...

[Mark Crofton]

Jason,
Your assertion about margins is interesting and I don't disagree with your reasoning. However, once all the elephants have been shot by any of the big game hunters, you gotta go after the smaller game. There are by definition only 1000 Fortune 1000 firms. So even if the margins are not as good (and i'm unclear on the difference in margins to be honest with you. If you set up an entirely different cost structure, indirect, partner-supported etc, you will have a different cost struture) you still need to keep hunting.
SAP has publicly spoken a great about and has launched a number of initiatives aimed at the mid-market. (http://searchoracle.techtarget.com/originalContent/0,289142,sid41_gci1135109,00.html)
As far as autonomy, I'm not sure to be honest. SAP has Donna Troy, the SVP of SMB reporting right into the president of global field operations (but not to the head of the Americas region, McDermott)
-mark

[Jason Wood]

Mark,

From an investor perspective, it's always been viewed that large apps vendors don't want to REALLY attack the SMB for a lot of reasons. But the principal reason is margin per sale. When your primary product carries 98% gross margins, the last thing you want to do is provide something for significantly lower costs that maintains even 70% of the high end functionality.

In SAP particularly, I have to look at McDermott and the culture he's developed and wonder how a true SMB strategy fits. McDermott is fostering a true "big game hunter" mentality, and that permeates the company's entire sales chain now (at least in my opinion).

Would you agree that for an SMB strategy to work within the confines of SAP, ORCL, et al it would have to have a level of autonomy, even perhaps having the division head not be a direct report to the worldwide head of sales?

J

[Mark Crofton]

Zoli,
I don't disagree that selling to SMBs takes a different approach (indirect, channel selling is quite different than a having a large enterprise field org) I just don't see the need to have it in a separate company. It's still unclear what you gain. SAP seems to have realized that it will take a different approach, but we've set up the channel organization within SAP. Aren't we better able to leverage our corporate knowledge, employees' experience not to mention spread our fixed costs (PPE and G&A) b/c we're not two separate entities?

[Zoli Erdos]

Mark, I agree with your analysis:
"If you look at where Oracle doesn't compte (in the app market) it's at the bottom end; smaller-mid and below" - but for me the conclusion is the exact opposite. 2 separate armies for two very different battlefields.

[Jason Wood]

Mark,

Ultimately I can see NetSuite becoming part of Oracle, but there are compelling reasons why Larry and the NetSuite team might want to avoid that, too.

1) There's virtually no way Oracle shareholders (Larry included) would capture the same kind of equity premium by bringing NetSuite in-house. Investors would be forced to look at NetSuite as a small part of a bigger, slower moving equity and simply wouldn't be able to comfortably assign the SaaS premium it would likely get as a standalone public entity.

2) NetSuite, like SFDC, wants to ultimately become a platform for smaller, SaaS functionality. That's a message much easier digested by customers and partners alike if NetSuite isn't under the Oracle umbrella.

[Mark Crofton]

Not sure why it makes sense for Larry to take NetSuite public (other than to let some of the other execs cash out).

I posted on this yesterday:
My thought is that Oracle will acquire NetSuite some day to compete in the SME market. If you look at where Oracle doesn't compte (in the app market) it's at the bottom end; smaller-mid and below. This is the area of the Sage's and Microsoft Dynamics (and to a degree the SAP Business One offering). Oracle's EBS Special Edition could therotically play here, but my understanding is that that offering is more aimed at the middle of the mid-market. I always thought a Oracle NetSuite offering would fit nicely in this space.