Marketo - Demand For Cloud IPOs Sends Valuations To Stratospheric Highs

| About: Marketo (MKTO)

Marketo (NASDAQ:MKTO) made its public debut on Friday, May 17. The provider of a leading cloud-based marketing software platform ended its first trading day with gains of 77.7% at $23.10 per share. The offer took place the same day that Tableau Software (NYSE:DATA) went public, marking the second offering of the day.

Shares kept on rallying on Monday, reaching intra-day highs of $26.70 per share, to close with gains of 5.3% at $24.33 per share, making shares too expensive for my investment standards.

The Public Offering

Marketo, which essentially sells software to automate marketing processes, has developed a software platform that improves marketing execution, analytical measurement of client relationships, and the acquisition of customer relationships.

Marketo sold 6.1 million shares for $13 a piece. The company sold 5.75 million shares to the public, thereby raising $74 million for the firm. The remaining 300,000 shares were sold by selling shareholders including Institutional Venture Partners, InterWest Partners, Storm Ventures and Battery Ventures.

The public offering values the equity of the company around $465 million. The offering was quite a success. The firm and its bankers sold shares at the high end of the preliminary price range of $11-$13 per share.

Some 17% of the total shares outstanding were offered in the public offering. At Monday's closing level of $24.33 per share, the firm is valued around $869 million.

The major banks that brought the company public were Goldman Sachs, Credit Suisse, William Blair, Canaccord Genuity, Raymond James and JPM Securities.


Marketo's platform is easy-to-use and the possibility of integration with third-party applications has created an ecosystem surrounding its product. The company has more than 2,000 customers in every business size and across major industries including large names like Capgemini, Citrix (CTXS), General Electric (GE), Medtronic (NYSE:MDT), Panasonic and Symantec (NASDAQ:SYMC). The company has already achieved significant diversification as no customer made up more than 1% of total revenues over the past year.

For the year of 2012, Marketo generated annual revenue of $58.4 million, up 81% on the year before. At the same time, operating expenses increased by 70% to $68.0 million. Marketo reported a net loss of $34.4 million for the year, which compares to a loss of $22.6 million a year earlier.

The company ended its fiscal-year 2012, with $44.2 million in cash and equivalents and $3.6 million in total debt, for a net cash position of around $40.6 million. Factoring in the public offering proceeds, and the company could operate with roughly $100 million plus in net cash, valuing the operating assets of the firm at $770 million.

As such, the firm is currently valued around 13 times 2012's annual revenue.

Investment Thesis

As noted above, the public offering of Marketo has been a great success. Shares were offered 8.3% above the midpoint of the preliminary offering range, and are currently exchanging hands at $24.33 per share, trading an astonishing 103% above the midpoint of the guided range.

The company has not yet reported its first-quarter results in its S1-filing, still there are some encouraging signs to be found. Gross margins for the full year of 2012 increased by 390 basis points to 57.8%. At the same time operating expenses fell by 690 basis points to 116.4%, resulting in a loss coming in at the equivalent of 58.6% of total revenues.

At the same time, fourth-quarter revenue growth slowed down to 66.0%, with revenue coming in at $16.8 million. As a result of margin expansions and tighter operating expense control, net losses increased just slightly from $7.6 million a year earlier to $8.0 million in the final quarter of 2012. Losses were also down from second and third quarter losses over the past year.

Marketo is not even close to reporting operating profits, a reason why its revenue multiple of 13 times annual revenues, represents a significant discount to other IPOs, including that of Tableau currently valued at 21 times annual revenue. The significant public offering proceeds allow the company to further invest and expand the business, while continuing to report losses in the meantime. There are still vast overseas expansion opportunities as the company only generates 13% of it revenue abroad.

The whole cloud-based business software area is getting crowded. Names like Marketo, but also Tableau Software and Splunk (NASDAQ:SPLK) have operations focused on that area. In recent years, large ERP firms have announced their intentions in the field as well. SAP (NYSE:SAP) bought SuccessFactors already back in 2011, while Oracle (NASDAQ:ORCL) bought Taleo a year later.

After the incredible initial returns, I am a bit skeptical. Shares are valued around 13 times 2012's annual revenue as growth rates are already coming down, with revenue growth decelerating toward 66% in the final quarter of 2012. While the company is making progress to improve its profitability, Marketo remains far away from its break-even levels. With more competition to be anticipated in the coming time periods, the industry might get crowded.

While I do not like Marketo's valuation at these levels, shares are no obvious short. Given the modest market capitalization of the firm, a take-out remains always among the possibilities, as is a short squeeze given the limited short and current market euphoria.

Disclosure: I 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.