SoundView Techn...'s  Instablog

Sending email has become a major industry problem thanks to both the massive growth of legitimate sending mixed with an enormous amount of SPAM.  Much as it is in online security, there is no one “silver bullet” to efficiently and effectively deliver large amounts of email.

For small organizations the typical answer has been one of the many email marketing service providers.  This includes companies like Constant Contact (NASDAQ:CTCT), MailChimp, VerticalResponse, ExactTarget, and many others. Most relationship management solutions like Salesforce (NYSE: CRM), Responsys (NASDAQ: MKTG) andUnica (acquired by IBM) include email services as part of their solution.

Large organizations don’t need or want the content creation and management features of these marketing tools and they need to send far more email than these solutions are built to handle.Large-scale applications require a “sending platform” to deliver the emails, which can reach into the millions.

 There’s also a big difference between internal company email and external consumer email.  Thanks to new rules and regulations, many types of emails have become legal documents.  There’s now a significant compliance burden on company email for retention, discovery, content management, etc. Large external email distributions simply don’t belong in this environment and are better handled externally with a service provider.

Sending large volumes of emails effectively requires infrastructure, technology, tools and expertise.   To make it even more challenging, SPAM has become such an issue that large senders of email are viewed as “guilty until proven innocent” which means their sent email may never reach the intended destination. Senders must develop an online infrastructure reputation.

These dynamics favor specialty cloud infrastructure service providers like SMTP (OTC: SMTP).   Over time we expect this market to evolve in a similar fashion to content delivery networks and financial market technology. Institutions use purpose-built online infrastructure for services like video asset management, funds transfer, stock trading and transaction processing.

The size of the email market in general and the slice for SMTP in particular is not well-documented.  The largest segment of the market is internal email, which is estimated to cost about $20 to $25/month in the enterprise.  If outsourced to Google this cost can drop to about $8/month but companies give up considerable flexibility and integration by doing so.

 These high costs are forcing companies to move their high volume emails to clients, customers and prospects outside of their internal systems.  In addition, there are large organizations without substantial internal infrastructure (like non-profits) that want to reach millions, tens of millions and in some cases hundreds of millions of email subscribers.  Estimates for external email volumes are notoriously flawed due to the high percentage of SPAM in the raw numbers.  However, many would agree that the figure is “around” 300 billion email messages sent per day with about 3 billion email accounts.  The line between SPAM and that subtle opt-in when someone checks the “I want to receive updates from American Airlines” box is a blurry one.

The fact is that almost every successful consumer-focused organization is likely to need this service.  This is as true for the Catholic Church as is for Groupon, Patron Tequila, Budweiser, American Airlines, or Coca Cola.  One fairly simple back-of-the-envelope way to get at the size of the market opportunity for SMTP and other high end email outsourcing companies is to base it on volumes.  We’ll assume that just 1% of the daily volume is bona fide consumer marketing email sent to large lists by big organizations.  That’s 90 billion messages per month to parse into potential revenue.  We used a typical power law distribution of customer email volumes to segment the market and determine how many customers are in each segment. Then it’s a matter of applying the normal pricing to come up with the current market size of just over $500M per year.

The Highlights of the Full SMTP Report (link below):

• SMTP, Inc. (SMTP) is a cloud service provider that specializes in the increasingly challenging task of sending email on behalf of their clients by providing intelligent engine to power successful email delivery.  In this regard SMTP is more akin to a technology service provider like Amazon or Rackspace rather than an email marketing company like Constant Contact.
• Volumes of email continue to increase and the cost, complexity and ever-shifting nature of what is required for successful delivery is driving the majority of organizations to outsource all or part of their email delivery.
• Over time we expect this market to evolve in a similar fashion to the content delivery space and include some dedicated providers (like CDN players Akamai & Limelight) and the large general players offering some level of service (like Amazon and Rackspace.)
• SMTP is a small but rapidly growing company that is very capital efficient.  The company generated $2.7m in revenues for 2010 (an increase of 76%) with 27% operating margins. Our market size estimate for the services SMTP provides is approximately $500m/year. SMTP is growing faster than the overall market but is unlikely to hit any market limitation for some time.
• The company recently completed a “direct to market” IPO process and is just now accessible to pubic investors. Our intrinsic valuation (IV) suggests a share price of $3. The shares just started trading and as the float is limited the shares will fluctuate more sharply than normal. Both our IV and peer analysis are attached.

The full research report is available here: SMTP Coverage Report May 3 2011 and contains more information regarding the company, the market, competition and valuation.

[Disclosure: SMTP, Inc. is a corporate research advisory client.  Please see the disclosure information in the research report and on our website for more information.]