Tech company SolarWinds (NYSE:SWI) released further details about its upcoming IPO. Nasdaq reported that SolarWinds plans to raise $756 million by selling 42 million shares at a price range of $17 to $19. At the midpoint of the proposed range, SolarWinds would command a fully diluted market value of $5.4 billion.
Many tech companies like Pluralsight (PS) and Dropbox (DBX) have had mixed results after going public, and so investors should wonder whether SolarWinds will follow the same results. And while there is nothing explicitly disqualifying about SolarWinds, there are some concerns which keep it from being a great tech IPO choice. Investors who can get in on the ground floor should count themselves lucky, but most of us should wait until the inevitable drop-off in value.
Business Structure and Market Opportunity
It should be noted that this is not SolarWinds' first time going public. The company was founded in 1999 and went public in 2009. In 2015, CNBC reported that SolarWinds was to be acquired by private equity firms Silver Lake Partners and Thoma Bravo, and the transaction formally happened in February 2016. The two firms are some of the premier private equity firms investing in technology companies and will still control 83% of SolarWinds' voting power after the IPO.
So, what does SolarWinds do? SolarWinds describes itself in its S-1 report as "a leading provider of information technology" which helps organizations worldwide manage their IT environments. SolarWinds' approach called the "SolarWinds model" lets them sell their tech products to network and systems engineers, database administrators, and storage administrators among other tech experts. By aiming directly at technology professionals and not at business leaders who may be more skeptical about the value of such technology, SolarWinds uses what they call a "selling from the inside" approach which creates loyal customers with minimal marketing expense.
As a result of this approach, SolarWinds has 275,000 customers as of June 30, 2018, including 499 of the Fortune 500. Nevertheless, it has a major market opportunity to grow further. Technology is growing more complex, particularly in the cloud as businesses must determine whether they will stick with legacy approaches, join the cloud, or adapt a hybrid model. This is particularly true overseas, and SolarWinds identifies "expanding our international footprint" as a key means for further growth.
Keeping track of SolarWinds' financial numbers is rather tricky because the company draws a distinction between the time that it went public and when it went private due to the aforementioned acquisition. SolarWinds states that its total revenue in 2016 was $469 million compared to $728 million in 2017, representing a growth of 55%. Furthermore, SolarWinds' net losses over that same time period decreased from a loss of $334 million to $83 million.
These numbers might be enough to attract investors, but there are other reasons to be concerned. First, revenue growth from the first six months of 2018 compared to the same period in 2017 was just 17%, while net losses rose from $45 million to $86 million. We could be seeing the nightmare scenario of slow revenue growth while SolarWinds fails to reach profitability.
SolarWinds' inconsistent if not declining revenue growth does make it difficult to calculate valuation compared to expected future earnings. But the company has 301 million shares, which at the midpoint IPO price of $18 would create a market cap of around $5.4 billion. Divide that by the total 2017 revenue of $728 million and we are looking at a P/S ratio of 7.46. This is higher than two of the biggest competitors SolarWinds mentions, Micro Focus International plc (NYSE:MFGP) and NetScout Systems (NASDAQ:NTCT).
The second concern is SolarWinds' debt. SolarWinds' private equity owners have shouldered their own debt onto the company, leaving SolarWinds with a total of $2.24 billion in debt. SolarWinds has stated that it plans to use its net IPO proceeds "to repay the borrowings outstanding under our second lien term loan," and investors should never feel great about seeing their money used for such a purpose instead of fueling growth. SolarWinds' efforts to grow internationally could also be stymied due to its lack of experience operating overseas and with foreign countries which take different perspectives on technology and privacy.
Hold Off for Now
SolarWinds is not a bad choice for a tech IPO and it can plausibly argue that its valuation is fairly cheap and it can continue to grow given the high demand for its tech products. Those investors who can buy at that $17 to $19 level should feel confident about their prospects.
But most investors will not have that opportunity and will have to consider whether they want to buy in the aftermath of the typical post-IPO bump. I would argue no. SolarWinds could be a good company, but so could many of the other tech IPOs which have gone public only to fall back to Earth later. If it does eventually fall back to less than $20, then investors could look at its potential and consider buying. But over the short time, it will be better to look elsewhere.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.