Qualtrics IPO: Does It Provide 'Alpha' At 11x Forward Sales?

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About: Qualtrics International (XM)
by: Wilsonville Capital

Summary

Qualtrics develops a new type of software sold under the name of XM™ Platform that helps organizations collect feedback and data and transforms it into insight to create value.

The initial public offering price will be between $18.00 and $21.00 per share.

Qualtrics is not expensive as other software companies with similar gross profit margin trade at 13x sales. However, the company is not cheap either.

In 2017, the company reported revenue of $289 million, 52% more than the revenue in 2016. Additionally, the gross profit is also quite impressive.

Sequoia Capital, Insight Venture Partners and Grandview Holdings LLC decided to invest in Qualtrics.

Reporting 52% y/y revenue growth and cash comprising of 41% of the total amount of assets, Qualtrics (XM) will interest growth investors. In addition, the company reports positive and growing net income, free cash flow and CFO, which should also capture the attention of value investors. The price is not overvalued at 11x forward sales as other software companies trade at 13x sales with similar gross profit margin. However, it is not undervalued either. Other software companies trade at 7x sales.

Source: Prospectus

Source: Prospectus

Business

Founded in 2002, Qualtrics develops a new type of software sold under the name of XM™ Platform that helps organizations collect feedback and data and transforms it into insight to create value.

The company's platform has five key elements. Firstly, there is a research core, which helps collect and build data systems as well as aggregate and analyze data. Additionally, the company offers four more modules for understanding customer sentiment, employee experience from recruiting and onboarding to performance management, brand perception and product assessment. The images below provide further details:

Source: Company's Website

The solution of Qualtrics seems to be helping many large organizations. It says a lot about the company. The XM™ Platform is being used by over 9,000 international customers and about 75% of the Fortune 100.

There is another very relevant fact to be mentioned. The fact that large organizations are ready to trust Qualtrics seems quite beneficial. Keep in mind that the software assesses data that could interest competitors very much. The software seems to be very well prepared to protect the data being assessed. It is a benefit that is highlighted in the prospectus. Read the following lines for further details:

Source: Prospectus

The ratings given by users are very beneficial. Investors can take a look, for instance, at this forum. Clients noted that the software can be used easily and the analytics are very informative:

Source: Fitsmallbusiness

On the contrary, many clients complained about the price of the platform. According to the same forum, not every company can afford a high price of the company's solution. Shareholders should not really care about this comment. For them, free cash flow and net income seem more relevant than the price of the software. The image below provides further details:

Source: Fitsmallbusiness

The prospectus reads that the total market opportunity equals $44 billion in 2018. In order to obtain this figure, Qualtrics estimated the number of clients with revenues larger than $50 million, governments, and K-12 academic institutions. The number of potential clients was multiplied by the calculated annual contract value. The company did not mention the CAGR at which the market opportunity grows, which is not ideal. The lines below provide further details:

Source: Prospectus

52% y/y Revenue Growth

Growth investors should appreciate the income statement very much. In 2017, the company reported revenue of $289 million, 52% more than the revenue in 2016. Additionally, the gross profit is also quite impressive. Qualtrics reported gross profit of $210.8 million and $129.62 million in 2017 and 2016 respectively. The image below provides the income statement:

Source: Prospectus

Value investors should also appreciate Qualtrics because the company reported positive net income in 2017. It was equal to $2.55 million, which is much better than the losses reported in 2016, equal to -$12.034 million. Qualtrics seems to be experiencing an upward trend both in revenues and net income. If the good results continue, shareholders should benefit.

The cash flow statement is also beneficial. The company reported positive CFO in 2016, equal to $17.8 million, and 2017, equal to $39.6 million. This means that the CFO is growing 122% y/y. DCF modelers should appreciate it. If the company can deliver similar returns in 2018, the share price could be pushed up. The image below provides the cash flow statement:

Source: Prospectus

The company also reported positive cash flow in 2016 and 2017, equal to $3.4 million and $21.3 million respectively. The image below provides more details:

Source: Prospectus

Finally, growth investors will appreciate that the company has been able to report positive FCF since it commenced in 2002. Read the lines below:

"Qualtrics has steadily grown and been free cash flow positive in each and every one of our 16 years." - Source: Prospectus

Cash Comprises 41% Of The Total Amount Of Assets

The balance sheet is quite beneficial. The asset side shows everything that an analyst is looking to find. Firstly, 83% an increase in the amount of cash in 2017, totaling to $113 million. In addition, in 2017, there was a 55% increase in the amount of assets, totaling to $280.33 million.

The amount of receivables is not significant, equal to $81.6 million, and the amount of intangibles and goodwill is small. The most significant asset of Qualtrics is its cash on hand, which comprises almost 41% of the total amount of assets. The image below provides more details on this matter:

Source: Prospectus

Liabilities

The liability side should not worry investors. The amount of total liabilities was equal to $260 million, which is not large. In addition, it is beneficial that the company shows no financial debt. The most significant liability is deferred revenue of $216.39 million. The image below provides further details:

Source: Prospectus

The list of contractual obligations given by Qualtrics shows that the company has no financial debt. Additionally, it shows that the operating lease commitments are only equal to $56.6 million. The company has to pay a total amount of obligations of $63 million, which is less than the total amount of cash. The table below provides further details:

Source: Prospectus

Use of Proceeds

Given that the company has cash on hand and is in a solid financial shape, investors may be wondering why it organized an IPO. Qualtrics is expected to use the cash to satisfy tax withholding obligations for the settlement of restricted stock units. Investors may not appreciate this feature. With that, the company also expects to use some proceeds for sales and marketing and other purposes. The lines below provide further details:

Source: Prospectus

There is an alarming fact that investors should take into account. The company expects to have cash on hand for at least the next 12 months. After this time period, it could sell more equity, which could push the share price down.

"We believe our existing cash and cash equivalents, together with cash provided by operations, will be sufficient to meet our needs for at least the next 12 months." - Source: Prospectus

Capitalization

The company expects to have $510 million in cash after the IPO. With 215.952 million shares to be outstanding after this offering at $19 per share, the market capitalization should be $3.593 billion. The image below provides further details:

Source: Prospectus

Investors may not appreciate that the company expects to have several class types. The following lines provide details on different amount of votes of each class type:

"Class A-1 common stock, Class A-2 common stock, and Class B common stock. Class B common stock is entitled to one vote per share and Classes A-1 and A-2 common stock are entitled to ten votes per share." - Source: Prospectus

Directors own large amount of A-1 and A-2 common stock, and they own 81.3% of the total voting power. Investors should not appreciate this fact. The Board of Directors could be non-independent and take decisions to benefit the largest shareholders. It could damage the interest of small shareholders. The image below provides additional details:

Source: Prospectus

It is beneficial that institutional shareholders, Sequoia Capital, Insight Venture Partners and Grandview Holdings LLC, decided to invest in Qualtrics. These investors do not seem to care about the fact that Qualtrics is a controlled company.

Valuation

Assuming revenue growth of 52% y/y, forward revenue of $323 million seems reasonable. With an enterprise value of $3.593 billion, the EV/Forward Revenue equals 11x.

The prospectus reads that Qualtrics competes with the following companies:

  • Medallia (MEDAL)

  • Aon Hewitt

  • Towers Watson (NASDAQ:WLTW)

  • SurveyMonkey (NASDAQ:SVMK)

SurveyMonkey seems a suitable company for making a comparison with Qualtrics. SurveyMonkey has an enterprise value of $1.72 billion, and trades at 7.4x forward revenues. The numbers were taken from YCharts. They can be seen in the image below:

Source: YCharts

The gross profit margin of SurveyMonkey is 70%, but it does not report large revenue growth. With these figures in mind, it makes sense that Qualtrics trades at an EV/Forward Revenue larger than that of SurveyMonkey.

There are other software companies, which recently organized an IPO and could be comparable with Qualtrics. DocuSign, Inc. (DOCU), with revenue growth of 35.51% and gross profit margin of 76%, trades at 13x sales. There are also Avalara (AVLR) and Eventbrite (EB), which trade at 8.74x sales and 8.71x sales respectively with a large gross profit margin. The numbers were obtained from YCharts:

Source: YCharts - Valuation

With these figures in mind, Qualtrics is not overvalued as DOCU trades at 13x sales with similar gross profit margin and revenue growth. However, it is not cheap either. AVLR, EB and SurveyMonkey trade at below 9x sales. Let's tell it this way. The current price does not represent an opportunity. Investors should wait for some time until the company trades a bit lower.

Conclusion

With 52% y/y revenue growth and cash comprising 41% of the total amount of assets, Qualtrics will interest many investors after the IPO goes live. The company is profitable at the net income level and reports positive free cash flow and CFO.

The shares are being sold at 11x forward sales in the IPO. It is not expensive as other software companies with similar gross profit margin trade at 13x sales. However, the company is not cheap either. Keep in mind that there are other competitors trading at 7x sales. Perhaps, waiting for a share price decline to buy shares is the most interesting strategy.

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.