IPO opportunities in the cloud — Charles Kane

MIT Sloan Sr. Lecturer Charles Kane

MIT Sloan Sr. Lecturer Charles Kane

From the Boston Business Journal

IPOs are making a comeback, according to Ernst & Young. E&Y surveyed 300 institutional investors and found that 82 percent had invested in IPO or pre-IPO stocks in the previous 12 months, compared with only 18 percent in the prior two years.

While the rebound has occurred across industries, investors clearly like certain kinds of companies more than others. Biotech has had a string of successful IPOs. This infusion of capital will allow companies to get their products to market faster, which should get us closer to curing or combating diseases. The social media industry also has been drawing IPO investors of late, despite Facebook’s bungled IPO in the spring of 2012.

Another area where firms have had success going public is software as a service or SaaS. I am on the boards of two SaaS companies that went public in the past two years — Carbonite and Demandware. The stock price of Carbonite has appreciated nearly 40 percent from its initial pricing, while Demandware’s value has gone up over 300 percent from its initial pricing. After some initial wariness, Wall Street has come around to understanding and appreciating the Software as a Service business model.

SaaS offers software to customers on a subscription basis, usually via the cloud. From a business standpoint, the most attractive thing about the model is its predictable revenue. SaaS companies book revenue the same way the phone company does — a month at a time. And customers commit for multiple years, which means that revenue and cash flow become highly visible over extended periods of time.

This sort of predictability is a CFO’s dream and exactly what Wall Street is looking for today. After the market ups and downs of the past six years, investors don’t want to be surprised anymore.

It took investors awhile, but they have finally gotten the SaaS model. Salesforce, founded in 1999, had a successful IPO in 2004, and others soon followed. Customers like the model, which allows them to lease software, paying for it in small pieces. The growth of the cloud and the spread of Internet access have helped to fuel Software as a Service.

Big bursts of profits are unlikely for companies that derive their revenue from monthly subscriptions. But slow and steady growth is not a bad prospect for any company or for investors looking for valuation enhancement.

Charles Kane is a senior lecturer in finance at the MIT Sloan School of Management.

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