Key Takeaways for the Rapid7 IPO
Rapid7, a leading provider of security risk intelligence solutions, plans to raise at least $80MM and is opening on secondary markets tomorrow. Rapid7 uses data analytics to detect and reduce security threats and has received $90MM in funding from investors such as Bain Capital and Technology Crossover Ventures. After combing through their S-1 and looking at SaaS benchmarks, I am bullish long on the Rapid7 IPO because they show significant potential from both technological and financial angles. Here are the top three takeaways for the Rapid7 IPO:
1. In 2014, Rapid7 had $76.9MM in revenue but a net loss of $32.6MM. However, investors will not be particularly focused on profitability while valuating the Rapid7 IPO. SaaS valuations are not directly correlated to EBITDA margins, in fact, it is sometimes even discouraged when growth stage SaaS companies boost their margins at the expense of revenue growth. FireEye’s 2013 IPO serves as a very strong benchmark from both a business perspective (IT Security, B2B SaaS) and financials standpoint. In 2012, their revenue was $83.3MM with a net loss of $35.8MM, and they smoothly beat expectations by opening at $20/share for a $2.3B valuation. Investors were focused on FireEye’s 147% jump in revenue from the previous year and aggressive growth strategies. While a potential big difference is that Rapid7’s 2014 revenue is significantly more modest at a 28% increase from their 2013 figures (with a similar growth rate projected for 2015), it is also important to note that the high end of their expected IPO range at $15/share would translate into a market value of approximately $691.07MM. This is 8.3x LTM Revenue. Currently, public comparables such as FireEye and CyberArk trade at significantly higher multiples (16x and 14x revenue respectively). From this first glance, it is likely that the Rapid7 IPO will meet expectations given the amount of implied value they have.
2. While valuating the Rapid7 IPO, it is important to be aware that a common theme before IPO’ing among successful public B2B SaaS companies is moving away from research & development (R&D) and focusing on growing direct sales. The point of this turnaround in hiring strategy is that SaaS enterprises are simply looking to invest more into selling the product when R&D reaches a matured state. Looking at Rapid7’s operating expenses, we see a steady increase in sales & marketing expenditures vs. R&D costs. For example, sales & marketing expenses increased $17.22MM from 2013-2014 vs. R&D increases of $4.17MM in the same period – clearly representing a larger budget/revenue. Also interesting is that R&D even started off by having a slightly larger budget/revenue increase than sales & marketing from 2011-2012 ($2.61MM more). Therefore, it was not until 2013 when Rapid7 showed a full turnaround in hiring strategy. After the Rapid7 IPO, it would be interesting to see if they aim to become more of a pure product portfolio company in the long run; in that case, expect to see a return in more budget allocated for R&D.
3. An important metric for the Rapid7 IPO is sales efficiency. Now that we know they have put a greater emphasis on sales, it would be nice to understand how well they return on this investment. Their total revenue in 2015 Q1 was $23.57MM with a total sales & marketing expenditure of $13.23MM, indicating a quarter sales efficiency of 1.78. To double-check for potential cyclical variance, we derive a 2014 annual sales efficiency figure of 1.57 just for comparison and as a more conservative reference. Tomasz Tunguz of Redpoint Ventures provides a benchmark study for sales efficiency, showing that the average 15 year old SaaS companies operates around the 0.85 mark (Rapid7 was founded in 2000), and that average sales efficiency does not surpass 1.35 for SaaS groups of any age. This metric does not take into consideration churn so we should take into account Rapid7’s churn rate of 15% for 2014. Using FireEye as a “success” case, we can see that Rapid7’s 2014 churn rate is actually higher than FireEye’s 2011 and 2012 (right before their IPO) churn of “less than 10%”. I calculated FireEye’s 2012 sales efficiency to be 1.23, which means that right before their IPO, they had a lower sales efficiency than Rapid7 even while boasting a higher renewal rate. Thus, we can assume that Rapid7 performs relatively well in sales efficiency and is expected to do so in the near future.
(Courtesy of Tomasz Tunguz)
The success of the Rapid7 IPO will be dependent on a plethora of variables and intangibles. That being said, these are some of the more interesting points one could take away from their S-1 release.