Technology initial public offerings have proven to be among the best investment opportunities to capitalize on in recent years. Advances in technology and the continuous shift toward data-driven economies have played their part, causing the number of tech startups going public to increase.
As recent history has shown, however, not all emerge strongly from their IPOs. Companies like Twitter Inc. (TWTR, Financial), Zynga Inc. (ZNGA, Financial) and Groupon Inc. (GRPN, Financial) have struggled to live up to their potential. As such, there is always a level of risk involved. In addition, even after an impressive performance during the first few months after going public, long-term success is never guaranteed.
Therefore, when Smartsheet Inc. (SMAR, Financial) went public last week, many would have been excited by the opportunity to invest in this pure-play unified operations platform. Smartsheet is a software as a service application that boosts efficiency by creating an interface that links different work teams together to improve collaboration and work management.
The cloud-based software allows organizational teams to initiate tasks, manage and work on projects while providing real-time insights to managers. This unique approach to operations has seen the company register more than 92,000 customers already. Reports also indicate that two-thirds of the companies in the S&P 500 index are using the application, which again provides Smartsheet with a vote of approval from the corporate sector’s largest companies.
Analysts deemed the company’s IPO price of $15 per share as expensive, but after going public last week, the company’s stock is up approximately $4.20 to around $19.20 per share, valuing the company at nearly $1.9 billion.
Based on Smartsheet’s 2017 revenue of about $111 million, the company’s stock is effectively trading at about 17 times price-sales. This is a significantly rich valuation for a company that, despite its disruptive business model, still faces stiff competition from industry giants like Microsoft Corp. (MSFT, Financial) and Alphabet Inc. (GOOG, Financial) (GOOGL, Financial).
Rather, perhaps investors are looking at Smartsheet’s revenue growth over the last three years, which, according to records, has averaged a compound annual growth rate of 65%. In 2015, the company posted sales of $40.8 million, which increased 64% to $67 million in 2016 before jumping 66% to $111.3 million last year.
The downside to the company’s top-line growth has been its rapidly rising expenses. Last year, Smartsheet’s operating expenses more than tripled to $49 million from the previous year’s figure of $15 million. While the company still boasts a strong cash position of nearly $200 million, potential investors will be looking at its negative bottom line coupled with rising costs as a potential obstacle to sustained growth.
While Smartsheet’s early life as a public company might be appealing to investors, following the 28% gain in stock price since its IPO, others will remember previous tech startups that came with disruptive business models but failed to rally after an initial spike in price.
Daily goods giant Groupon and social gaming company Zynga are good examples in this case.
In summary, based on Smartsheet’s recent history of revenue and operating expenses, the company is clearly spending a lot to generate sales, which will be detrimental to its ability to break even and start netting profits. Furthermore, now that it is a public company, it will be under more scrutiny, which makes it harder for subpar performances to go unnoticed.
While the company’s access to capital via public funding might significantly bring down its overall cost of capital, administrative costs will certainly increase, which will affect its short-term performance. Therefore, now may not be a smart time to buy Smartsheet. Waiting for a pullback might create a better opportunity to buy the stock.
Disclosure: I have no positions in the stocks mentioned in this article.
