Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

If you take a highflying technology startup and remove its essential essence of unprofitability, will it still stay aloft?

Just 17 percent of technology companies that hit the stock markets this year have been profitable, tied with 2014 for the lowest mark since the dot-com bubble, according to data from University of Florida finance professor Jay Ritter. It’s fair to assume the current crop of richly valued private tech companies range from unprofitable to wildly unprofitable .

Slim Chance for Profits
The share of technology companies that are profitable when they go public is at a level last seen during the dot-com bubble.
Source: University of Florida Finance Professor Jay Ritter
Profitability in most cases is for the 12 months prior to the IPO.

And now here comes the initial public stock offering of Atlassian, founded by two Australians who run the company like twins with a shared brain. It is in the unglamorous business of making software such as HipChat and Jira used by teams of employees to swap digital messages and organize work projects.

And the company makes money. Atlassian posted net income of $6.8 million in the year ended June 30, and revenue rose 49 percent. Square, in a not atypical startup financial profile, had a loss of $154 million in 2014, when revenue rose 54 percent. 

“We are proud of our history of profits and cash flow,” Atlassian’s top finance executive said in a video pitch for the company’s initial public offering.

At Uber, you get your mouth washed out with soap for talking that way. 

I wondered about the investor appetite for owning a piece of a company like Atlassian that had rapid sales growth -- but not lightning fast, by startup standards -- plus profits.

It turned out the appetite was ample. Atlassian bumped up the estimated share price for its initial public offering, and on Wednesday evening sold its first batch of public shares even higher. The IPO gives Atlassian a market value of about $5 billion, including the value of stock previously  issued to employees. This is the way IPOs should go -- with a first-day valuation pleasantly higher than when the company was private. Yet that pattern hasn’t held recently, at Square or Box or Hortonworks or more.

The IPO market in general -- and tech offerings in particular -- has had an annus horribilis and could use a dose of good news like Atlassian’s flashback to the good old days. The share of new offerings from the tech industry hit a seven-year low in 2015.  For 12 of the 27 tech companies that have held IPOs in North America this year, their shares trade now below the price of the first sale of stock, according to Bloomberg data. 

Unfortunately for people pining for a rebound, Atlassian’s odd financial profile makes it a poor barometer for the broader tech IPO market in 2016. Part of Atlassian's investor pitch was it is different in part because it is profitable and proud. The tech startups that may test the IPO waters soon -- mostly little known business technology companies such as AppDynamics, DocuSign, Nutanix -- most likely aren’t making money. 

And even for Atlassian, its profitable business model may not work as well in the future. Like many young companies that offer software for businesses rather than for consumers, Atlassian has sought to avoid one of the costly trappings of older, corporate tech companies such as EMC or Oracle: sales representatives who butter up the executives who buy corporate technology over games of golf or steak dinners.

The thinking goes that new technology is so good it sells itself. Companies or their workers can just go to a website, try out software free for a while and fork over a check if they like what they use. 

Atlassian’s costs to advertise its products, pitch its wares at conferences, pay sales partners and more was 16 percent of revenue in the most recent quarter, and 21 percent of revenue in the year ended June 30. Compare that with other business software companies such as Box or Salesforce, where 81 cents and 48 cents, respectively, of every dollar of revenue goes to pay salespeople and for related costs. Keeping sales expenses and marketing expenses low is a big reason Atlassian turns a profit. 

Sales in Force
Atlassian spends far less than its peers on salespeople and marketing to pitch its products.
Source: Company filings

It turns out, though, that even young companies find they need some closers with suits and ties to sell software, particularly if they want to sign up the biggest and stuffiest corporations. Box, a maker of software to stow digital files, at one time didn’t think it needed salespeople, either. Customer-service software firm Zendesk, which went public last year, has increased spending on salespeople and marketing to give itself a better shot at landing contracts with large corporations that have big tech budgets. 

Technologists like to believe the best product always wins. But business isn't a meritocracy, and good technology often needs a good sales-and-marketing organization behind it. Investors who plan to buy and hold a novel tech company with profits should consider that Atlassian’s most distinctive quality may not last. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Being unprofitable is not necessarily a bad thing. For private companies, investors have recently rewarded companies that are grabbing like mad at new business opportunities, no matter the cost. Public market investors have grown more skeptical of this growth-at-all-costs dynamic, and there are signs some private startups also are under pressure to scale back their ambitions and spending.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net