Tech

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

All those technology startups avoiding IPOs like the plague -- and putting off potentially painful reality -- now have a new champion to justify clinging to the land of unicorns

AppDynamics Inc., a startup whose software helps companies pinpoint hiccups with their websites, was set to become the first significant IPO of 2017, which many experts think will bring a much-needed end to a two-year scarcity of new tech listings. 

Gone Missing
There have been relatively few U.S. technology IPOs in the last two years. Experts expect 2017 to break the drought.
Source: Bloomberg
Note: The number of listings exclude IPOs that raised less than $5 million.

Roughly 24 hours before AppDynamics was set to sell its first batch of public stock at a valuation of $2 billion or so, bigfoot Cisco Systems Inc. swooped in with a buzzer-beater purchase offer that snatched it from the IPO market. Cisco's offer was at a healthy markup of $3.7 billion, which includes existing AppDynamics stock awards. 

It's hard to ignore a sale that values AppDynamics at about 18 times the company's revenue in the past 12 months. For comparison, Facebook trades at 15 times trailing 12-month sales, and AppDynamics' publicly traded peer, New Relic Inc., as of Tuesday was valued at 8 times trailing 12-month sales. (One rich sale price lifts all boats. New Relic shares were 11 percent higher Wednesday morning on news of the AppDynamics deal.)

Pretty Rich
AppDynamics' sale to Cisco values the young software company at 18 times its revenue in the past 12 months. That's higher than Facebook's comparable multiple.
Source: Bloomberg and SEC filings
Note: Estimated IPO multiple for AppDynamics is based on its diluted share count as of Oct. 31, and assumes the company had sold 12 million IPO shares.

I'll acknowledge that AppDynamics is a real company with real technology that could be extremely valuable to Cisco. A doubling of valuation was apparently the price needed to take AppDynamics off the IPO table, and Cisco, with its $71 billion in cash and investments, doesn't care about outlandish multiples. 

The sale also renders moot some qualities that weren't ideal for AppDynamics' start of life as a public company. Like many young tech companies that grew up in the years when startups had easy access to cash, AppDynamics had a messy capital structure and lack of financial discipline. Like many young software companies, AppDynamics has fast-growing revenue but no profits, even though software companies tend to have gross margins north of 70 percent and have to try pretty hard to be unprofitable.

The company also reached to get a headline valuation of $1.9 billion a year ago -- and the bill for that decision was coming due. If AppDynamics had gone public at less than the $1.9 billion equity value from a late 2015 private stock sale, it would have owed those investors more shares to make up the difference. Those types of investor protections have become commonplace in recent years and helped startup valuations to balloon beyond those of comparable public companies. AppDynamics employees hired in the last year were issued equity valued at $12.48 a share or higher -- not so far off the $12 to $14 price that AppDynamics expected to sell its stock in the IPO. 

Still, AppDynamics most likely would have been a fine public company, just as New Relic is a fine public company even though it hit the public markets with a discount to its valuation. Until Wednesday's bump on the AppDynamics sale news, New Relic's stock price was essentially flat from the first day it ended trading after its 2014 IPO. The question is how long it would have taken AppDynamics to significantly and sustainably increase its pre-IPO valuation. 

Not Budging
Shares of AppDynamics' closest public peer, New Relic, are essentially flat since the company ended its first day of trading as a public company
Source: Bloomberg

It doesn't matter now. AppDynamics opted for the sure thing rather than risk life as a public company. It worked out great for AppDynamics, its early investors and employees.

But it's not a stellar message to send to other richly valued private tech companies that may not be able to go public today at their current valuations: Run the company however you like. Stretch valuations beyond reason. It could all work out fine. Someday your prince may come in the form of a rich tech company with a hunger for sales growth, cash burning in its pocket and dreams of a Trump tax break raining even more in the future.

Public market reality is boring. It's more fun to keep living in the mythical land of unicorns. 

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

  1. Of course there's always a risk AppDynamics sold too soon. 

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