Public Markets

Market Rewards Forescout’s IPO Haircut

TL;DR: Forescout’s IPO shows that demand for technology shares includes an appetite for stiffly-unprofitable cybersecurity firms.

Forescout is the latest US technology IPO of the year, with the cybersecurity company selling just under 5.3 million shares at $22 per share. In midday trading today, the company’s equity has risen 16 percent in value to $25.52 per share.

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The company priced at the peak of its proposed IPO share range, boosting the number of shares it would sell in its flotation as well.

The successful debut must be a welcome result for the San Jose-based firm which was founded in 2000, several eras ago in technology time. But it did come with a cost, or, more precisely, a haircut.

To get out the door, Forescout reduced its valuation from prior levels, as WSJ’s Cat Zakrzewski reported at the time of the firm’s final pricing:

The offering of 5.28 million shares raised proceeds of about $116 million, putting market capitalization at $806 million. ForeScout’s last private funding, led by Wellington Management in 2016, came at a $1 billion valuation.

A 20 percent cut is nothing to fall over about. Public companies may endure such corrections — and their inverse — on a nearly quarterly basis, for example. But among private companies, such changes carry more narrative weight.

Regardless, the firm has picked up a reward for taking the haircut and still pulling the trigger to go public in the form of a first-day bump. We never want to over-index learnings from a single data point, but this isn’t the first time we’ve written a sentence to that effect this year. Perhaps there is something to their shared directional bent.

Regardless, the firm is now worth nearly what it was before, it seems. Starting at $806 million, Zakrzewski’s IPO valuation for the firm, and moving up 16 percent takes us to $935 million, which is almost rounding-territory to flat for Forescout. It has filled its coffers once again.

Notes From The Spreadsheet

It being Friday, we can take a minute to stretch our legs to go over what is interesting about Forescout’s recent financial performance to underscore why this IPO is, in some ways, notable.

Forescout grew its revenue from $68.7 million in the first half of 2016 to $90.6 million in the first half of 2017. That nearly 32 percent growth came with a cost: losses ramping during the periods from $39.3 million to $46.9 million, a 19.3 percent change.

We can handicap those results however we want: It could be argued that the firm is posting material revenue growth at scale while showing improving margins and, thus, a path to profits. And it could be argued that the firm fails the Rule of 40 test by a fat margin and its losses in dollar-scale are too large for comfort.

But what we care about is that investors just priced a new chunk of revenue, which, in the case of Forescout, is about 50 percent product and 50 percent not. This matters, as we reported previously:

ForeScout isn’t growing as quickly as we might have expected from a heavily venture-backed, still-scaling company. One element of that is the firm’s revenue mix, which in the first half of this year came in two nearly-perfect halves: “Product,” and “Maintenance and professional services.” Only the latter is treated by the firm as recurring.

From page 57 of its S-1, observe how those revenues are discussed:

“Our net-recurring revenue retention rate on support and maintenance contracts as of December 31, 2014, December 31, 2015, December 31, 2016, and June 30, 2017 were 120%, 116%, 127%, and 128%, respectively.”

I raise this to underscore the IPO’s results. Forescout is not your traditional SaaS shop, a substance that is now well-understood by investors, private and public alike. Instead, Forescout is more of a traditional tech company, selling products and supporting them. More pre-Satya Microsoft than post-Satya Microsoft, if you will.

And the firm is back to being worth nearly $1 billion, putting its revenue multiple around 5, a level that we see mostly at SaaS firms.

That’s a bit odd. After all, recurring revenue is prized as it is recurring and thus more predictable. So why does Forescout end up worth just about the same on a per-dollar-revenue basis? I have a small guess: The firm was operating cashflow positive in the first half of 2017. That’s very non-SaaS and, frankly, positive.

To sum quickly: Forescout priced high in its range and saw its share price rise on day one, but it had to take a haircut in value to get out the door, perhaps due to its increasing deficits. However, the firm’s revenue is growing more quickly than its losses, and it is now operational cash flow positive.

Welcome to the public markets, in other words.

iStockPhoto / mattjeacock

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