Public Markets

Under The Hood Of The Zscaler IPO

Illustration of piles of gold coins to represent money

Cloud security shop Zscaler filed to go public last week, a move that didn’t garner much attention and was later trampled by Dropbox, which dropped its own S-1 last Friday.

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But let’s not let that stop us from taking a look under the hood. After all, Zscaler is worth north of a billion dollars and has raised more than $100 million, making it part of the unicorn cohort that investors are hoping will go public this year, at last.

(TechCrunch’s Katie Roof broke the news that Zscaler filed privately back in October.)

To get our mitts around the company’s history, we’ll take a peek at its funding saga. Then we’ll dive into its newly-public numbers. Let’s go.

The Past

Zscaler’s funding history is surprisingly relaxed, according to Crunchbase, which lists just two rounds for the San Jose-based enterprise cybersecurity startup.

The company raised a $38 million Series A led by Lightspeed Ventures in 2012, and a massive $110 million Series B led by TPG Growth in 2015. The $1.1 billion round came at a post-money valuation of $1.11 billion, according to Crunchbase.

And that’s it. Notably, Zscaler’s S-1 notes that it raised $84.7 million from “the issuance of preferred stock” in 2015, and $25 million from the same source in 2016. Those two figures add up to just under $110 million, so it seems somewhat likely that the firm’s 2015, $110 million round came in two tranches. That explains perhaps somewhat why it hasn’t raised since.

But, no matter, the firm has a nine-figure IPO coming up. With a $100 million placeholder number on its S-1 for its expected raised, Zscaler has given us a general range for its impending self-powered exit, but we won’t know more until it drops a price range.

The More Recent Past

Now, to the good bits.

As we dive into its numbers, it’s important for us to bear in mind that Zscaler operates as a SaaS company, meaning that it reports its retention rates, cohort group performance, and more. And, as a SaaS company, it spends heavily to attract new customers that it expects to generate expanding, future revenues.

So it’s top-level financials are not entirely surprising. They show growth, heavy spend on sales and marketing, and recurring losses:

The company’s calendar is weird, so keep in mind that the first three full-year columns deal with periods ending on July 31st, while the final two columns compare half-year results ending January 31st. Why? Many SaaS companies shift their quarters back by a month so that their salespeople don’t wrap their Q4 on December 31st. That gives both the salespeople and the company a better chance to have a good holiday quarter. So here the firm is showing us three full-year, fiscal periods, and two H2 results so that we have the company’s performance through the end of January 2018.

That aside, how do the numbers look? Greater than 50 percent revenue growth from fiscal 2016 to fiscal 2017 is good at its reported revenue baseline. And the firm’s net losses aren’t too scary on a percentage or raw basis compared to its top line.

That’s especially true looking at the firm’s half-year results ending January 31, 2018 (the final column). Zscaler’s net losses were 21 percent of its revenue in that quarter, off of 51 percent revenue growth. That’s not quite Rule of 40 range, but if you instead considered the firm’s adjusted losses, I’m sure it would meet the benchmark.

The Incremental Present

Now let’s zoom in to quarterly results. Before we tease out things to dial in on, here’s the raw tally:

I know that’s a bit small. To help, here’s what to see:

  • Smooth sequential revenue growth. No one-off declines and the same goes for the firm’s gross profit.
  • Decelerating net losses in the last few quarters. From the quarter ending July 31, 2017, to the quarter ending January 31, 2018, Zscaler’s revenue grew from $36.5 million to $45.0 million, or 23 percent, while its net loss fell from $13.3 million to $6.5 million, a 51 percent decline.

The firm’s quarter-ending 14 percent net loss percentage (of revenue) is the lowest in its reported quarterly results. So the firm recorded its largest raw dollar gain in revenue (from the October quarter to the January quarter) while posting a record-low net loss, as a percentage of revenue.

In human, that simply means that the firm is losing less money as it grows more quickly. That’s good and nearly odd for a SaaS company.

Speaking of which, how are its SaaS vitals?

Interlude For The SaaS Nerds

During its last two fiscal years, Zscaler posted a dollar-based net retention rate of 115 percent. That’s pretty good. But the firm also posted a 122 percent dollar-based net retention rate during the six-month period ending January 31.

So the firm managed to expand that figure in recent quarters, a fact helps explain its recent growth and declining net loss as a percentage of revenue.

How does the firm decline dollar-based net retention? Here’s the verbiage:

Our dollar-based net retention rate compares the recurring revenue from a set of customers against the same metric for the prior 12-month period on a trailing basis. […] Our dollar-based net retention rate includes customer attrition. […] Dollar-based net retention rate is obtained by dividing the ARR in the current trailing 12-month period by the previous trailing 12-month period.

Unless I am missing something, that sounds pretty reasonable. This is one of those SaaS metrics that you don’t want to be too squishy.

Moving along, how is the firm doing on a billings basis? After recording a $156.4 million billings result during its fiscal year ending July 31, 2017, the firm put up the following figures:

What will be interesting is how public investors stack that billings result against the same-period revenue result of $84.8 million for the six month period ending January 31, 2018.

The Future

Zscaler had negative free cash flow of $13.5 million in its last two quarters. Compared to its extant $71.6 million in cash and impending IPO haul, it will have more than enough capital for several years of growth. Perhaps enough to get it to free cash flow break even. But let’s not prognosticate there.

Instead, the next question for Zscaler is what is it worth. The firm’s books, I reckon, are good enough for it to go public. At what price is the obvious question.

Quadrupling its last quarterly result gives us a $179.9 million ARR figure. Using Box’s last quarter’s reported revenue as a similar starting point to calculate its ARR, the storage company’s ARR multiple is about 6.25 (data via Yahoo Finance). At that multiple, Zscaler is worth $1.13 billion.

Which, if you recall where we started this piece, is nearly precisely what the firm was valued at in 2015. So Zscaler has grown into its prior valuation—at least according to our very crude math. Perhaps it won’t price down, giving a bit of tailwind to Dropbox.

More when it prices.

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