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Pretend you are a SaaS company. And you have a pretty ok valuation. Nothing crazy, mind, you aren’t going to be worth as much dollar-for-dollar of revenue as say, or even will be once it debuts. But you’re a healthy SaaS company with a brand and a publicly traded stock.

Good job, it’s hard to reach this point. Most SaaS companies fail far before, so you’re a survivor. And you are worth a few billion dollars. That makes you a success as well. There have been articles written about you. Maybe your CEO has written a book. Or been on a hundred stages.

But then something bad happens. In one day, one moment, the stock market cuts your valuation by double-digit percentage points. It’s brutal, harsh, and a surprise. Things had been going so well!

Putting our little game aside, this has actually happened three times this week. Let’s explore why. The lessons here are warning signs for startups. This is what you don’t want to do once you go public.

Box, Zuora, And Pivotal

You’ve heard of the three companies: , , and .

, Box’s CEO, is a famously active executive which helped make his company far better known than it otherwise might have been. And that’s not a diss, nearly no one can make enterprise productivity and file storage hot. Levie actually pulled that off during the later-quarters of his company’s pre-public life.

Zuora is a stranger cookie. The firm is a SaaS company that powers SaaS companies. And that’s jolly good, really. The firm is a veteran of its space, and while it might not be as well known outside of tech as Box and Levie, it’s a name inside of the industry.

And Pivotal is a company that helps other companies use and manage clouds. As fewer companies want to build out their own server footprint, companies like Pivotal help firms use the cloud more intelligently. At least, that’s the idea.

So, what happened to each of our companies? Here’s the scorecard of their respective share prices after their results came out:

• Zuora: -29.7 percent on May 31 2019
• Box: -14 percent on June 4, 2019 (before recovering in later trading)
• Pivotal Software: -41 percent on June 5, 2019

We’re keeping Box as an example even though it recovered somewhat quickly as the initial market response to its earnings report meets our criteria. Here’s what each company did to garner the shocks, according to contemporaneous coverage:

:

The San Mateo company’s stock dropped [to] $14.72 after it said it expects revenue for 2020 to be between $268 million and $278 million — short of the $292 million expected by Wall Street analysts.

:

Box lowered its outlook for the year, leading to a sharp drop in the stock price. Box said it expects revenue for full year fiscal 2020 of between $688 million and $692 million, well short of the average analyst estimate of $702 million, according to Refinitiv.

:

Pivotal […] lowered its full-year revenue guidance and now expects sales of $756 million to $767 million, well below the Refinitiv consensus estimate of $803 million.

The theme is pretty simple. If you are a SaaS company that has long been valued on a hybrid of revenue quality (high-margin, recurring revenue) and growth, losing one of your two arguments in favor of your valuation is painful. To see three of these in such quick succession underscores the situation; this can happen to anyone, regardless of where they operate in the SaaS universe.

Illustration: .

The two companies filed recently (March 23 for Pivotal, March 26 for Smartsheet), so today we’ll take a quick look at the pair’s numbers to get a better sense of their respective health. As they will go out likely in a similar-ish timeframe (barring calamity), looking at them together doesn’t seem inappropriate.

We’ll begin with Pivotal, look at its funding history, peek at its operating results, and then do the same for Smartsheet. In we go.

Pivotal Software

Pivotal, a from VMware and EMC, raised extensive capital during its short life as an independent company. The self-described “cloud-native platform” shop raised an enormous from its parents (EMC, VMware), a comparatively modest from General Electric also in 2013, and a in 2016 from investors including Ford.

That’s about $1.7 billion in capital, .

So, ? For the fiscal year ending February 2, 2018, Pivotal had revenue of $509.4 million, up from $416.3 million the year before. The company’s revenue in its last fiscal year (up 22 percent, roughly), was split roughly 50-50 between subscription top line and services income.

As you might expect, the former has much higher margins than the latter. Pivotal generated $281.0 million in gross profit in its February-ended fiscal year, up nearly $100 million from the preceding year. And, despite increased costs in each operating category, the company’s GAAP net loss fell to $163.5 million, from $232.9 the preceding fiscal year.

Looking at a non-cash costs, the firm’s share-based comp costs came in between $28 million and $29 million its last two fiscal years, so the company’s GAAP losses are material. Indeed, Pivotal’s operating activities consumed $116.5 million in its last fiscal year, albeit an improvement from a $166.4 million operating cash burn the fiscal year before.

Still, there is some hope. Pivotal’s last fiscal year’s gross margin of 55 percent was up from 44 percent the year before, and up from 33 percent the year before that. That’s a ramp towards profits, just a long one from a company that remains so deeply unprofitable.

And why is Pivotal going public? It needs the money. With just $73 million in cash on its books, the firm needs more cash to feed its growth or it dies. Still, observing Pivotal’s quarterly results we can see generally falling net losses, and generally growing revenue. That’s worth something.

Smartsheet

is an interesting company. Based in Bellevue (that’s somewhere near Seattle, but not Redmond, where Microsoft is located), the SaaS work management tool (projects, tasks, calendars, etc) in its life, across four rounds.

Founded in 2005, Smartsheet raised $1.5 million in 2010, $17.5 million in 2012, $35 million in 2014, and $52.1 million in 2017.

That funding ramp helped the in top line during its fiscal year ending January 31, 2018. That was up about 66 percent from its preceding fiscal year ($66.9 million), which in turn was up 64 percent from $40.8 million.

That all sounds nice, until we examine the firm’s incredible net loss expansion. That’s not really what you want to hear, but observe the figures:

• Fiscal year ending January 31, 2016 net loss: $14.3 million (35.0 percent of revenue)
• Fiscal year ending January 31, 2017 net loss: $15.2 million (22.7 percent of revenue)
• Fiscal year ending January 31, 2018 net loss: $54.7 million (49.1 percent of revenue)

So, that’s yucky. Especially as the firm claims that a 130 percent “dollar-based net retention rate for all customers” in its most recently concluded fiscal year, up from 122 percent the fiscal year prior, and 113 percent the fiscal year before.

So, the company’s SaaS compound rate has gone up, while its percentage growth rate has been flat (no sin there: higher bases and nil percent growth are fine at scale), but its costs have skyrocketed. Why? A few reasons. First, it has raised its operating costs across each category. Again, not a huge sin. But the company did take a $15.5 million charge in its quarter ending July 31, 2017 relating to its “2017 Tender Offer.” Thus, to understand the firm’s rising unprofitability, we’ll have to grok that event.

In short, the firm allowed “current and former employees and directors” to sell $55 million in shares. That led to a share-based compensation cost of $15.5 million to the company due to a “premium over the fair value of the shares of common and convertible preferred stock.” So, that $15.5 million is a big whatever, for today at least.

So what happens to the firm’s net loss as a percent of revenue for the fiscal year ending January 31, 2018 if we cut out that line item? It runs out to 35.2 percent, which is more in line with its two-years-ago figure (see above), and quite higher than its prior-year result.

The question here, it seems, is how much investors like 65+ percent growth at scale (over $100 million in revenue), and if they are willing take on higher operating losses in the short term to buy revenue that may compound at a pretty significant net retention rate.

What’s The Short Version?

Fair ask, given that we ended up going on a bit above. So, as briefly as we can:

• Pivotal is a big firm backed by bigger firms that bleeds lots of money, but has its trend lines moving in the right direction (revenue up, losses down). The question for it is how the public market will value a company that consumes so much cash, and is only growing in the 20s.
• Smartsheet is a rapid-compounding SaaS firm that has an interesting cost question baked into its S-1. What trailing revenue multiple it can pick up going public could help us understand how to value other SaaS companies. However, not all its recent losses are real, as we learned from examining its recent tender offer.

There, now you are all prepped!