This week has brought with it two tasty pieces of IPO news — Rackspace’s return to the public markets and BigCommerce’s debut will be far more interesting now that we know what a first-draft valuation for each looks like.
But amidst the numbers is a question worth answering: Why aren’t cloud-focused Rackspace and e-commerce-powering BigCommerce worth more?
Using a basic share count and the top end of their initial ranges, Rackspace is targeting a roughly $4.8 billion valuation, and BigCommerce a $1.3 billion price tag. Given that Rackspace had $652.7 million in Q1 2020 revenue and BigCommerce reaped $33.2 million in the same period, we have a puzzle on our hands.
Let me explain. At its IPO price, Rackspace is worth around 2x its current revenue run rate. For a company we associate with the cloud, that feels cheap at first glance. BigCommerce is targeting a valuation of around a little under 10x its current annual run rate, which feels light compared to its competitor Shopify’s current price/sales ratio of of 66.4x (per YCharts data).
We did some maths to hammer away at what’s going on in each case. The mystery boils down to somewhat mundane margin and growth considerations. Let’s dive into the data, figure out what’s going on and ask ourselves if these companies aren’t heading for a second, higher IPO price range before they formally price and begin trading.
Margins and growth
Let’s unpack Rackspace’s IPO pricing first and BigCommerce’s own set of numbers second.
Rackspace
While Rackspace has a public cloud component, its core business is service-driven, so it isn’t a major cloud platform that competes with Microsoft’s Azure, Google’s GCP or Amazon’s AWS. This isn’t a diss, mind, but a point of categorization.
The company has three reporting segments:
- Multicloud Services
- Apps & Cross Platform
- OpenStack Public Cloud
It’s the last segment that you might associate the most with Rackspace, but Multicloud Services makes up around 75% of its revenue, Apps & Cross Platform work accounts for another 13%, while its public cloud efforts a mere 12%. Rackspace, therefore, generates less than an eighth of its top-line from its public cloud.
The gross margins associated with its products are also far from what we tend to see from cloud-powered companies: 42.3% for Multicloud Services, 37.2% for Apps & Cross Platform efforts, and 51.0% for its public cloud, all from the 2019 period.
Now, factor in that the company’s revenue shrank by a slim margin in 2019 compared to 2018 and grew just 7.6% in Q1 2020 compared to Q1 2019, and you can start to see why Rackspace is worth a single-digit multiple of its revenue instead of what we might have guessed before reading its S-1 filings. It’s not hard to find other issues, either. The company’s gross margins eroded in Q1 2020 compared to Q1 2019, from a blended 41.3% to just 38.2%. Throw in nearly $4 billion in debt, and it’s a tough package to price along regular cloud multiples.
Is $21 to $24 per share (valuing Rackspace between $4.2 billion and $4.8 billion) a surprise once we’ve chewed through the numbers? Not really. If it can overshoot that range, however, it would do the company well. The more money that Rackspace raises in its IPO, the more debt it can delete from its balance sheet. That would help it get closer to GAAP profitability.
BigCommerce
Given the torrid rise of Shopify, you would be forgiven for expecting BigCommerce to price its shares at a stratospheric revenue multiple. Provided the company’s Q1 revenue result of $33.2 million, BigCommerce had a $132.7 million annual run rate at the end of March. So, what sort of valuation would you anticipate?
Let’s give you even more data: At the midpoint of its Q2 revenue range, BigCommerce’s annual run rate ticks up to $142.6 million.
Here’s the answer: At its interval of $18 to $20 per share, BigCommerce is worth between $1.18 billion to $1.31 billion. In multiple terms, at its Q1 run rate, BigCommerce is valued at 8.9x to 9.9x its run rate. At its Q2 midpoint run rate, those fall to 8.3x and 9.2x.
Given that the mean multiple SaaS and cloud companies receive today is in the upper-teens and Shopify is around four times that number, what’s up with BigCommerce?
Let’s stack it next to Shopify across a few metrics, using Q1 numbers as we don’t yet have Shopify’s Q2 results:
- Q1 2020 YoY revenue growth: 29.7% for BigCommerce, 47% for Shopify
- Q1 2020 gross margin: 77.5% for BigCommerce, 55% for Shopify
The comparative growth rates are not great for BigCommerce, but its gross margins are pretty legit compared to what Shopify is putting up. (Why are they so different? Revenue mix.) Given that it’s a bit plus one/minus one when we boil the two companies down to their most basic financial metrics, BigCommerce feels cheap at its current multiple.
Toss in the recent market exuberance for cloud shares that we’ve see in other IPOs, and it feels even more underpriced.
With Rackspace then, its valuation multiple feels reasonable, if perhaps a tiny bit cheap, but BigCommerce feels even cheaper.
Given that we’re in the pricing dance, both IPOs are rapidly approaching. Just don’t be too surprised if they price a bit higher than they are currently targeting.
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