But, those dark clouds on the horizon have indeed turned into a storm. Following two postponements (Riley Exploration, Valtech), a very weak pricing for a biopharmaceutical IPO (PHAS), and a cut in deal size for Niu Technologies (NIU), prominent cloud software company SolarWinds (SWI) also struggled to garner much enthusiasm for its deal.
Not only was SWI forced to drastically slash the IPO to 25.0 mln shares from 42.0 mln, but the deal also priced at the low end of a downwardly revised $15-$16 expected price range. Originally, the IPO was expected to price within $17-$19. So, in all, SWI generated $375 mln in gross proceeds, a whopping $381 mln less than it was looking for.
Again, in our opinion, the poor performance for SWI's IPO is more a function of the turbulent market for IPOs right now, rather than the health of its business. In fact, the company's gross margin is expanding, its is comfortably profitable, generating plenty of cash, and has a dominant market position. That's a lot more than many cloud software IPOs can say.
Unfortunately for SWI, though, the timing of its IPO did not help its cause. The good news, however, is that investors will be able to buy the stock as a significant discount, as compared to the original terms of the IPO.
The IPO, which was led by Goldman Sachs, JP Morgan, Morgan Stanley, and Credit Suisse, is set to open for trading later this morning on the NYSE.
Unlike a majority of cloud software developers that target non-IT users, SWI's products are used primarily by IT administrators. Put simply, its software gives enterprises and organizations of all sizes and types the ability to monitor and manage the performance of their IT infrastructures on premise, in the cloud, or in a hybrid setting.
Since being taken private in February 2016, the company has undergone some major changes -- namely, in the breadth of its product offerings and the markets it can serve. When the company launched in 1999, it mostly focused on on-premise desktop applications for network engineers. However, since being acquired, SWI began entering the cloud and Managed Service Provider (MSP) markets, expanding its product lines and addressable market. More specifically, over the past three years SWI has added 14 products. At the same time, it invested in its sales and marketing teams to better address these new markets.
Today, its products are designed to manage and monitor networks and systems across on-premise, cloud, and hybrid IT environments. As the company has launched more product offerings, it has also moved more towards a subscription-based model, as opposed to one-time sales, which has made its business more predictable but has also helped boost margins.
SWI calls its approach the "SolarWinds Model", enabling it to market and sell its products directly to network and systems engineers, database administrators, storage administrators, DevOps professionals and managed service providers. The company implements a high-velocity, low-touch direct marketing and direct inside sales approach. SWI also engages with 150,000 registered members through "THWACK", its online community designed to train and inform IT professionals about its products, while providing network effects to support word-of-mouth marketing.
Its total addressable market is vast, targeting businesses and organizations of all sizes, while having a very significant presence in the largest corporations. In fact, technology professionals in 499 of the Fortune 500 use its products. Overall, SWI has over 275,000 customers across 190 countries. Overall, the company estimates its total addressable market to be nearly $67 billion, with a majority residing in the under-penetrated SMB market.
Taking a look at its results for the six months ended June 30, 2018, revenue rose 17% to $398.6 mln. Subscription revenue, or, recurring revenue, increased by 28% to $324.1 mln, primarily due to sales of additional cloud management and MSP products. SWI's net retention rate for its subscription products averaged approximately 105% over the 12-month period ending June 30, 2018.
Thanks to the stronger growth in subscription based products relative to maintenance revenue, gross margin improved to 69.2% from 66.5% in the year ago period.
Total operating expenses increased a very management 9% to $231.7 mln and as a percentage of revenue actually fell to 58.1% from 62.4%. Like many other tech IPOs, Sales & Marketing is its largest expense. But unlike many tech IPOs, SWI has kept a lid on this expense; it has increased only 8% year/year.
As a result, the company's operating income surged by 217% to $44.1 mln.