Category: Technology Stock Research

The Tech IPO Well Has Run Dry

Barrons logoAbout the author: Ben Rose is president of Battle Road Research, an independent equity-research firm.

After a banner year for initial public offerings of technology companies in 2021, the number of new issues dropped precipitously last year. The stock market correction of 2022 saw the largest tech stocks decline by a greater percentage than the S&P 500. The fall in investor appetite for even the most established tech stocks was a key reason for the dearth of new issues. The correction signaled an end to the era of free money, and the deep compression in valuations made it difficult for private companies to get a clear picture of their public market value. All of the tech-company IPOs of 2021 came to market having demonstrated revenue growth often exceeding 20% in the year prior to their debuts. But virtually all of the tech IPOs that we added to our Battle Road IPO Review generated losses leading up to their IPOs. Not only were the companies unable to turn a profit, virtually all recorded even greater losses over the prior year, as if the companies were being urged by their shareholders to indulge in a final feast to drive top-line growth. Many of these companies promised that after their IPO, they would embark on a steady diet of reduced operating expenses, in order to demonstrate a reasonable path to profitability.

One reason for executives and private round investors to justify the spending binge lies in the faith in the Rule of 40, which holds that any combination of revenue and earnings growth summing to 40% will be the best determinant of sustainable demand for a company’s public market valuation. In theory as well as in practice, a company could have a 20% revenue-growth rate, for instance, and operate at a substantial loss. The formula worked for several years leading up to last year’s tech stock rout. But the stress test of last year’s market correction debunked the Rule of 40. Even the fastest growing companies had their market capitalizations cut to the bone in a year of growth-stock compression.

The demand for growth stocks has undergone a sea change in the last six months. Technology behemoths Microsoft , Google , Amazon , Meta Platforms, and Salesforce , among many others, shed staff in the aftermath of an unsustainable rise in demand for their services, coupled with over-hiring during the pandemic. The decision to reduce operating expenses by companies that were already profitable is a sign that the terrain has shifted away from revenue growth at any price, to growth with a sustainable level of profitability.

Before answering the question why does profitability matter, it is worth asking whether companies with aspirations to go public in 2023 have the discipline in place to show not only top-line growth, but a pattern of steadily narrowing losses. My hunch is that many do not. The message that growth at any price will no longer cut it, is however, being learned the hard way. Many private companies have had their valuations slashed to reflect the lower valuations of their public-company peers. Indeed, venture-capital funding fell to a nine year low in the fourth quarter of 2022, The Wall Street Journal reported. Managing a business profitably will ultimately be rewarded, but the number of companies able to do so may remain limited.

Profitability matters because it demonstrates that a company has the potential, if not the power, to determine its own destiny. Conversely, operating losses are an indication that a company has yet to prove a working business model. The concern is that a company that loses money today will need to be bailed out tomorrow with future stock offerings or convertible debt, which in turn will dilute the interest of existing shareholders. It also means that a company will be unable to repurchase shares to offset equity issuance, a favored form of tech-company compensation which, if not held in check, results in shareholder dilution.

A company incapable of generating earnings today—no matter how promising its top-line growth prospects—may not yet be ready for the rough and tumble of the stock market. And if an unprofitable company does slip through the IPO window, it will likely need to be bailed out by a new round of investors, public or private. Until private companies and their financial backers realize that the terrain has shifted away from growth at any price in favor of growth along with profits—or at least a near-term path to break-even—the tech IPO well is likely to remain dry.

Pure Storage: Bringing Sustainability To Data Storage

Pure Storage LogoFirms of all sizes from every industry need a system to store and manage their data.  To do this, organizations require powerful solutions and technologies.  Unsurprisingly, these powerful data storage solutions consume vast amounts of energy, thus having an adverse impact on the environment.  As a pioneer in all-flash data storage – data storage infrastructure that only includes flash memory drives rather than spinning disk drives – Pure Storage’s systems mitigate the toll on the environment from all of these data storage endeavors.  With sustainability becoming increasingly important to companies, investors, and global citizens, Pure Storage is emphasizing and enhancing the environmental benefits of its data storage solutions over alternatives.

On January 17th, Pure Storage announced that it is now offering an enhanced Evergreen//One Energy Efficiency service level agreement (SLA) that guarantees energy efficiency for firms of all sizes.  This new SLA is the first and only guarantee of energy efficiency in the enterprise storage-as-a-service market.  The SLA allows companies to measure the energy usage of their data storage systems in Watts per tebibyte.  If firms’ maximum Watts per tebibyte thresholds are passed, Pure Storage is committed to providing them with service credits and will undertake remediation actions at no cost.  We note that this SLA fully aligns with Pure Storage’s mission to provide organizations with the most sustainable storage solutions.

This new SLA continues Pure Storage’s commitment to offering highly sustainable data storage products that contribute significant environmental benefits over alternative storage systems.  Beyond the new SLA, Pure Storage offers the densest and most efficient flash modules on the market, enabling firms to leverage better data storage features at a lower power output and cost than from the company’s rivals.  Pure Storage notes that its all-flash storage solutions operate up to 80 percent more efficiently than competing all-flash products.  As Pure Storage develops its products with an evergreen architecture – so they do not grow obsolete or have to be replaced – the company can mitigate energy waste by extending the lifespan of its hardware and delivering non-disruptive over-the-air updates.  We note that 97 percent of Pure Storage’s products are still in use six-years after they are purchased.  Pure Storage is able to provide more effective data storage with less power output and physical equipment, enabling organizations to limit their environmental impacts and costs.

With more and more importance placed on sustainability and the environment, combined with the need for organizations of all kinds to store and manage their data, it is crucial for firms to be able to operate data storage solutions that are not detrimental to the planet. Pure Storage is capitalizing on this, as the company’s all-flash data storage systems are the most environmentally friendly on the market.  As firms both large and small view the impact of their decision-making on the health of the planet, Pure Storage has leaned into its ethos, and stands to benefit from rising customer adoption.

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