Kellblog

I finally found  some time to read over the approximately 175-page registration statement (S-1) that enterprise social networking software provider Jive Software filed on August 24, 2011 in support of a upcoming initial public offering (IPO) of its stock.

In this post, and subject to my usual disclaimers, I’ll share some of my thoughts on reading the document.

Before jumping into financials, let’s look at their marketing / positioning.

• Jive positions as a “social business software” company.   Nice and clear.
• Since everyone now needs a Google-esque (“organize the world’s information”) mission statement, Jive has one:  “to change the way work gets done.”  Good, but is change inherently a benefit?  Not in my book.
• Jive’s tagline is “The New Way To Business.”  Vapid.
• Since everyone seems to inexplicably love the the tiny-slice-of-huge-market argument in an IPO, Jive offers up $10.3B as the size of the collaborative applications market in 2013.  That this implies about 2% market share in 2013 at steady growth doesn’t seem to bother anyone.  Whither focus and market dominance?

Now, let’s move to financials.  Here’s an excerpt with the consolidated income statement:

The astute reader will notice a significant change in 2010 when Jive Founder Dave Hersh stepped down as CEO and was replaced with ex-Mercury CEO Tony Zingale.  Let’s make it easier to see what’s going by adding some ratios:

Translating some of the highlighted cells to English:

• Jive does not make money on professional services:  they had a -17% gross margin 2010 and -13% gross margin in 1H11.
• In 2009,  a very difficult year, Jive grew total revenue 77% and did so with a -15% return on sales.
• In 2010, Jive grew revenue 54% with a -60% return on sales, while in 1H11, Jive grew revenue 76% with a -64% return on sales.
• In 2010, Jive increased R&D, S&M, and G&A expense by 127%, 103%, and 132% respectively.
• In 2010, Jive had a $27.6M operating loss, followed by a $30.6M operating loss 1H11

To say that Jive is not yet profitable is like saying the Tea Party is not yet pro-taxation.  For every $1.00 in revenue Jive earned in 1H11, they lost $0.90. People quipped that the Web 1.0 business model was “sell dollars for ninety cents.”  Jive seems to be selling them for about fifty-three.

But that analysis is unduly harsh if you buy into the bigger picture that:

• This is the dawn of a large opportunity; a land-grab where someone is going to take the market.
• You assume that once sold, there are reasonably high switching costs to prevent a customer from defecting to a competitive service.
• These are subscription revenues.  Buying $1.00 of revenue for $1.90 is foolish on a one-shot deal, but in this case they’re buying a $1.00 annuity per year.  In fact, if you read about renewal rates later on in the prospectus, they’re actually paying $1.90 for a $1.00 annuity that grows at 25% per year.

I’d say this is a clear example of a go-big-or-go-home strategy.  You can see the strategic tack occurring in 2010, concurrent with the management change.  And, judging by the fact that they’re filing an S-1, it appears to be working.

Before moving on, let’s look at some ratios I calculated off the income statement:

You can see the strategy change in the highlighted cells.

• Before the change, Jive spent $1.16 to get a dollar of revenue.  After, they spent $1.90.
• Before, they got $2.91 of incremental revenue per incremental operating expense.  After, they got $0.90.  (It looks similar on a billings basis.)
• Before, they got $6.76 of incremental product revenue per incremental S&M dollar.  After, they got $1.73.

Clearly, the change was not about efficiency.  You could argue that it was either about growth-at-all-costs or, more strategically, about growth as a landgrab.

But we’re only on page 6 of the prospectus, so we’re going to need to speed up.

Speaking of billings and revenues, let’s hear what Jive has to say:

We consider billings a significant leading indicator of future recognized revenue and cash inflows based on our business model of billing for subscription licenses annually and recognizing revenue ratably over the subscription term. The billings we record in any particular period reflect sales to new customers plus subscription renewals and upsell to existing customers, and represent amounts invoiced for product subscription license fees and professional services. We typically invoice the customer for subscription license fees in annual increments upon initiation of the initial contract or subsequent renewal. In addition, historically we have had some arrangements with customers to purchase subscription licenses for a term greater than 12 months, most typically 36 months, in which case the full amount of the agreement will be recognized as billings if the customer is invoiced for the entire term, rather than for an annual period.

The following table sets forth our reconciliation of total revenues to billings for the periods shown:

This says that billings is equal to revenue plus the change in deferred revenue.  Billings is a popular metric in SaaS companies, though often imputed by financial analysts, because revenue is both damped and seen as a dependent variable.  Billings is seen as the purer (and more volatile) metric and thus seen by many as a superior way to gauge the health of the business.

For Jive, from a growth perspective, this doesn’t strike me as particularly good news since billings, which were growing 99% in 2010, are growing at 59% in 1H11, compared to revenue which is growing at 76%.

Now we’re on page 8.  Happily the next 20 pages present a series of valid yet unsurprisingly risk factors that I won’t review here, though here are a few interesting extracted tidbits:

• The company had 358 employees as of 6/30/11.
• They plan to move from third-party hosted data centers to their own data centers.
• Subscription agreements typically range from 12 to 36 months.
• They do about 20% of sales internationally.
• They recently completed three acquisitions (Filtrbox, Proximal,  OffiSync).
• There is a 180 day lockup period following the offering.

Skipping out of page-by-page mode, let me pull some other highlights from the tome.

• There were 44M shares outstanding on 6/30/11, excluding 15M options, 0.8M in the options pool, 0.9M shares subject to repurchase.  That, by my math, means ~59M fully-diluted shares outstanding after the offering.
• Despite having $44.6M in cash on 6/30/11, they had a working capital deficit of $15.9M.
• The Jive Engage Platform was launched in February 2007.  In August 2007, the company raised its first external capital.
• The Jive Engage Platform had 590 customers as of 12/31/10, up from 468 at 12/31/09.  There were 635 as of 6/30/11.
• The dollar-based renewal rate, excluding upsell, for 1H11 for transactions > $50K was over 90%.  Including upsell, the renewal rate was 125%.
• Public cloud deployments represented 59% of product revenues in 1H11.
• The way they recognize revenue probably hurts the professional services performance because they must ratably take the PSO revenue while taking the cost up-front.

One thing soon-to-be-public companies need to do is gradually align the common stock valuation with the expected IPO price to avoid a huge run-up in the weeks preceding the IPO.  Gone are the days where you can join a startup, get a rock-bottom strike price on your options, and then IPO at ten times that a few weeks later.  Companies now periodically do section 409a valuations in order to establish a third-party value for the common stock.  Here’s a chart of those valuations for Jive, smoothed to a line, over the 18 months prior to the filing.

This little nugget was interesting on two levels, bolded:

The core application of the Jive Engage Platform is written in Java and is optimized for usability, performance and overall user experience. It is designed to be deployed in the production environments of our customers, runs on top of the Linux operating system and supports multiple databases, including Microsoft SQL Server, MySQL, Oracle and PostgreSQL. The core application is augmented by externally hosted web-based services such as a recommendation service and an analytics service. We have made investments in consolidating these services on a Hadoop-based platform.

First, it seems to suggest that it’s not written for the cloud / multi-tenancy (which, if true, would be surprising) and second, it suggests that they are investigating Hadoop which is cool (and not surprising).

More tidbits:

• 105 people in sales as of 6/30/11
• 122 people in R&D as of 6/30/11
• Executives Tony Zingale (CEO), Bryan LeBlanc (CFO), John McCracken (Sales), and Robert Brown (Client Services) all worked at Mercury Interactive.  The latter three were brought in after Zingale was made a director (10/07) but well before he was appointed CEO (2/10).
• Zingale beneficially owns 7.5% of the company pre-offering.  This is high by Silicon Valley standards, but he’s a big-fish CEO in a small-pond company.
• Sequoia Capital beneficially owns 36% of the company.  Kleiner Perkins owns 14%.
• I think Sequoia contributed $37M of the $57M total VC raised (though I can only easily see $22M in the S-1).
• If that’s right, and if Sequoia eventually exits Jive at a $1B market cap, that means they will, on average across funds, get a ~10x return on their investment.  $2B would give them 20x.

What’s left of my brain has officially melted at page F-11.  If I dig back in and find anything interesting, I’ll update the post.  Meantime, if you have questions or comments, please let me know.

As a final strategic comment, I’d say that investors should consider the possibility of an increased level of competition from Salesforce.com, given their massive push around “the social enterprise” at Dreamforce 11.