Tuesday, April 02, 2013

Marketo Files for IPO: Will High Growth Outweigh High Losses?

Marketo made good today on its promise to file for an initial public offering (IPO). Congratulations to them for reaching this step. It’s a major accomplishment.

The S-1 registration statement gives considerable new information about Marketo’s business. Revenue for 2012 is reported at $58.4 million, an impressive 80% growth rate vs. 2011 although not quite the doubling that the company had forecast earlier.

More significant, the company continues to have huge losses – it lost $34.4 million in 2012, or 59% of revenue. By comparison, Eloqua lost just 7% of revenue in the year before its IPO, and even Salesforce.com, the benchmark for all Software as a Service (Saas) start-ups, lost just 20% of revenue in its final year as a private company.

 A loss that big is pretty scary. Part is due to heavy spending on sales and marketing – 65% of revenue – but that’s not the whole story: Salesforce.com had also spent 65% on marketing before its IPO (although Eloqua spent just 40%).

The difference is that cost of revenue (costs of delivering service to clients, including subscription, support, professional services, and other) was 42% for Marketo, vs. 20% for Salesforce.com and 32% for Eloqua. That figure hasn’t changed in recent years, suggesting economies of scale have yet to appear. A high cost of revenue makes it hard for a company to become profitable even as it grows, since much of the new revenue is spent on the new customers. SaaS economics aren’t supposed to work that way.

Marketo’s other operating costs (research and development and general and administrative) are also high – 52% of revenue, compared with 35% for Salesforce.com and 33% for Eloqua. That percentage has also been pretty much stable for the past three years – again suggesting that expected scale economies haven’t appeared yet.

Another way to look at it is this: Marketo would earn just 6% profit even if its sales and marketing costs were zero. So its losses aren’t simply due to high investment in new customers.  The comparable figures for Eloqua and Salesforce were 39% and 45%, respecitvely.

The S-1 also reports the company had 339 employees as of December 2012. Of course, the average for the year was much lower but, ignoring that, this still yields a perfectly respectable $172,000 revenue per employee. But it also means expenses are $273,000 per employee – much higher than the $200,000 rule of thumb. I know everyone at Marketo works incredibly hard, but something is clearly out of line in their cost structure.

Perhaps stock investors will look only at Marketo’s growth rate. There is certainly an argument that the company will eventually become profitable as it spreads its fixed costs over more revenue.   On the other hand, as I argued recently in DemandGen Report,  it may not be possible for any large marketing automation firm to thrive as an independent.  If that's correct, then Marketo's growth will never happen and the investors' only hope will be a buy-out by a larger firm.  Let’s hope the stock market sees hope somewhere in all this: otherwise, Marketo stock will be much harder to sell than its software.


sg said...

Very interesting analysis. I had read somewhere that SaaS businesses typically have 80% or higher margin (most likely that piece was talking about Salesforce) but the Salesforce margin sans sales/marketing costs is just 45% so I was just wondering if their margin has reduced over the years?

David Raab said...

I'd guess the 80% figure refers to "gross profit", which is revenue less the cost of revenue. In Salesforce.com's case this was indeed 80% (because cost of revenue was 20%). That was the figure in 2003, before the IPO. It has been pretty much the same in recent years: hovering between 20% and 23% from 2008 - 2012.

For what it's worth, their sales and marketing costs have fallen somewhat since 2003, running 46% to 52% of revenue in recent years. Revenue growth has run 21% to 44% per year.