(This article originally appeared on Medium.)
ZoomInfo, Procore, and Going Public in Uncertain Times
It’s a question that I used to hear all the time when I worked in tech investment banking:
“Is the tech IPO market open?”
We’d hear it from management teams, investors, lawyers, and journalists. It’s not a bad question, per se. It’s simple enough to understand. But it’s also just so broad. And the answer is always yes. So do we really need to keep asking?
There are times, I suppose, when, on the way to the inevitable yes, there can be some genuinely interesting and valuable information that gets conveyed.
Let’s say, for example, that the question was posed by the CEO of a high growth technology startup to an equity capital markets banker a few years ahead of a potential IPO. In my view, that’s a great time to be asking the question. The response will be helpful.
It will start with the macro.
“Well, quarter over quarter issuance trends looks like this, the number of tech IPOs over time looks like that.”
Then it will shift to the more specific.
“In 2019, the average software IPO filed at this multiple of forward revenue, priced at a 10% premium to that, and then traded up another 20% on the first day. Of course, Zoom led the way with…”
Before ending with what the CEO really wants to hear:
“For your company, with your trajectory, on your timeline, yes, the market is open. And it is robust.”
That is a good exchange. The CEO received some useful information (e.g., trading and operating data for comps, a boost of confidence). The banker started positioning themselves as a trusted advisor ahead of potential IPO. But, a casual observer may ask, was the market really open for that startup? Yes. It was. It is. It always will be. Don’t get me wrong, both parties know full well that an IPO may never materialize and that the odds are fairly long. But the IPO market is always open; it’s the company’s trajectory and timeline that are up for interpretation, obviously.
Ironically, you know what isn’t the best time to ask the “is the tech IPO market open” question? When you’re doing an actual IPO. To understand why, it helps to have a bit of context about the IPO process itself.
Let’s Talk Process
First, the process is surprisingly long — a typical IPO takes between 6–8 months to execute from bakeoff to pricing. Second, there’s a lot of work to do. You’ve got to draft the prospectus, build the street model, audit your financials, prepare the roadshow materials, find time to film a movie (really), and the list goes on and on. As a result, folks generally aren’t all that concerned with the “openness” of the market for the first few months. They’re focused on executing the IPO. The market is open as long as the timeline is fluid.
Everything changes, however, with the public filing. This is the first time that a company’s S-1 becomes available to the general public. (Prior to the public filing, companies file their draft S-1’s confidentially, enabling them to receive and respond to feedback from the SEC in relative safety.) If you file publicly, it’s because you expect to be a public company within a month. For the casual observer, there are three key milestones to note: (i) the initial public filing with no price range; (ii) the filing with an initial price range, which signals the start of the roadshow; and (iii) the pricing / initial allocations, which are typically completed after market close the day before the first day of trading.
A month is a long time in financial markets. Things happen. The “yes, we can definitely get this done at that price at that time” can change to “no, definitely not” pretty quickly. Sometimes the issue is investor demand. Investors will read the newly filed S-1 and decide, “You know what, the testing-the-waters meetings were great and all, but, honestly, you couldn’t pay me to buy that.” Other times there are macro-related challenges. Tweets, volatility, trade wars— those sorts of things. More often, it’s a combination of the two.
But sometimes, it’s clearly one or the other. It’s not like the VIX cancelled WeWork’s IPO. On the other hand, if you decide to delay your offering after filing with Lehman Brothers as your main underwriter in August 2008, then everyone sort of understands that it’s not your fault.
Which brings us to ZoomInfo and Procore, the only two software companies that have attempted to IPO so far in 2020. And who managed to publicly file their S-1s just as the world began to realize that it was in the middle of the largest global pandemic in the last hundred years.
Bad Timing
The facts here sort of stand on their own. The S&P 500 hit an all-time high on Feb 19th, ZoomInfo publicly filed on Feb 26th, Procore publicly filed on Feb 28th, and then everything went off the rails from there.
Should They Not Have Done That?
The decision to file publicly isn’t one that you make lightly. You don’t bring the decision to the board and say, “Look, things are choppy, so it’s probably a long shot, but the team’s worked really hard on the prospectus and we think it’d be great for morale if their families are allowed to read it. Also, we went with the refundable rate for all the roadshow hotels, so we’re covered there.” You only file your S-1 publicly after you’ve looked at all the available data — public comps, market conditions, investor feedback — and determined that there is an extremely high probability that you can be a public company within the next month.
Why then, you might ask, did ZoomInfo and Procore decide to proceed with their public filings given what was happening in the world? The S&P was down, the VIX was up, what were they thinking?
There are a few things here. First, most obviously, the downward trend in the S&P was off of an all time high. Valuations for comparable companies were still up compared to when they started the process in the fall of 2019, probably significantly so. Second, the impact of COVID on the US was still somewhat unclear. Here’s a quote from the White House Press Briefing on Feb 26, the same day ZoomInfo filed: “As of today, we have 15 cases of COVID-19 that have been detected in the United States, with only one new case detected in the last two weeks.” IPO advisors aren’t epidemiologists (and, in my experience, not the most active on Twitter). Given that, it seems at least somewhat defensible that they viewed the disease as a low probability, tail risk to completing the IPO. Something to be monitored, but not something to derail the entire production. (Also, I’d assume that neither company had seen a material impact to business performance — both ZoomInfo and Procore are predominantly US-based, with 91% and 89% of sales in 2019 coming from the US, respectively.)
But you know what IPO advisors are experts in and were definitely watching as they approached the public filing? The VIX! The VIX is a measure of expected volatility on the S&P 500. Put simply, when the VIX goes up, investors expect more near-term volatility. The general rule of thumb is that IPOs can only happen when the VIX is stable and below 20. That threshold hasn’t been much of an impediment to IPOs in recent years — from Jan 2016 to May 2020, the VIX has been below 20 on ~83% of total trading days. And, even when it has exceeded 20, it’s tended to stabilize fairly quickly.
So the VIX needs to be stable and less than 20. Got it. (Why 20 and not 30 you might reasonably ask? Good question. The people making the decisions for ZoomInfo’s IPO had the same question, but we’ll touch on that later.) Empirically, the rule of thumb appears to hold true for the vast majority of software IPOs since 2016.
Glad you asked. The median EV / NTM Revenue multiple for all software companies was about ~9.0x and up slightly year to date when ZoomInfo and Procore publicly filed their S-1s. That’s for a universe of 66 companies. And bankers would have focused the discussions on a set of more attractive (appropriate?) comparable companies — think higher growth, cloud-based models that tend to trade at higher than median multiples.
What I’m getting at here is that the market looked, not amazing, exactly, but receptive. To summarize the key data points:
So both companies decided to proceed. That was the right decision. It gave them optionality to move forward, should things stabilize. There were more than a few excited headlines. They hoped things would get better.
Things did not get better. Once again, with an additional row for March 16:
So what next? Well, the velocity of the selloff sort of sucked all of the drama out of the situation. Both companies put their IPOs on hold. It wasn’t them, it was the pandemic. Again, right decision. Everyone understands.
What Are Our Options?
IPOs are financing events. Their impact is best captured by a single line-item in the financing section of the cash flow statement: Proceeds from issuance of common stock upon IPO (net of issuance costs, of course). So what does it mean to push your IPO? It depends on the circumstances, really. If it’s only a temporary setback, then you’re probably fine to sit tight — hopefully you have a large enough cash buffer to carry you through. However, if you’re in the middle of a global pandemic where the magnitude and duration of the impact is unknown, then you need to explore your options.
At this point, we should probably take a moment to discuss what these companies actually do.
Because, in addition to historically bad timing, Procore and ZoomInfo have quite a lot in common — they’re cloud-based, subscription software businesses with 80%+ gross margins, strong net retention metrics (117% for Procore, 109% for ZoomInfo), and are demonstrating rapid growth at scale ($340M ARR growing 54% for Procore, $400M ARR growing 42% for ZoomInfo). Both are phenomenally great companies.
Despite those similarities, they are very different businesses, particularly when it comes to their ability to operate in a work-from-anywhere, COVID-impacted world. ZoomInfo is a sales intelligence platform (think lead enrichment, scoring, segmentation) that leverages a high velocity sales cycle (~30 days) to sell into a diverse mix of end customers, spanning all sizes and verticals. Procore is a construction management platform (think project management, on-site collaboration) with a longer sales cycle that sells to construction customers, including owners, general contractors, and specialty contractors.
In February, both of those models worked well. (Again, it helped to be predominantly US-based at the time.) From March onwards, however, it was a different story.
ZoomInfo experienced increased demand as companies scrambled to add tools with the potential to reduce friction for newly remote sales and marketing teams. This isn’t speculation — the company shared as much in the Recent Development section of their updated S-1, where they provided performance data for the month of April (shown below). Specifically, new ACV was $8.8M in April, an increase of 87% YoY, compared to 36% YoY growth in March.
(As a complete aside, the other Zoom, delightfully, is a named customer in the ZoomInfo prospectus, which led to my favorite S-1 customer statistic of all time: “Within the first year of deployment, Zoom Video increased its number of ZoomInfo licenses by 1,050%, and today licenses are up by 5,900% since the first deployment.” 5,900% percent! Zoom only had ~1,400 US employees as of their latest 10-K. If we just pretend for a second that the initial deployment was 24 licenses, then everyone at Zoom Video would now be using ZoomInfo, and that, for some reason, brings me tremendous joy.)
On the other hand, Procore saw the entire construction industry grind to a halt. That couldn’t have been great for business. But the halt, and its impact, were also temporary. Construction will return; in many areas, it already has. Autodesk, another construction-focused software company, saw its share price hit an all time high of $219 on June 1, 2020, up 17% year to date. Procore, with a 95% gross retention rate and $118M of cash on hand as of Dec 2019, is not going anywhere.
So, to summarize, in ZoomInfo, we have a company experiencing a potentially sustainable tailwind. And, in Procore, we have a company experiencing a temporary headwind. Wait. That sounds like a 2x2!
- Good impact, sustainable — ZoomInfo potentially falls here. Somehow, in all of the madness that defines the first half of 2020, there are companies that have seen their cost of capital come down. The financing world is their oyster.
- Good impact, temporary — The key question for companies in this quadrant is not whether you can raise, but whether you can deploy that capital productively when things normalize.
- Bad impact, temporary — Procore potentially falls here. These companies are experiencing temporary increases in their costs of capital so it’s probably best to avoid massive equity rounds (like, say, an IPO).
- Bad impact, sustainable — I don’t know. Bailout?
A key thing to note about the framework is that the x-axis requires a significant amount of personal judgement. What’s temporary to me, may be sustainable to you. (Also, how long, exactly, is temporary? In reality, the ‘temporary’ half of the 2x2 isn’t a binary outcome at all — it’s a probability distribution that reflects one’s beliefs about second waves, societal risk tolerance, and, ultimately, vaccine timing.)
And, thanks to a combination of sensationalist headlines and inconsistent data, opinions can change quickly. In some ways, I use the framework as a personal Rorschach test. If I’m feeling optimistic, all companies move to the top right or bottom left. If I wake up to a headline like this, the mix looks a little different.
Regardless of mood, however, my view is that the vast majority of tech companies fall into either the top right (like ZoomInfo) or lower left quadrants (like Procore). But the lower left is tough to navigate — scenario planning for something temporary, but with an unknown duration is hard and, as with the x-axis of the framework above, comes down to personal judgement. Financing decisions always reflect company risk tolerance to some extent, but that’s never been truer than over the last few months.
What Did They Do?
Let’s bring things back to the respective outcomes for ZoomInfo and Procore.
First, Procore. On April 30th, Bloomberg reported that the company would postpone its IPO in favor of a $150M private round at a $5.0Bn valuation. On its face, that seems to be a pretty good outcome. It’s more expensive capital than they would have raised in an IPO, sure, but it’s also fairly de minimis dilution (3%) and provides the company plenty of runway moving forward (only $35M burned in 2019, excluding acquisitions). I expect Procore to retest the public market waters sooner rather than later.
Which brings us, finally, to the ZoomInfo IPO.
Before we discuss the outcome, let’s start with the decision to move forward with the IPO. A few key events to level set:
- On May 11th, ZoomInfo filed an updated prospectus (with no price range) with the SEC that included the Recent Development section referenced above, confirming that the IPO was back in play. Again, those Recent Developments removed all doubt that ZoomInfo belongs in the “good impact, sustainable” quadrant — new ACV in April grew 87% YoY vs 36% in March. This filing effectively restarted their one-month-to-IPO countdown.
- On May 27th, ZoomInfo filed with an initial pricing range of $16 to $18 per share. The IPO was underway.
What gave them the confidence to move ahead?
First, the public market data improved — indices stormed back, comps traded up, and volatility, while still elevated above traditional IPO-able levels, stabilized. If you’ll indulge me, one final table:
It’s worth taking a moment to touch on the multiple expansion that we’ve seen in the software sector over the last few months. Here’s how EV / NTM Revenue has trended for software companies in 2020, broken out by 25th percentile, median, 75th percentile, and median of the top 10.
Two things to highlight. First, the highest quality companies have benefited the most, with higher multiples seeing larger YTD gains than peers. Second, the software rally has been remarkably broad. Even the 25th percentile multiple is up 10% YTD. It turns out a flight to quality was a flight to all of software.
What did that mean for ZoomInfo’s IPO? Well, typically, the time it takes for changes in public market valuations to impact private market valuations varies widely. It depends on a lot of factors — sector, stage, expectation of downstream valuations, investor risk tolerance, etc. In the context of pricing an IPO, however, it’s much more straightforward — the impact is direct and it’s immediate. Which means that ZoomInfo was a massive beneficiary of software’s run up in the public markets ahead of its IPO. If multiples for your direct comps are at all time highs, then a VIX hovering near 30 (and well above 20), doesn’t seem so scary.
The second reason that ZoomInfo felt confident enough to follow through with their IPO was — to state the obvious — because investors told them it was a good idea. Not through password protected Zoom meetings or secondhand feedback channeled through brokers, but, like, with money. It’s right on the cover of the prospectus (lightly edited): “Prior to the date hereof, BlackRock, Dragoneer, and Fidelity (collectively, the “cornerstone investors”) have indicated an interest in purchasing an aggregate of up to $100.0 million each (up to $300.0 million in the aggregate).” For perspective, by my count, there were ~11 software IPOs in 2019 and 5 of them (45%) raised less than $300M in total. ZoomInfo had that much demand from a high quality investor base before they even launched their roadshow.
(By the way, there may be some people out there who read the indication of interest statement and say, “Well, yeah, but investors always put in comically inflated orders during IPOs and never expect to get those allocations actually filled.” That’s a good point and, for the majority of investors, particularly certain hedge funds, that’s true. You know who probably doesn’t have too much trouble getting their entire order filled, though? Money managers with trillions of dollars in AUM.)
But, not to be naive, there were other factors that influenced the decision as well. ZoomInfo is a private equity owned company after all. Their S-1 has a lot of things that you don’t typically see in software IPOs. There are blocker corps, there are tax receivables agreements, there is significant positive unlevered free cash flow (to the tune of $154M in 2019, a margin of 53%, $95M of which was consumed by interest payments). They drew down $35M on a revolver on March 25th 2020, which is after they decided to postpone their IPO. There are 440 words in the press release to announce the IPO pricing and 108 of them are just to discuss the use of proceeds (e.g., pay down debt, redeem an expensive class of preferred shares). So there was at least some incentive for them to recapitalize the business as soon as possible.
So that’s what I think gave ZoomInfo the confidence to pull the trigger — markets improved, business performance accelerated, investor demand materialized, and interest payments kept coming.
What Does that Mean for the Tech IPO Market? Is it Open?
ZoomInfo is now a public company. The IPO, as far as these things go, went well. They not only raised the price range from $16 to $18 per share to $19 to $20, but also priced above the revised range at $21. The stock closed at $34 on its first day of trading, up 62%. That is about as good as you can do it… right up until that last part about the 62%, which was a little on the high end, implying that the company may have left some money on the table. But, overall, that’s a pretty good outcome. (It also continues a recent trend of the first software IPO of the year trading up massively on its first day—in April 2019, PagerDuty shot up 59%, and in March 2018, Zscaler popped 106%.)
But doesn’t that mean they under priced the offering? Why didn’t they do a direct listing? Sigh. First, again, I refer you to the use of proceeds section of the S-1. As of today, companies are not allowed to raise capital via a directly listing. (Although, rightfully, that is changing.) Second, let’s put the first day closing price ($34 per share, ~$13Bn market cap) in context. Assuming that ZoomInfo guided investors to expect 35% growth through 2021 (vs 39% in 2019), here’s how the implied 2021 revenue multiple compares to the top 10 software multiples today:
Will ZoomInfo continue to trade in the top 10? I don’t know. Maybe. The day before they priced their IPO, the other Zoom printed the best quarterly earnings report in the history of software — not only beating revenue expectations by 63%, but also raising guidance by 123%. The other Zoom may need some more ZoomInfo licenses to handle all that growth!
My main point here is that it doesn’t make sense to adjudicate on the pricing strategy based solely on the first day of trading. First, obviously, let’s at least get to the other side of the lockup.
Second, more importantly, consider the context in which ZoomInfo launched its roadshow. It was an uncertain environment (remember the VIX). Sure, with the benefit of hindsight, could they have started a dollar or two higher on the initial pricing range? Yes. But that’s in the world where everything went exactly according to plan (i.e., nothing blew up in the markets.) That was not the only way things could have gone! There were a wide range of potential outcomes when they launched their roadshow, and the vast majority of them would have been worse than what actually happened. In this case, it was the right decision for ZoomInfo to err on the side of caution (i.e., start with a more conservative initial pricing range) given the circumstances. Just because you don’t extract every dollar of available capital in pricing your IPO doesn’t mean that your pricing strategy was wrong.
Ultimately, IPOs are based on supply and demand. In the current market, there is a huge amount of investor demand for software companies. That’s been consistent and, if anything, is growing by the day. But the market just went through a significant supply shock as a result of every IPO going pencils down at the exact same time due to the pandemic. It is a good market in which to be a seller. And that’s the market that ZoomInfo sold a billion dollars worth of stock into.
(By the way, a quick point on virtual roadshows. Certain things change very gradually and then, suddenly, all at once. I think that’s about to happen with roadshows — they’re about to become virtual permanently, particularly for tech company IPOs. Think about the circumstances surrounding ZoomInfo’s roadshow — there were protests and curfews in every major city and, oh by the way, the pandemic. And all of that had no impact. Zero. They generated more than enough demand from investors in a far more efficient way by using technology. How is that not a better approach that is particularly appealing to technology companies? Look, I’ve been in those roadshow meetings. They’re an hour long, they usually involve a random junior banker or two sitting in the corner of the room taking notes on his iPhone (told you I was there), and, when they end, you grab the presentation materials and immediately run to the next meeting. You don’t get to know someone in those meetings. You transact. It seems like video calls should work?)
Okay, big finish. Does that mean the tech IPO market is open? Again, yes, it is, it was, it always will be. It was open for ZoomInfo and it will be open for Procore. Just as long as you aren’t looking for any specifics on timing or price, of course.