The way Steve Singh sees it, big changes are coming to the enterprise software world.
“There will be a next generation SAP or Oracle that will be created in the next 20 years,” he said on stage at an Alliance of Angels dinner in Seattle last week.
Singh is worth a listen when it comes to enterprise software. He co-founded travel expense company Concur and sold it to SAP in 2014 for $8.3 billion, spent three years at the German software giant, and now runs Docker, the fast-growing cloud container technology platform.
“Enterprise applications will get completely rewritten,” Singh added.
That re-write, if you will, could create an entirely new cast of characters, bringing new efficiencies to the workplace and making businesses more data-enabled.
Incumbent tech giants have long dominated the enterprise software landscape. But a new crop of companies are emerging, using technologies like machine learning, artificial intelligence and the cloud to gain market share, attract investor attention, and win customers.
Optimism for the future of enterprise software showed last month when cloud storage behemoth Dropbox went public and saw shares spike 35 percent. Cloud security startup Zscaler, meanwhile, saw shares grow 106 percent in its first day of trading in mid-March.
Others are also now eager to test the public markets. Work automation service Smartsheet filed for an IPO last week, and digital signature giant DocuSign did the same a few days later. Zuora, an enterprise resource planning software company, also filed to go public last month, while workforce training platform Pluralsight did the same on Monday.
The companies follow a run of similar corporations that went public in 2017 and have seen rising stock prices since. They include Alteryx (up 110 percent); Okta (up 70 percent); SendGrid (up 50 percent); and others.
So why the fervor in the un-sexy world of enterprise software? Venture capitalists and industry insiders say that the boom in enterprise software is a result of a tectonic shift in technology, tied to the rise of cloud computing and the ability for software companies to deliver their services more efficiently to businesses.
The excitement comes at the same time consumer tech companies like Facebook and Snap have seen shares fall in recent months over data privacy regulation concerns and layoffs. Music streaming service Spotify went public this week; Bloomberg reported that “in one respect, Spotify’s first day as a public company was a failure.”
“We are seeing some negative big movement happening in tech as a whole, led by social media companies,” said Kathleen Smith, a principal at institutional research provider and IPO expert Renaissance Capital. “When investors see this happening with tech, they may want to sit on the sidelines a little bit for all the companies.”
Even still, momentum — at least for the moment — appears to be picking up for the enterprise software segment. Why is that?
For starters, the balance sheet speaks for itself. These companies boast increasing annual revenue growth driven by subscription software-as-a-service (SaaS) business models. Many sell to large customers — Smartsheet’s client list, for example, includes 90 percent of the Fortune 100 — in big markets that are equipped with plenty of cash. And they take advantage of the newest technology, offering data-driven tools and services that help employers improve how their employees operate in a constantly-evolving work environment.
According to a report from Draper Fisher Jurvetson, the global software industry now produces more than $500 billion in annual revenue, a number that continues to increase thanks to a SaaS sector that saw 20 percent growth from 2016 to 2017. The increases are driven by “continued digital transformation initiatives, shift to cloud, new compliance/reporting requirements, security, etc.,” the report noted.
Bill Bryant, a partner at Draper Fisher Jurvetson, said that IT and software have been a major driver behind improvements in workplace productivity for decades, evolving how employees get their work done. He said trends in automation, machine learning, cloud computing and security continue to create new opportunities for enterprise software companies.
“Public market investors are recognizing these drivers and thus are broadly supportive of companies like Smartsheet and Docusign going public,” said Bryant, whose firm has backed enterprise software companies such as Twilio, which went public in 2016 and now commands a market value of $3.5 billion, and Outreach, one of Seattle’s fastest growing startups.
IDC estimates that spending in AI and machine learning will grow from $12 billion last year to $57.6 billion by 2021. Gartner said that by 2021, 28 percent of all IT spending will be dedicated to cloud-based infrastructure, middleware, application and business process services.
Smith, the IPO expert from Renaissance Capital, said that enterprise software companies have been outperformers in the IPO market over the last year.
“Investors like the idea of a subscription setup and a more stable business, with products that may be sticky within the businesses,” she said.
Many companies that sell enterprise software have shifted toward subscription-based price models and found success. Tableau Software, for example, saw revenue from its subscription offerings increase 235 percent in 2017. Selling subscriptions, rather than perpetual licenses, makes its data visualization products more available to a variety of organizations and easier to use for employees at large businesses, the company said, while providing a more stable revenue stream.
“With the lower upfront cost and reduced risk that subscription licensing offers to customers, a record number of organizations are turning to Tableau as the mission-critical analytics platform for their data needs,” Tableau CEO Adam Selipsky said in a statement in February.
Singh said simply that the market is “looking for great growth businesses.”
“That’s what Dropbox represents and that’s why investors are embracing it,” he said. “It’s great growth at a reasonable price.”
Dropbox recorded a net loss of $112 million during 2017. But revenue growth at an enterprise software business may trump negative earnings, at least in the eyes of some investors. The company reported $1.1 billion in revenue for 2017.
“In general, the first-day pops for both Dropbox and Zscaler speak to the unmet demand from public investors for high-growth innovation companies, especially in the better-understood enterprise space,” said Minh Le, a market manager for Silicon Valley Bank. “And while there’s a renewed emphasis on profitable growth, higher revenue growth rates still explain the majority of high IPO valuations.”
Smartsheet, which helps customers like Hilton, Netflix, Starbucks and Cisco manage and automate key work processes, saw revenue grow by 66 percent to $111.2 million for the fiscal year ending Jan. 31, 2017. DocuSign, a leader in digital signatures and electronic contracts, saw revenue spike by 36 percent to $518 million for the fiscal year ending Jan. 31, 2018.
Both companies still have losses. Smartsheet reported a net loss of $49.1 million for the period ending January 2017, while DocuSign posted a $52 million loss for the period ending January 2018.
A “State of the Markets” report from Silicon Valley Bank noted that of the 15 enterprise software public market listings in 2016 and 2017, none were profitable. Valuations “correlate closely to growth regardless of margin,” the report said.
Dropbox also boasts positive cash flows — another attractive sign for investors. When Dropbox became cash flow positive in 2016, CEO Drew Houston said that the milestone “means you control your own destiny” because the business is funding itself. Docusign revealed this week that it was cash flow positive for the year ended January 2018.
“For any enterprise subscription-based business that wants to come to market, being cash efficient is incredibly important,” said Nizar Tarhuni, associate director of research and analysis at PitchBook.
Smith noted that recent large enterprise acquisitions, such as Salesforce buying MuleSoft this month for $6.5 billion, also make it an opportunistic time for enterprise tech companies to go public, regardless of how their stock will perform.
Tech giants like Salesforce or Microsoft could acquire fast-growing enterprise companies, but they could also develop their own competing products.
In its IPO filing, Smartsheet noted competitors like Asana, Atlassian, Planview, Workfront, as well as tech titans such as Google and Microsoft which also offer online tools to better manage work processes.
“While we currently collaborate with Microsoft and Google, they may develop and introduce products that directly or indirectly compete with our platform,” the company noted in the filing.
In its filing, DocuSign called out Adobe as its primary global competitor, in addition to “a select number of niche vendors that focus on specific industries or geographies.”
“One of the common fears you see from analysts is, do these companies have the right competitive and wide moat around their business?” said PitchBook’s Tarhuni. “And does it make sense for a Microsoft or a Google or somebody else to penetrate that business? Is there enough of a pie or revenue stream that they are really missing out on?”
There were 36 total IPOs in the U.S. for Q1 2018 — including four tech companies — which was up 44 percent from last year and the highest since 2014, according to a report from EY. The U.S. IPO market had its best quarter measured by proceeds in the past three years, according to data from Renaissance.
“There are so many companies that instead of waiting, should hit the market while the window is open like this,” said Smith from Renaissance.
There are now 45 public SaaS companies worth more than $1 billion, according to DFJ. Judging by the initial filings of 2018 and the recent share increases of companies like ServiceNow, Workday, Shopify, Splunk, and Atlassian, that number may increase as investors keep faith in the future value of enterprise software.
