The folks at RiskHedge are out with a new IPO-focused newsletter called IPO Insider ($2,997/yr is the promoted price), aiming to find “Hidden IPOs for Extreme Wealth” using Justin Spittler’s “SONAR” system for identifying the best IPO opportunities. Spittler used to write for a newsletter or two for Doug Casey’s firm, we’ve covered a few of his pitches in the past few years, mostly for cryptocurrencies and mining and marijuana stocks, but it sounds like he’s moved on to a new job.
And, naturally, the ad included hints about one of the IPOs they’re recommending — so I thought we’d chew on those a bit and see if we can get you started on your research.
The basic premise is that Justin follows his “proprietary system” for identifying the IPOs that are most appealing, and the dream is that this turns into you buying into the best new companies and eschewing the rest (which I guess would mean buying Beyond Meat and Roku, and skipping Uber and Slack).
That “SONAR” system breaks down like this:
“S” for “size” — he thinks that a market cap around $1.5 billion offers the most opportunity.
“O” for “organic growth” — companies who are growing revenue rapidly without acquisitions.
“N” for “network of bankers” — identifying the bankers who routinely underprice the IPOs they back and therefore give the company a chance to have what he calls a “lucrative honeymoon phase.”
“A” for “abnormal activity” you want to avoid — like companies whose insiders sell a lot of shares before the IPO, like WeWork or Groupon, or other odd warning signs.
“R” for “rapid growth” — which seems like they really just wanted to use the acronym “SONAR”… yes, of course, you usually want to buy a new company only if its growing quickly.
And he says that his back testing leads him to think there are about 10 IPOs a year where “SONAR” would give the “green light”… and they give a freebie recommendation of a soon-to-come IPO…
“The first company is called Rubrik.
“Rubrik is a private data management company that’s getting ready to go public….
“Justin’s research shows it should go public in the next 3 to 12 months. And he’s confident that, like the other Hidden IPOs we’ve shown you, Rubrik can jump 100% or more, right out of the gate.”
So you can keep an eye out for that one if you like, it doesn’t look like they’ve filed their S-1 yet (that’s the registration filing with the SEC that really starts the “going public” process, and usually includes the first ‘real’ numbers most investors will have seen from the company).
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But the tease in the ad was for something else, a company that went public recently that you can buy now. Here are the hints from the pitch:
“A fantastic buying opportunity….
“Justin calls this company “the other search giant.”
“That’s because while Google gets the lion’s share of search engine traffic…
“This little known company provides the backbone for searches on some of the biggest websites in the world.
“So, when you search for a friend or a local business on Facebook, you’re using this company’s services.
“Same when you search on Wikipedia.
“Or search for tickets on TicketMaster.
“Or order an Uber.
“If you’ve done any of those things, you’re using this company already.
“But I can practically guarantee you don’t know the name of this company. Because not long ago, it had a Hidden IPO.”
We’re told that this “Hidden IPO” matches the SONAR criteria, and that it has gone “on a solid run” since it went public… and they also share a chart with us as further inducement, so that will help us to confirm that the Thinkolator is right on target when it identifies this as… Elastic (ESTC), the developer of the Elasticsearch open source search and analytics engine. Here’s how they describe themselves:
“Elasticsearch is a distributed, open source search and analytics engine for all types of data, including textual, numerical, geospatial, structured, and unstructured. Elasticsearch is built on Apache Lucene and was first released in 2010 by Elasticsearch N.V. (now known as Elastic). Known for its simple REST APIs, distributed nature, speed, and scalability, Elasticsearch is the central component of the Elastic Stack, a set of open source tools for data ingestion, enrichment, storage, analysis, and visualization. Commonly referred to as the ELK Stack (after Elasticsearch, Logstash, and Kibana), the Elastic Stack now includes a rich collection of lightweight shipping agents known as Beats for sending data to Elasticsearch.”
I don’t know if Uber and TicketMaster specifically are Elastic customers, but they are either using the Elasticsearch open source software or have tinkered with it (Elasticsearch itself is based on another search software, Lucene, that’s part of the open source Apache universe). Elastic’s basic systems are free and open source, so like other companies who are built on top of open source projects they rely on selling services and extras on top of that open source stak (Red Hat, which is probably the largest “open source” company with their many projects, starting with Linux, and Hortonworks and Cloudera distributing Hadoop, for example). They say they have more than 8,000 customers and that no one customer represents more than 10% of revenue.
In their words…
“Elastic builds self-managed and SaaS offerings that make data usable in real time and at scale for use cases like application search, site search, enterprise search, logging, APM, metrics, security, business analytics, and many more.”
And it is, I imagine, those SaaS offerings that make this a for-profit endeavor. Or, well, a prospective for profit endeavor, since they haven’t actually made a profit yet. The stock went public just over a year ago, in October of 2018, and they have roughly doubled sales over the past 18 months, but it has been expensive — they are still at the point where they’re spending more to bring in each new dollar of revenue than they did a year ago, so you can’t draw a line on a chart and say, “hey, this is the point where we’ll start generating cash instead of spending it”.
To put that into number terms, over the past year ESTC has pretty consistently had a gross profit margin of about 71% — meaning the direct cost of supplying the product or service is only 29% of the revenue, which is pretty good but not unusual for a software company. The challenge is that the gross margin has gradually gotten a little worse over the past year or two (it was 72-75% before they went public), but the spending on marketing and overhead has also grown considerably as they built staff to sell and service that customer growth… Sales and Marketing was 54% a year ago and is now 58%, and the administrative overhead has gone from 19% to 21%, while R&D has stayed about steady at 39% of revenue.
The end result is that although quarterly revenue has gone up nicely in the past year, from $56 million to $90 million, the amount of money they spent to get that revenue has gone from $75 million to $132 million. Which means the “growth” of $34 million in revenue for this past quarter over the year-ago quarter cost them $57 million, and that when it comes to hoped-for scalability (where income grows faster than expenses) they’re going the wrong direction so far.
That’s not a deal-breaker if you’re convinced of the market opportunity or the unique products this company offers over the longer term, but it does mean that profitability is not at all visible — which is a really hard sell these days. Some of that is also exaggerated by stock-based compensation and perhaps by their receivables numbers in any given quarter, since their subscription model to some degree might favor the future over the present compared to someone who sells software directly (about 90% of their revenue is from subscriptions, and that has not changed over the past year, so this isn’t a new impact)… and it might also be impacted by the fact that companies want to put on their best face before they IPO, so maybe they pushed off some costs and accelerated some revenue to make things look better a year ago, and that’s catching up a little bit.
But it’s probably just that they’ve embraced the mentality of “we’re going to spend heavily to grow” that is very common among younger tech companies (and not necessarily wrong, to be clear, sometimes it works exceptionally well in the end). They do have plenty of cash on hand, more than $300 million, so their investment in growth is still quite sustainable for the foreseeable future, as long as they get that growth.
Elastic won’t report for a couple more weeks, results should be available on December 4, and it has been a rough year so far with a couple major drops in the share price — but the last earnings report was a good one (they reported a “beat and raise” quarter on August 29, and the stock popped up by about 10%… though that pales in comparison to the big moves the stock has made before and after that as it reacted wildly to every analyst upgrade or downgrade and, seemingly, every sentiment shift among the cloud software stocks). I ran into a analyst note on Briefing.com that really caught my eye, Canaccord Genuity upgraded ESTC to buy yesterday and included this quote:
“Of course, in a market where algorithms and some traders view lunch as long-term, there is a roughly 99.9% chance that ESTC’s path will be volatile — if only because the pot of free cash flow gold is several years into the future. Thus, for those able to withstand the noise, Elastic’s fundamental outlook, the signal, looks bright and with the stock back down to another low for the third time this year, we suggest at least starting a position in ESTC. Upgrade to BUY.”
So that’s one other opinion for you. Analysts on average rate ESTC as a mild “buy” and have an average price target of $104, and as long as expenses don’t really balloon out of control I imagine the primary concern of most investors will continue to be revenue growth. The estimate from the average analyst now is that they’ll have revenue growth of 50% in 2020 and another 30% or so in 2021, and right now the stock is valued at about 15X expected current year revenues (they’re in the second quarter of their FY 2020 right now). Analysts see them losing money for at least two more years as revenue roughly doubles, with losses on a per share basis actually accelerating, particularly in GAAP terms (partly because of delayed subscription revenue, I imagine, but mostly because of stock-based compensation), so I can see why that analyst says the “pot of free free cash flow gold is several years into the future.” That means the stock will largely trade on sentiment, and sentiment can move a lot faster than numbers… so buckle up.
I hadn’t ever heard of Elastic before, and, frankly, my first response was not “I should buy this” but “maybe this would be a better search engine for Stock Gumshoe, since our search kind of stinks” … but there is at least that appealing high revenue growth rate, and the fact that having a custom search and analytics tool that’s beyond the control of Google is appealing (and necessary) for a lot of companies. And I would definitely rather buy an IPO six months or a year after the company comes public, once the insider selling has settled down and there’s some indication of the financial trajectory after the hubbub eases (the time around the expiration of the lockup period is often particularly interesting), but that doesn’t mean they’re always appealing.
And while IPOs are always an exciting thing for investors to chatter about, which means there’s always a new IPO-focused newsletter being released by someone, I can’t think of any IPO-focused newsletters that have stuck around for very long — perhaps that’s partly because the universe of IPOs often lags for long periods of time. This is the chart, just FYI, of the Renaissance IPO ETF (IPO, in blue) total return versus the S&P 500 (orange) and the Nasdaq 100 (red) since that ETF started trading about six years ago:
That doesn’t mean there haven’t been some good IPOs during that time, particularly among the smaller companies (the Renaissance ETF is not a perfect representation of the IPO market, and it has also lagged over time, in part, because the biggest IPOs have been some of the worst, and it’s market cap-weighted so they own more of the big ones)… but it does mean that over the past few years, picking stocks from among established companies that are well-known would have had better odds of success than choosing among newly public stocks in the Renaissance IPO index.
So there you have it, dear friends, I guess Elastic was kind of a “hidden IPO,” at least to the extent that I hadn’t paid attention to it before now, but it’s not all that small of a company, with a market cap of about $6 billion, and it’s an interesting company but it’s seeing both rising sales and growing losses… and, at least so far, has shown a serious tendency to move in concert with all the other richly-valued cloud software stocks when those stocks have their big moves up or down on sentiment shifts. Might be a rocky ride, but at least you get to choose — do you find Elastic interesting? Think it’s got potential, or too much risk? Have any experience with Justin Spittler or this IPO Insider service? Let us know with a comment below.
Disclosure: Of the companies mentioned above, I own stock or call option positions in Google parent Alphabet, Slack, and Facebook. I will not trade in any covered company for at least three days after publication, per Stock Gumshoe’s trading rules.