Elastic (ESTC) IPO research and discussion

[I started to post this as a reply to another thread, but figured it should warrant its own discussion…]

Alright, I skimmed the majority of the 256-page Elastic IPO prospectus and read certain sections in their entirety. Exhausting… but I was very interested in this company and what it does and, more importantly, their financials. Now, I have some observations and maybe a few questions:

For those who have no idea what Elastic does, a quick introduction:

Search is foundational to a wide variety of experiences. Elastic makes the power of search—the
ability to instantly find relevant information and insights from large amounts of data—available for a
diverse set of applications and use cases. (marketing blurb direct from their IPO prospectus)

Translated into practical English: they’re the engine behind how a company like Uber can quickly find the car nearest you, or how Tinder matches people together or how a large company like Sprint is able to filter through billions of log events daily to monitor their website performance issues and outages. Basically, they have a handful of “modules” that handle ingestion of data (products called “Beats” and “Logstash”) and reporting of metrics, application performance monitoring (APM) info, and other business and security analytics (using Kibana, an open source deal, as the visualization layer). Ostensibly, there would be some overlap with companies like Splunk, Alteryx, Hortonworks and Cloudera, and New Relic. All of this can be deployed locally inside a customer environment, or via cloud offering, and looks like it is very user- and developer-friendly to actually deploy.

They only have 1000 employees (or just under) as of July 2018. The company was incorporated in the Netherlands, but its HQ is in Mountain View, California (with a Delaware incorporation for US “Inc.” purposes). They have 5,500+ customers in 80+ countries (up from 2,800 a year ago). Majority of their revenue is from the United States (61%) with the remaining 39% from elsewhere in the world.

Now to the IPO itself…

The IPO is for 7,000,000 shares, but there are another 43,000,000+ already “assigned” through other means to insiders and employees (options, RSUs, etc.) and a total of 70 million that will be outstanding after IPO. With that much already locked up, it seems almost imminent that the share price has to fall as they’re sold off – the average exercise price of almost 24M of those shares is just $9.48/share. Not to mention, that 7M represents less than 20% of the whole, so just understand that there’s no effective voting power in ownership, if that’s of concern to you. (Another 1.05M shares could get bought by the underwriters, at their option, on top of the 7M.)

Current CEO Shay (pronounced “shy”) Banon is relatively “new” to the position. He’s a co-founder and actually the original creator of all of the core Elasticsearch “stuff,” but from 2012 to mid 2017, Steven Schuurman (another co-founder) was CEO. Not sure why the change – perhaps Mr. Schuurman didn’t want the job going into IPO territory, or maybe he wasn’t the right face guy for an upcoming IPO, or maybe he has a secret past or who knows… He’s still a member of the BoD, though.

Revenue breakdown is split between recurring SaaS subscriptions (billed annually) and professional services. The PS piece is growing, which would seem to mean that customers need and are willing to pay for deployment help, most likely on larger analytics projects. Still, PS revenue is less than 10% of the total, and has dipped as low as 7% in multiple quarters.

A quick rundown on past quarters’ select financials (unaudited, pg 90 of the prospectus at https://www.retailroadshow.com/NrsService/api/retailroadshow… helps) – all numbers in thousands, QoQ/YoY math is mine so check for errors:


 **7/16    10/16     1/17     4/17     7/17    10/17     1/18     4/18     7/18**
**Revenue**        $16,572   21,305   23,128   27,172   31,644   37,038   41,681   49,572   56,644
  (QoQ change%)            28.6%     8.6%    17.5%    16.5%    17.0%    12.5%    18.9%    14.3%
  (YoY change%)                                       90.9%    73.8%    80.2%    82.4%    79.0%

**Gross Profit**    12,629   16,915   17,948   20,840   24,230   28,078   30,915   35,972   41,087

**OpEx**            20,924   23,673   39,591   31,316   33,404   35,204   43,374   55,207   59,502

**Operating Loss**  (8,295)  (6,758) (21,643) (10,476)  (9,174)  (7,126) (12,459) (19,235) (18,415)

**Net Gain/Loss**  $(9,504)  (8,474) (22,221) (11,769)  (9,967)  (8,027) (13,330) (21,403) (18,578)

**Stock-Based Comp** 1,098    1,195   15,087    1,506    2,254    2,770    3,554    4,164    5,665

I suppose you can draw your own conclusions, but revenue growth appears to be slowing a little to me, and OpEx and SBC are climbing. Their fiscal year ends in April, by the way, so FY18 encompasses May 2017 to April 2018, inclusive. Quarterly losses are also increasing along w/ the OpEx spend. Some of this is “land and expand” I assume, but it’s hard for me to see how, when and where those costs might either drop or be offset by higher revenues/profits.

[Side note: I’d love to know what happened in January 2017 w/ stock comp. It wasn’t like they had a blowout quarter compared to the one prior.]

A lot of the prospectus is on their risks and all the reasons they might never be profitable. Some of that is boilerplate, I’m sure, but the numbers above are a little more tangible to me in that regard. Net losses continue to mount, and this IPO isn’t going to save that – 7 million times $27.50 is only $192 million, and that barely covers the $183M of liabilities on the books already.

It seems like they have some knobs they can use to fix this, such as raising their prices, especially for professional services. If they offend customers, their recurring revenue/re-subscription can die off, so I imagine they’re reticent to do that this early in their lifespan (they started in 2012, so still verrrry young). They can reduce expenses, but that might mean layoffs and all the inherent survivor risk that entails – disenfranchisement, attrition, turnover, re-hiring costs, etc. They can add more offerings, either organically or through acquisitions (they’ve bought 2 or 3 companies already) and increase the value proposition, but that costs up-front money that puts them further in the hole.

Share offering is expected to be $26 to $29/share, so let’s assume midpoint of $27.50. With 70 million shares in play somewhere, that would give Elastic a market cap of $1.925B (I’m being very generous here). Against annual losses of $160M and growing, no less. Roughly estimating, that puts the Price/Sales at a hair over 12 (!!).

Net-net, the interest level I had for ESTC is greatly diminished after looking at the numbers. They say their TAM is $45B, but looking above, it will be costly to expand to capture even 1/3 of that.

Someone else seeing something I’ve missed? Should I be ignoring the losses and focus only on the recurring revenue and number of total customers? Subscriptions account for 93% of their revenue, and their customer retention and expansion rates are high (142% at end of July 2018 and over 130% for each of the last seven quarters). So maybe that’s enough growth to offset the current losses and … but I try not to bank on hope.

80 Likes

Share offering is expected to be $26 to $29/share, so let’s assume midpoint of $27.50. With 70 million shares in play somewhere, that would give Elastic a market cap of $1.925B (I’m being very generous here). Against annual losses of $160M and growing, no less. Roughly estimating, that puts the Price/Sales at a hair over 12 (!!).

Yep and that is the IPO price but not likely what the retail investor is getting a shot at…perhaps twice that P/S??

But that said, it does seem interesting as an NPI type company.

Your writeup was very well done and what I liked most about it was how you synthesized the more important data together that an investor would want to know…like the high revenue % that is subscription.

I did think this video previously linked was a nice review:

https://www.retailroadshow.com/presentation/#/disclaimers?pr…

https://seekingalpha.com/article/4207941-elastic-aims-193-mi…

https://seekingalpha.com/article/4205119-first-look-elastics…

But what still perplexes me is who their direct competitors are and just how solid a moat they possess.

They have quite a few reputable customers but who/what else can replicate what they do?

May I suggest you post this at he NPI?..cause if we get some interest there…like a dog on a bone (MDB, NTNX, etc.)……it won’t be released until these issues are ferreted out…and that tends to irritate many here with incessant posts.

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hlygrail,

Thanks for the research and write up.

I’m a bit more bullish at first glance than you. There was mention of slowing growth yet the earlier base was appreciably small. Losses don’t seem to be growing as a percentage of revenue though operating leverage hasn’t taken hold. Gross Margins appear to be healthy around 70%+ and the expansion rate is quite solid. So far, the numbers seem very good, but I may be missing something.

A.J.

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I get IPO alerts from Etrade and I did get one the other day about Elastic. It essentially says to call them if you are interested in participating. No guarantee that you’ll get in (I’ve never tried for any that they’ve emailed me about).

But if you have Etrade and are interested, it can’t hurt to give them a call and find out.

I’m probably going to sit this one out, but would be curious how the process plays out (e.g. is there a minimum that they require you to buy etc) if you elect in

-mekong

Hlygrail,
Great write up. Thanks. After reading your post I’m a committed wait and see . . .

Hlygrail,

Good information. Thanks for all that legwork, another reason why this board is fantastic. My plan was to buy some on the first day since Fidelity is not participating in the IPO. However, after reading your post and crunching the numbers some more, I believe I will wait for the lockup period or just get a tiny position if I can get below $35. The quarterly revenues and margins are similar to ZScaler (ZS) and my guess is the P/S (on retail IPO day) would end up as high as ZS is currently without the same TAM.The P/S would be around 16 at $40 and 20 at $50!

With their high quarterly SBC and OpEx, growth will come with a cost to us.

… and I was so looking forward to my first IPO purchase.

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I actually chatted with an eTrade rep during the day yesterday to ask if it was even available… Was told they were NOT participating… And then I got the same email last night that they were.

Im probably going to call tomorrow just to see what the process is, assuming some more looks at the data aside from my own.

May I suggest you post this at he NPI?..cause if we get some interest there…like a dog on a bone (MDB, NTNX, etc.)……it won’t be released until these issues are ferreted out…and that tends to irritate many here with incessant posts.

Relatively new to both boards. Just wondering, why can’t we discuss the issues here? Isn’t it exactly what this board is about — discussing high growth stocks?

On the other hand, the NPI board seems to have a rather low signal to noise ratio these days because of a recent tsunami of political posts.

So, please, let’s continue the discussion of the Elastic IPO here?

Oh, and before I forget, thanks to hlygrail for the great write-up. Always good to learn the many ways to approach these things :slight_smile:

Benjamin

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Someone else seeing something I’ve missed? Should I be ignoring the losses and focus only on the recurring revenue and number of total customers?

Nope. I think all your questions are right on target and get to the heart of the matter. A TAM of $99 Zillion doesn’t help if you keep playing “the more you sell the more you lose.”

I’d like to make a suggestion. Why don’t you call the company’s investing liaison and ask him/her your questions? You might be amazed at what a company is willing to tell you. FWIW, I’ve always (except once) found them very friendly and willing to help.

  1. Why the switch in the head office?
  2. When do you expect to be profitable?
  3. What will SBC likely be going forward?

Dan

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Totally agree with Dan that contacting investor relations often leads to very fruitful result, however it is quite likely in this case that you won’t get a response as ESTC is probably in the pre-ipo quiet period.

David

Agreed, I suspect they can’t say anything that isn’t already in the prospectus, since the IPO is scheduled for…6 market days from now.

So, two possible high-level outcomes:

  1. It “pops” at IPO and that 27.50 midpoint becomes $40 or $60, just because there hasn’t been a LOT of IPO traffic recently, and this one has some tech gravitas. That’s more than the 33% required to unlock everyone, if I read (skimmed, honestly, that part) correctly, so then it will go back down in a sell-off. At that point, maybe we know more and can make a more informed decision, plus it may be in a more reasonable/deterministic pricing.

  2. It doesn’t pop at IPO and none of #1 happens, except over time we get to learn more and make hopefully better-informed decisions.

In the middle of both of those is still that nagging observation I made about the IPO amount (at midpoint) not even really covering their outstanding liabilities, much less giving them a lot of leeway to grow. It seems like they really will have to raise prices AND attract more customers (some of which get at least some of the products’ usefulness for FREE without any support) in order to get to profitability.

Or maybe there’s a #3, which is that they run the Amazon model and run negative until they don’t… but I don’t see that they have anywhere near enough gravity to do that (yet?).

I think I’m leaning toward #2 with my money – wait and see. But it was exciting for a few minutes at least. :slight_smile:

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“1. It “pops” at IPO and that 27.50 midpoint becomes $40 or $60, just because there hasn’t been a LOT of IPO traffic recently, and this one has some tech gravitas. That’s more than the 33% required to unlock everyone, if I read (skimmed, honestly, that part) correctly, so then it will go back down in a sell-off. At that point, maybe we know more and can make a more informed decision, plus it may be in a more reasonable/deterministic pricing.”

I bet it pops at the open. Seven million shares at the IPO is what is called a “sliver deal” where only a small portion of the shares are released at the IPO.

Rob

I think it’s total BS that TDA and IB claim they are “not participating”
in the ESTC IPO…yet IB can me an IPO inclusion on several Chinese stocks (eye roll…).

– This…is the MaineReason
Very interested in ESTC
Calling BS on TDA’s, IB’s and others’ “non participation”

Hi hlygrail,

[Side note: I’d love to know what happened in January 2017 w/ stock comp. It wasn’t like they had a blowout quarter compared to the one prior.]

“This decrease in stock-based compensation was due to an $11.0 million charge in fiscal 2017 related to a tender offer allowing certain employees and founders to sell ordinary shares” [pg 84]

which I believe relates to this:
“In November 2016, the Company’s board of directors approved a tender offer which allowed the Company’s employees and founders to sell ordinary shares to a third-party investment fund. This investment fund purchased 3,347,193 ordinary shares from participating founders and certain employees for a total purchase price of $44.9 million.
Since the purchasing investment fund is an entity affiliated with a holder of economic interest in the Company and the fund acquired shares from employees and founders at a price in excess of fair value of such shares, the amount paid in excess of the fair value of ordinary shares at the time of the tender offer was recorded as stock-based compensation expense.” [F-34]

that sounds fair enough to me…?

cheers
Greg

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Did you get this figured out?
I had to call twice to get to somebody who knew what they were taking about. Turns out the IPO pages are having problems with chrome and edge. (Come on E-Trade) They told me to try Internet explorer and there it was.

eTrade is full on the Elastic (ESTC) IPO. It turns out it’s right there on the Trade > IPOs and New Offerings menu (which I’d never visited before), but when you get there and go through all of the checkboxes, you’ll discover that it’s closed to new interest – meaning they filled up their pool of maybe-allocations. Even everyone in that pool isn’t guaranteed to get some.

This was the first time for me that eTrade’s customer service was poop. Gave wrong info for sure. Usually they’re pretty good, by chat or by phone.

While investigating the ESTC ipo I ran across this. https://markets.businessinsider.com/news/stocks/charles-schw… .

Back in 1999 a bunch of brokers including schwab and ameritrade created, Epoch Partners. Part of the idea behind it was to allow retail investors access to IPOs. Goldman Sachs acquired Epoch in 2001 and part of the acquisition was that they would continue reserving 15% of an IPO for retail investors. Last week on thursday GS terminated the agreement unilaterally and is now getting sued. Be interesting to see how this plays out. But this is part of the reason so many of us can’t participate in the ESTC ipo.

-e

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And you would be right to assume that Gold ManSacks is one of the lead underwriters for the Elastic IPO… (along w/ JP Morgan, Barclays, RBC, BofA, Citigroup, Jefferies and Canaccord Genuity). Surely no conflict of interest there, right?

Looks like they just updated their filing, and the new range is $33-35 (up from 26-29) and the same 7,000,000 shares at Etrade.

Well, that makes it a little harder to make quick money (I had them pegged at a high-fair value somewhere in the $30-32 range myself)… May have to sit this one out. Maybe their first Q report is poop and it drops, but that seems unlikely.