June 23, 2016 was an important day for the tech community. After 6 months without a tech IPO, a Silicon Valley darling, Twilio (a cloud communication platform company), went public. More impressive? This “darling” is a full-bred unicorn – a company valued over $1 billion.

In its first day of trading, Twilio’s enterprise value surged 92%. Since Atlassian’s IPO, this marks the second consecutive tech unicorn IPO that soared.

Are the public markets finally ready for more unicorns to take flight?

Maybe. First a bit of context. Why the dearth of tech IPOs? Mostly because capital markets are currently flush with capital. Interest rates in the West have been nearly at zero % for almost a decade. In turn, the equity markets have had unprecedented growth rates, tripling in size in seven years.

Screen Shot 2016-06-29 at 11.20.04 AM

Access to cheap capital means “risky” businesses with high growth potential could receive private financing across a spectrum of angels, VCs, foreign investors, and hedge funds. Consider that Twilio “only” raised $150M at IPO. Unicorns are finding hundreds of millions of cash from private coffers with less scrutiny and pressure.

Secondly, going public has been challenging for innovative companies. Shortly after IPO, private tech companies like Box, Square and Apigee shed significant enterprise value.  Worse, according to Bloomberg data, “of the nearly 200 tech companies that held IPOs on U.S. stock exchanges since the start of 2010 and are still alive and independent, more than half are trading below the price at which the company first sold shares to the public.”

So what does Twilio’s IPO tell us about future tech IPOs?

IPO markets tend to favor certain metrics at certain times. In a previous post, I mentioned: “Pre 2000, the focus for tech was on companies with a lot of registered internet users or, in the tech vernacular of “eyeballs” – in hopes of future monetization. The tech resurgence leading up to 2008 focused on the ability to monetize the technology. Perhaps the 2016 write-downs [of LinkedIn and Twitter] indicate the market’s requirement for double-digit QoQ revenue growth.” Clearly, that’s the market we’re in today.

Twilio’s value is not based on its profitability, which their S-1 filing indicates won’t happen for another 18-24 months. Instead, Twilio’s untapped revenue growth potential (estimated at 60% this year) is what the public markets are betting on. Consider Twilio’s rankings from Seeking Alpha:

  • First out of 31 for 2015 annual revenue growth (88% for Twilio, with next highest at 58% (Tableau) )
  • First out of 31 for 2016 estimated revenue growth (Twilio will achieve 60%+ full year growth – next highest is 47%)
  • At that revenue growth rate, Twilio will likely trade at 5-6x+ 2017E revenue ($1.7B to $2.0B+ EV).
Ent Valuation assessment of Twilio on LTM growth rate vs. 2017 E Revenue Multiple       Source: Seeking Alpha

Revenue growth is great, but why are companies that make no money so valuable?

For all the disdain the VC industry receives for backing companies that don’t make money, you may be surprised to see the public markets do the same. Consider that nearly 70% of IPOs from 2013 entered their IPO as unprofitable, according to research from University of Florida’s Professor Jay Ritter.

Companies like Twilio are valued on the belief they can continue to grow at a rapid pace and stay on a “path to profitability.” Of the 30 pages of risk factors detailed in Twilio’s S-1, it seems markets want to believe Twilio has an ability to grow beyond its 28,000 active customer accounts and 900,000 registered developers.

Certainly, the market opportunity is there for Twilio. IDC estimates Twilio’s addressable market for 2017 to be $45.6B for their Programmable Voice, Messaging, and Video products.  Twilio’s elegant APIs created the software defined telephony industry. And the future is bright with the growing importance of messaging platforms and Twilio’s new product releases including Facebook Messenger API, unified notification API, two-factor authentication, programmable video and more.

What does this mean for other unicorns – or would be unicorns?

Keep innovating, or your wings will get clipped. Though filled with optimism, Twilio’s IPO and lessons from other tech write-downs demonstrate the necessity to continuously release new products that have frenzied customer adoption and rapid revenue growth. Failure to do so in this IPO will have harsh repercussions that Twitter and LinkedIn suffered in February. A company with billions in annual revenue and healthy to negative profitability doesn’t look like a unicorn to public markets, but an overvalued horse that can’t fly.

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