A tale of two S-1’s

Today was a busy news day on many fronts. In particular, two notable companies filed to go public – New Relic and Hortonworks. These two companies do not have a lot in common, but they are both on my list of companies I want to know more about. It is a long list, so I am a bit behind, and I will try to play a bit of catch up here. More importantly, I think these companies say something about the changing world of software development, but they also mark an ominous note for the health of the current IPO window.

I know New Relic through some of the work I have done looking at developer tools companies. I have posted on this space in the past. New Relic creates software that helps other people make better software. They have a suite of tools for designing, streamlining and testing new apps. I know them mostly through their extensive work in the mobile space, but they do a lot more than mobile software. In that post I linked to above, I lamented the difficulty companies in this space have faced, so I am encouraged that New Relic thinks their prospects are strong enough to go public, and I think they are entering into some very large, untapped opportunities.

Hortonworks is the first of the “Hadoop companies” to go public. I am a big believer in Hadoop, but that phrase is pretty meaningless, like saying I am a big believer in databases. More to the point, I think the Street has a lot to learn about Hadoop and the changes it is bringing not only to the database industry but to the whole computing software space. Hortonworks has a business model similar to that of Red Hat, it gets paid for helping people use free software. Where Red Hat made Linux functional for the enterprise, Hortwonworks is attempting to do the same for Hadoop. For purely idiosyncratic reasons, I have never been a big believer in Hortonworks. Something about their marketing and positioning just never sat right with me. I had no rational reason for that gut feeling, but I want to be upfront with my biases, and my suspicions about Hortonworks were partially confirmed by a detail on the front page of their filing.

So we have one very new-day software-as-a-service (SaaS) company in New Relic, and an older model services and license model at Hortonworks. The Street really likes SaaS models now, but there is nothing wrong with Hortonworks model, at least in theory.

So we have one company that I have a vague good feeling about, and one that I have a vague not-so-good feeling about. The trouble with both companies is that they are both losing money. A lot of it. In the past nine months Hortonworks has lost $54 million from operations, while over that same period New Relic burned about $15 million. (And let’s not get me started about Hortonworks April year-end….)

Horton and New Relic financials

If the image above were readable, you would see that both companies have been losing money for a while, but are slowly improving. Well, the improving trend with New Relic is there. Hortonworks’ improvement requires a bit more faith. As I noted earlier, the two companies have very different models and probably should not be compared this way – 30% gross margins vs. 80% gross margins. These are very different companies.

There is a constant debate in the Valley as to whether or not we are in a ‘Bubble’. Those who argue we are point to things like San Francisco real estate, traffic on the 280 (let alone 101), and $19 billion for WhatsApp or a pre-revenue valuation of Snapchat of $7 billion. Those who say we are not in a bubble point to the fact that so many of today’s private companies are much more capital efficient. It costs very little to start a business when you do not have to spend any money on capex for servers, since you can run everything on Amazon’s cloud. In this era of ‘lean’ start-ups, the capital at risk is much lower than in the ’90’s dot.com Bubble.

What makes me uncomfortable is that we have two highly unprofitable companies filing to go public, and that has to be some kind of warning flag. Now there is an argument that we are in a golden age of software growth, and both companies tap into two very large market opportunities. So it makes sense that they should be investing heavily to build as big an advantage as they can right now. Companies do not need to be profitable to go public, but they should have a pretty visibile path to profitability. Otherwise, it just becomes an exercise in handing off risk to public investors, who have a much lower tolerance for new fangled ideas than venture investors. Even if we assume that both of these companies are making smart decisions about the risks they face, investors should start to get a little cautious that other companies with much higher risk profiles see these two come out and start to get ideas.

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