SimilarWeb: A Singularly Unprofitable IPO

SimilarWeb (NYSE:SMWB), the web analytics company, closed its initial public offering last week, with a valuation of $1.6 billion. According to the company’s F-1/A registration document, the Israeli company priced the 7.5 million shares it offered to the public, as well as the 500,000 shares offered by the selling shareholder, at $22 per share. The company raised $165 million through the IPO and could raise a further $24.8 million if underwriters exercise their option to buy additional shares in the next 30-days. The company mines web and mobile app data for insights and provides clients with deep analytics. It is used by analysts, businesses and marketing professionals.

The global health crisis is the most disruptive event that most businesses have faced in the last few decades. Nevertheless, a few select companies have benefited from the ravages of the pandemic. This is because these companies help their clients work better in a world of remote work. Consequently, demand for their services has never been greater. SimilarWeb is one of those companies that have grown during the pandemic as businesses have flocked to them for their services. Annual recurring revenue for 2020 was $123 million.

An ARR of over $100 million is a tell-tale sign that a private company will start contemplating an IPO and SimilarWeb was no exception. Revenue growth year-over-year was 32.4%, with revenue growing from $70.59 million in 2019 to $93.49 million in 2020. That pattern of high growth has continued into 2021: first quarter revenue in 2021 was 42.8% greater than the same period in 2020, with revenues growing from $20.6 million in Q1 2020 to $29 million in Q1 2021.

Readers are aware that the vast majority of IPOs are unprofitable. Indeed, of the 73 IPOs held by unicorns by November last year, only 6 were profitable and since Zoom Video's (NASDAQ:ZM) IPO in August 2019, no unicorn has been profitable on IPO. The data suggests that private IPOs are not only unprofitable, but that unprofitability is becoming an even greater problem than it was in the past. This is an important point to note when analyzing IPOs. SimilarWeb is part of that pattern of unprofitability.

The company remains unprofitable as a result of its large and growing operating expenses. Net loss widened from $17.7 million in 2019 to nearly $22 million in 2020. That pattern has continued into 2021: net loss in Q1 2021 ($12 million) is nearly double what it was in Q1 2020 ($6.2 million). Operating expenses grew from $66.19 million in 2019 to $91.7 million in 2020, representing a growth rate of 38.6%. That trend has extended into 2021: operating expenses in Q1 of 2021 ($34.7 million) are 63.5% greater than in Q1 2020 ($21 million). The biggest expenditure is on sales and marketing costs. $38.9 million in 2019, they rose to $53.6 million in 2020. Q1 2021 sales and marketing expenses stand at $19.6 million against $12.9 million for the same period in 2020.

Get The News You Want

Read market moving news with a personalized feed of stocks you care about.

Get The App

The point of the above is to highlight SimilarWeb’s strategy; the company is placing a binary bet in which it believes that by juicing up revenue growth, it will achieve economies of scale and build massive barriers to entry, thereby giving it the freedom to become profitable. By attaining minimal viable economies of scale, and barriers to entry, the company will be able to raise prices to a level at which it can be profitable and reward those investors who will have stuck it out. Essentially, the company believes it can grow itself into profitability. This may be a viable strategy for many startups, however, it comes with significant risks.

In highlighting its strategy, we can interpret its sales and marketing costs in a charitable way, as an investment in its revenue-growth-to-profitability strategy. In other words, these costs are essential for the company to become so big that it can raise prices. In a competitive market, it is impossible to have pricing power because there are so many competitors that business is essentially commoditized: everyone becomes a price taker and is forced to live with low prices. Competition is great for consumers but terrible for businesses. Right now, SimilarWeb has to eat whatever prices are put before it.

So, its strategy is a binary bet because there are only two roads available: either the company achieves minimal viable economies of scale and builds barriers to entry, or, it goes bust. In other words, the failure to achieve economies of scale and barriers to entry will mean that the company cannot become profitable and will eventually have to be shut down in capitalism’s process of creative destruction. The nature of a binary bet is that share price movements become extremely volatile as investors overinterpret every earnings announcement, every operating result and react manic-depressively, sending prices to euphoric highs or depressive lows.

Everyone loves the euphoric pricing but nobody wants the depressive pricing, yet the two are a consequence of taking on a binary bet. And downward volatility can easily wipe away the gains from euphoric pricing. At a time of investor uncertainty and the prospect of rising inflation and higher interest rates, it may be safer to invest in rare metals than on a bet with an extremely uncertain outcome. This is definitely a stock most of us will want to avoid.

Written By: Alex Newman