I am a huge fan of European tech and want to increase awareness of interesting listed tech businesses by writing company deep dives (similar to this one). As part of the research process, I have started tracking some European names and analysing their quarterly earnings. I found TeamViewer’s latest earnings quite interesting and wanted to share some initial thoughts on the business ahead of a deep dive. Please feel to reach out if you would like to share any feedback / discuss the company in detail.

Company Overview

Launched in 2005 and based in Germany, TeamViewer is a leading global cloud-based connectivity platform that enables users to connect to a wide network of different devices in order to: (i) control, manage, monitor and prepare these devices; (ii) assist users with daily problems and interact digitally with each other. While the company has expanded its product portfolio, it is primarily known for its remote access solution, used by IT. Listed in Germany, the company has a market cap of €7.0bn / $8.5bn.

Q1–21 Financial Performance

Background

In 2020, COVID-19 accelerated TeamViewer’s fundamental growth drivers as restrictions on mobility made remote access and collaboration functions critical to business success. In 2020, the company generated €460m in revenues (+42% y-o-y) and EBITDA of €261m (+44% y-o-y). Therefore, it should be classified as a clear WFH beneficiary as the company experienced incremental demand from COVID-19. As a result, TeamViewer’s share price did exceptionally well last year.

On 4th May 2021, the company announced their Q1–21 financial results and the share price declined by c.10%. While the company announced good billings growth and resilient margins, Q1–20 provides a tough comparison base for the financial performance this year as acknowledged by the management during the earnings calls.

Key Financial Highlights

The table above shows the Q1–20 and Q1–21 P&L in management view and accounting view. The difference in the “views” are due to non-IFRS adjustments such as deferred revenue, share-based compensation, one-off items. For the purpose of commentary below, I will use the financials from the management view.

A) Billings / Revenue: TeamViewer generated €147m in billings in Q1–21 (22% growth yoy on tough comps). There were a couple of factors that affected billings growth including:

• Increase in number of subscribers: In Q1–21, the company won additional 173 enterprise customers with an annual contract value of +€10k.
• Net retention remained at 100%
• Gross Churn: Subscriber churn of 15% (“retained subscribers amount to 437k compared to 514k at Q1–20”)
• Upsell/ Cross-sell: The company saw ACV expansion in the enterprise segment and a general shift of ACVs of €250k or more
• Down-sell: There has been “some rightsizing and proper procurement procedures of corona-driven subscribers” as anticipated by the company

B) Gross Margin: Gross margins have been resilient and above 90%, showing that the infrastructure is very scalable.

C) Sales Expenses: Over the last 12 months, the company has grown the number of employees by more than 40%, including significant additions to sales force. Therefore, the sales expenses have increased in absolute terms but have stayed constant as % of billings. It should be noted that the sales expenses have significantly increased under Accounting View — this is likely due to increased expenses from share-based compensation (variable cost) due to significantly higher billings as well as M&A related share-based compensation.

D) Marketing Expenses: As the company wants to position their enlarged product portfolio, it has significantly increased discretionary marketing spend (more details in the next section).

E) Adj. EBITDA Margin: In Q1–21, the company achieved c.60% EBITDA margin, virtually unchanged from Q1–20 despite continuous investments (management view).

Key Takeaways

The company has shown solid billings growth but will experience tough comps in the next 1–2 quarters. Furthermore, it is unclear to me whether COVID has primarily pulled forward future demand vs. created incremental temporary or permanent demand. Therefore, it will be interesting to see how the COVID cohort behaves relative to other cohorts in the coming quarters. It should be noted that the company is laser-focused on retaining these customers. Furthermore, the margins are very resilient, and the management has exerted cost discipline, which is great to see.

Operational Performance — Key Highlights

Focus on cross-sell and higher ACV accounts

The company is focused on two inter-connected strategic drivers to grow the business. Firstly, the company wants to sell more seats for each product/ use case per company (effectively targeting larger enterprises and/or increasing the share of wallet in existing customers). Secondly, the company wants to sell more products / use cases per company (effectively targeting different workflows within a company). Further details below:

(a) Use case / Product expansion: Historically known for its remote monitoring tool, the company has expanded its product capabilities, often through acquisitions. Product expansion has enabled the company to significantly increase its TAM. As an example, the company acquired Upskill and Frontline to increase their AR capabilities. The company does not provide billings breakdown by product category / use case as product expansion is in its early innings. However, I believe that use case expansion will be one of the key drivers for the business in the long term.

(b) Focus on larger enterprises: The company is also targeting higher ACVs in the enterprise segment (selling more seats per product within one enterprise), which requires a strong direct sales team, justifying increased investments in sales force.

Sponsorship Deals

To turn TeamViewer into a global tech brand, the company signed a strategic five-year partnership with Manchester United and Mercedes racing teams in Formula 1 and Formula E. The company expects these partnerships to deliver higher and longer growth 2023–2025 and beyond (expected €150m incremental billings in 2025) but they will be dilutive to margins in the coming years (2021 guidance for EBITDA margin lowered from 55–57% to 49–51%). When TeamViewer announced the Manchester United deal, the share price plunged by 16% as it represented a significant shift from previous management plans. The investors need some time to digest these sponsorship deals.

I think that the marketing deals have 2 important signal effects for investors. The management’s decision to invest in marketing vs. R&D and/or sales force can be a “mixed” signal. Management effectively took the view that these marketing deals offered the highest return on investment relative to (a) R&D, (b) sales force expansion and/or © M&A. While TeamViewer is a freemium product, it is not a consumer brand per se. In contrast, previous Manchester United sponsors included Chevrolet, AIG, Sharp and Vodafone, which have a clear consumer angle. Separately, it shows that the management is thinking long-term, which is a good signal (these deals would lead to short term pain (lower margins) but long term gains (incremental billings growth)).

Illustrative Valuation Considerations

Based on the latest share price (€35), the company trades on a 25x EV / 21E EBITDA and 20x EV / 22E EBITDA multiple. The company is expected to grow revenues at 29% (21–22E) with 56% 21E EBITDA margin. It implies a score of 85 on Software’s Rule of 40, which is exceptional.

Sources

• Company Materials
• Koyfin, Google Finance

Disclaimer

This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and affiliated persons and companies assume no liability for this information and no obligation to update the information or analysis contained herein in the future.

I am a huge fan of European tech and am very excited about the Darktrace IPO. I am writing this post as a way to better understand the company myself and hope it is of some use to other people. It represents my personal views and is for education purposes only.

The deep dive is primarily based on Darktrace’s IPO filing (“registration document”) and I have pulled out the most important bits. Furthermore, it is supplemented with external research and market data. I highly recommend that you read the actual registration document to gain a comprehensive understanding of the business. I should note that a lot of blood and sweat from junior bankers and lawyers went into drafting the document. :)

Darktrace Overview

“Darktrace was founded in Cambridge in 2013 out of a collaboration of cyber experts from various government intelligence backgrounds and mathematicians who were experts in machine learning. Together, they realized that mathematics could be applied to protect against cyber-security threats, leading to the inception of Darktrace.”

Darktrace’s product portfolio, inspired by the biological immune system, is effective in anomaly detection and serves as a weapon to discover and combat cyber threats that have successfully bypassed traditional cybersecurity products. The company’s product vision is to provide autonomous security (closed-loop solution) that offers autonomous detection, investigation, and response.

The company has grown significantly and generated c.$200m in revenues in FY20 (JuneFYE) with 45% y-o-y growth. It has received c. $346m in external funding and has only “burnt” c. $115m (adjusted for the $163m secondary convertible deal and cash balance of $104m as of Dec-20). The company has over 4,700 clients and currently employs c. 1,500 people across the world.

It is rumoured to IPO in May-21 at a c.£3bn valuation, implying c.11xEV/Revenue 22E multiple. It should be noted that there are several risk factors, including inherent product limitations and potential legal concerns around Mike Lynch’s involvement and minority ownership of the business.

Product Overview

What problem does Darktrace address?

There is a widely held notion that all large networks are infected. While traditional cybersecurity software solutions filter attacks at the perimeter and in the network, they can’t catch everything. Darktrace pioneered an approach that learns the normal behaviour of users, based on unsupervised Machine Learning, and detects outlier activity (similar to the biological immune system). Use cases include (a) insider threat and account takeover, (b) attacks on cloud, IoT and (c) Zero-Days, malware and ransomware.

Current Product Portfolio

According to the registration document, Darktrace’s key products include:

1. “Enterprise Immune System: Darktrace’s flagship AI technology solution, with individual Enterprise and Industrial focused products, provides self-learning technology for detecting cyber-threats and vulnerabilities. The average setup time is one hour and the machine learning gains visibility through software sensors that analyze raw, real-time data.
2. Darktrace Antigena: first proven Autonomous Response technology for the enterprise. The system operates as an AI decision-making framework that neutralizes fast-moving and unpredictable attacks in seconds while sustaining normal operations by design. Detailed product brief available here.
3. Cyber AI Analyst: automatically triages, interprets, and reports on a broad scope of security incidents, addressing a shortage of cyber professionals by augmenting human cybersecurity teams. It reduces triaging time by up to 92% and automatically writes reports in executive-friendly language.”

An excellent product overview can be found here. Interesting videos on the Darktrace product portfolio/demo can be found here and here.

Vikram Singh summarises Darktrace’s USP very well here. Excerpt below:

“What really sets Darktrace apart is the fact that it does not need periodic threat signature updates unlike most other cyber security systems. Rather than learning to identify abnormal behavior, it learns to identify normal behavior. Hence the lack of need for downloading signatures. It classifies anything outside normal behavior as a potential threat and lets system operators decide on how to respond to it. This makes it capable of addressing a wider array of threats. This also enables it to address novel threats before they can cause quantifiable damage. The system relies on no prior knowledge of threats as it does not look for threats in a conventional manner.”

Long term Product Vision

The long-term product vision is focused on providing a “closed-loop” solution to customers, already including detection and response, with remediation and prevention under development. Darktrace believes that the closed-loop approach creates a virtuous cycle in which each component feeds the next.

Product Limitations

Darktrace’s cybersecurity products use sensors placed in customer systems. These sensors can be delivered virtually (in software) or physically (using an appliance) and are commonly used in combination. In fact, c.$76m worth of appliances are recognized as assets under PP&E on the Balance Sheet as of Dec-20. These sensors collect network traffic that is analyzed using unsupervised Machine Learning. However, network protocols are increasingly encrypted so that Darktrace is only able to read the metadata, reducing the accuracy of the ML algorithms deployed and so making the solution potentially less effective. However, Darktrace is aware of the limitations and hence has developed an endpoint agent that can collect unencrypted data.

Furthermore, some IT teams have historically complained about the number of false positives that are picked up by the system (Source 1, Source 2). These issues may have been fixed over time as the reviews/articles are 1–2 years old. Recent Gartner reviews are indeed very positive.

GTM Strategy

Trials

“Darktrace’s primary approach to acquire new customers is through the Proof of Value (“POV”) trials of its technology. POVs require limited scoping and minimal set-up and thus can demonstrate Darktrace’s substantial value proposition to potential customers. The POV typically consists generally of a 2 week trial of Darktrace’s products. In 2020, c. 74% of POVs identified serious vulnerabilities in a prospective customer’s digital estate, providing a clear demonstration of Darktrace’s value proposition.”

Direct vs. Indirect channel strategy

“Darktrace generates c.65% of its revenue through its direct sales force but also relies on its channel partners to sell and support its Cyber AI Platform, particularly in parts of APAC, LATAM and the Middle East. Approximately 35% of the Group’s revenues involve channel partners and the Group expects that channel partners will represent a substantial portion of its revenues for the foreseeable future. The Group has over 370 active channel partners and includes Atos, BT, Reply, SHI, Bytes, Computacenter, Eurofins, Telstra, ConvergeOne.”

Market Opportunity

TAM

Firstly, Darktrace estimates that the current bottom-up TAM amounts to $40bn and can be disaggregated as shown below.

Secondly, from a top-down TAM perspective, “Darktrace considers the overall Information Security and Risk Management market. Gartner estimates that it amounts to approximately $125 billion in 2020. The total market is expected to grow at a compound annual growth rate of 8.2% from 2019 to 2024 on a constant currency basis.”

Current Customer base

Darktrace serves over 4,700 customers (implying a 3% market share based on 150k total addressable companies). In H2–20, the Group generated 18.1%, 20.5%, 39.4%, and 22.0% of its billings from customers in the UK, Europe (excluding the UK), the US and Canada, and the rest of the world, respectively. Average contract ARR was $60k with c.53% of total contracts below $100,000 ARR.

Competitive Landscape

The competitive landscape for Darktrace is multi-layered as it addresses various use cases and hence competes with various products in a fragmented cybersecurity market. However, it should be noted that buyers regard Darktrace as a complementary offering to strengthen their existing defences rather than replacing existing products.

For anomaly detection and behavioural analyses use cases, Darktrace directly competes with Vectra, Palo Alto Networks (LightCyber), F-Secure (Countercept), who represents direct competitors.

For insider threat use cases, Darktrace competes with Forcepoint (RedOwl Analytics).

Larger SIEM players such as LogRhythm, Rapid7, and Splunk also offer network anomaly detection capabilities.

Financials

Full P&L (in appendix)

Key Metrics vs. Peers

The table above provides a high-level financial comparison with other high-growth companies. Key observations include:

A) Darktrace’s growth is in line with Okta and Zscaler albeit Darktrace is at a significantly smaller scale. The key question is whether revenue growth will decelerate as the company scales

B) Darktrace’s net retention rate (which includes upsell) of 98.4% is significantly lower than peers, driven by a combination of higher gross churn (6.9%) and lack of up-sell opportunities due to a smaller product portfolio than peers

C) Average contract ARR per customer of $61k is lower than while 47% of all customers generate more than >$100k, which is significantly higher than peers. I think it indicates exposure to SMEs and lack of larger ($1m+) deals.

Darktrace’s Revenue Growth vs. Selected Players

Starting at c.$50m revenue as Year 1 for the companies, the chart shows the progression towards $500m. Darktrace has historically shown a revenue growth profile that closely aligns with Zscaler’s revenue trajectory. However, Darktrace’s revenue growth (as per the registration document) is expected to decelerate in the next 2 years so that it falls behind Zscaler in terms of growth profile.

Operating Cost Base Over Time and Long term Margin Framework

The chart above shows (a) the operating expenses and margin over the last 3 years as well as (b) the long-term margin framework (as outlined in the registration document). The improvement in operating margin, from (51%) in FY18 to (13%) in FY 20, demonstrates high operating leverage. It is primarily driven by Sales & Marketing expenses (decreasing from 115% of revenue in FY 18 to 82% of revenue in FY20). In the long-term, Darktrace expects operating margins in the 20s, which is in line with the long-term margin framework of other SaaS companies.

I have created a very simplified P&L (10y forecasts) just to play with the drivers and get a feel of the business. Feel free to reach out in case you would like access to it.

Valuation Perspectives

Illustrative Analysis at Various Prices

The table above shows the market cap, enterprise value, and the corresponding revenue multiples for various share prices. It should be noted that the share price corresponds to the internal share price (pre-IPO) and will be different from the actual IPO price range. According to the Guardian, Darktrace plans to IPO at c.£3bn, (highlighted via the green box), implying an 11.33x EV / 22E revenue multiple. In the next section, we will put it into the context of where listed comparables are trading.

Putting Valuation Into Context — Valuation Multiple vs. Revenue Growth

The scatterplot shows EV / 22E revenue multiple vs, revenue growth (21–22E) for selected cybersecurity players. Firstly, there is a positive correlation between revenue growth and valuation multiples (R² of 0.81). Secondly, there is a distinction between (a) hyper-growth cyber-security players (Okta, Zscaler, and Crowdstrike) and (b) medium growth cyber-security players (<25% growth). Darktrace is between these two sub-sets. Assuming Darktrace trades on the trend line, it would be trading at 20x EV/22E Revenue based on 30% growth, which would imply a c.$7bn / c.£5bn market cap. For context, Darktrace is rumoured to be IPO at c.$4bn / c.£3bn, implying 11x EV / Revenue 22E multiple.

Ownership

The ownership structure is shown above and discloses entities with >3% interest. Existing financial investors include KKR, Summit and Deep Defence (which I presume is Vitruvian Partners but not sure). Interestingly, Insight Venture Partners led the Series D in 2017 but are not disclosed as an investor.

Furthermore, Mike Lynch and affiliates own c.18.5% of Darktrace on a fully diluted basis. His involvement reflects one of the key risk factors and source of “controversy” around Darktrace, casting shadows over the IPO. A lot has been written in the press (FT, The Times) so I will not focus on the details. Key excerpt from an FT article below.

“Lynch was indicted in the US in November 2018 for allegedly artificially inflating revenues at Autonomy, the software company he founded and ran before selling it to HP in 2011 for $11bn. He has always strenuously denied any wrongdoing.”(…) “Darktrace disclosed in its registration document that in 2018 it was subpoenaed by US authorities for information about Invoke, warning there was a risk Lynch’s investment through Invoke could give rise to money laundering claims if the funds included cash from the Autonomy sale.” (FT).

Having read the registration document, the worst-case scenario (from a financial perspective) is still unclear to me.

According to the registration document “However, the consequences of liability under the Proceeds of Crime Act 2002 or similar U.S. laws could be significant for the Group and could include: financial penalties, forfeiture, management time and expense dealing with an investigation and defence, a criminal conviction and future debarment from public procurement. If any of the foregoing occurs, it could result in a material adverse effect on the Group’s business, financial condition, results of operations and prospects.”

A forced divestiture of his stake should not have any long-term material impact on the company itself. In fact, financial investors typically sell their stake post-IPO. Darktrace could also face “potential debarment from public procurement” in the US and financial penalties (amount unclear), which are tougher pills to swallow but not the end for the company.

It should be noted that the IPO process itself was affected by legal issues, which shows that the legal issues can manifest themselves in many ways. Several large underwriters, including Goldman Sachs, reportedly decided not to seek an IPO role. UBS, which was appointed in Nov-20 to advise on the IPO, resigned in Feb-21 as “its compliance department had decided it could not file the Suspicious Activity Reports (SARs) required to fulfil its role.” (Sky News)

Sources

• Darktrace Registration Document
• Koyfin, Market Research

Disclaimer

This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and affiliated persons and companies assume no liability for this information and no obligation to update the information or analysis contained herein in the future.

Appendix — Summary P&L

Quick Overview of the UK AIM Market

Launched in 1995, AIM (“Alternative Investment Market”) is the London Stock Exchange’s market for small and medium size growth companies. According to LSE, the AIM market has achieved several impressive milestones:

• In 1995, AIM launched with ten companies valued at £82m. Today, AIM is home to around 850 companies with a combined market cap of £104bn.
• Since 1995, over 3,865 companies have raised over £115bn on AIM.
• The average amount of money raised during the first five years of AIM was £2.8m. During the past five years it has been £21.4m.
• In its first full year of trading, the daily volume of trades of AIM companies averaged 21.9m. In the current year, it’s 2.4bn.

AIM-listed companies “represent many business sectors, ranging from mining, entertainment, retail and support services to software and biotechnology.” (HBCG) Particularly for high growth tech companies, an IPO on the AIM market can be a viable alternative to traditional VC / growth equity funding.

On first look — in terms of performance, the FTSE AIM All-Share index seem to have effectively traded sideways if you exclude the 2000 tech bubble. However, it should be noted that AIM-listed companies as they “grow / mature” often migrate from the AIM to the Main Market and are therefore excluded from the index. Over the last 10 years, c.35 UK companies have migrated and include several success stories such as Paysafe, GVC Holdings and BCA Marketplace.

In today’s post, I conduct a deep dive into the tech segment of the LSE AIM market and look at (a) size distribution, (b) sub-sector breakdown and © overview of the largest tech companies on AIM.

As of Jan-21, there are 88 tech companies listed on the AIM market with a combined market cap of c.£15bn. Full list available on request.

A. Size Distribution

The histogram above shows that sample size skews heavily towards micro-caps with 70% of the tech companies below £100m market cap and 53% below £50m market cap. Furthermore, there are only 3 tech companies (GB Group, Blue Prism and Learning Technologies) with a >£1bn market cap and 9 with a >£500m market cap.

From an institutional investor’s perspective, companies with <£100m market cap , would be too “illiquid”, which significantly reduces the potential universe of investable tech companies. It also means that retail investors tend to dominate the AIM market, especially in the micro cap (<£100m market cap) segment.

B. Sub-sector distribution of tech companies above £50m market cap

The subsample of 40 tech companies (>£50m market cap) shows that several sub-sectors are represented on the AIM. Firstly, software represent c.44% and typically includes on-premise / “legacy” software with a few exceptions. There are also an interestingly large number of vertical software companies (e.g. EMIS Group. Craneware, Tribal Group). Secondly, IT Services represent c.15% and typically include BPO / tech consulting companies. Thirdly, gaming represents c.12% with constituents including Codemasters (recently received an acquisition offer from EA) and Sumo Group. Finally, healthtech and payments represent small sub-segments with ‘others’ (includes Data Analytics, Ticketing, Telematics etc.) accounting for 19%.

Overall, the tech segment is relatively diversified but “frontier / new tech” is underrepresented.

C. Top 20 — Largest Tech Companies

The table above shows the top 20 tech companies by market cap. GB Group, a UK-based identity management business, is the largest constituent with a market cap of c.£1.8bn. Couple of observations on the top 20 list:

• Wide range of tech sub-segments are represented
• Valuation multiples for software companies are significantly lower than US software albeit unadjusted for growth
• Average LTM share price performance of the list above is 31%, significantly lower than NASDAQ
• Several companies on the top 20 list have IPOed in the last 5 years and have been quite successful, highlighting the potential of the AIM market:
• Blue Prism (RPA software provider): +1,500% since IPO in 2016
• Renalytix AI (AI-enabled in vitro diagnostics): + 380% since IPO in 2018
• Sumo Group (gaming): +190% since IPO in 2017
• Codemasters (gaming): +146% since IPO in 2018

Final remarks

The AIM market is an interesting hunting ground for retail as well as institutional tech investors. While larger and more established tech companies tend to IPO on the Main Market (e.g. The Hut Group) or prefer a US listing, AIM attracts interesting companies that are traditionally overlooked. These companies can generate excellent returns if they manage to “break out” of the AIM market. However, investors need to conduct in-depth research and require patience to find the diamonds in the rough.

There is a consensus that Europe has lagged behind the US and China in tech innovation due to a variety of reasons. Europe has been considered terrible at nurturing successful tech companies with only a few reaching significant scale (>€1bn value) compared to the US. While the debate has focused on private markets, much of the same negative sentiment / consensus is echoed in the European public markets with the tech sector to be “small” and overshadowed by the old economy.

In this post, I take a second look at the listed European tech sector to better understand its composition and assess its attractiveness from a long term investor’s perspective. I summarize my key initial findings in this post. Please reach out if you would like access to the data or exchange thoughts on this topic.

There are tech 71 companies with >€1bn Market Cap in Europe

Based on my screening, there are 71 European tech companies with a market cap above €1 billion, representing an aggregate market cap of €1.1 trillion (as a reference, Apple’s current market cap is €1.9 trillion). It should be noted that there is a long tail of 250+ smaller companies (<€1 billion market cap) with an aggregate market value of €90+ billion.

Sector Distribution

• Semis / hardware represent the largest segment. I was slightly surprised as it is not a sector I know well and hence was not aware of its scale. There are several large companies such as ASML, Infineon, STMElectronics in Europe. I suspect that the global nature of the semis, coupled with its manufacturing capabilities, enabled European companies to reach such scale.
• Consumer Internet is the second largest segment and comprises dominant regional players in classifieds / platforms, food delivery and e-commerce. Whilst there are several new-age players, particularly in food delivery and ecommerce, low-tech classifieds (Adevinta, Scout24, Schibsted) still represent a large portion of this segment.
• Software segment is the third largest segment with an aggregate market value of c. €235 billion (SAP represents c.60% of the aggregate market value).
• Majority of the European software companies are “mature-tech” with revenue growth <10%. However, several promising, high-growth companies such as TeamViewer have recently IPOed and reached significantly scale.
• It should be noted that successful high-growth tech companies tend to prefer a US listing (e.g. Spotify, Elastic), limiting the listing of break-out software companies in Europe.
• Gaming is the third largest segment with 7 out of 10 companies listed in two geographies (Sweden and the UK). Selected companies include Ubisoft, Embracer Group, CD Projekt, Keywords Studios.
• Others including (a) Edtech (Kahoot!, Learning Technologies), (b) HoldCo (Prosus), (c) Payments (Adyen) and (d) Ocado

Geographic Distribution

As expected, the majority (61%) of the tech companies are HQed / listed in the UK, Germany and Netherlands, which are the largest and mature financial exchanges in Europe. I was quite surprised to see 13 companies listed on the Nordic exchanges, containing some hidden gems in the European tech universe.

The 20 largest tech companies in Europe

The table above shows the top 20 largest listed tech companies in Europe, representing an aggregate market cap of €300 billion (c.27% of total universe). Some observations

• Lack of European “FAANG” — There is a clear lack of tech majors in Europe. While the US have their FAANGs and China have their BAT stocks, Europe doesn’t have any tech companies of such scale. In fact, most investors won’t even be familiar with the largest European tech company — ASML, a leading manufacturers of chip-making equipment.
• “Old-school” Semis / hardware are overweight on the list, similar to the overall sector distribution — As per the aggregate sector distribution, semis / hardware dominate the top 20.
• Several new-age, consumer internet players dominating — One common theme within the consumer internet is the emergence of dominant regional platforms in various verticals (classifieds, ecommerce, food delivery). Companies such as DeliveryHero, Zalando and Allegro dominate multiple geographic markets, enabling them to reach significant scale.
• Where are the software companies? There is a clear lack of software companies in the top 20. SAP, Dassault and AVEVA are the only software companies on the list. In contrast to the US, Europe is a tough place to scale a listed software business due to a variety of structural reasons (geographic fragmentation of end markets and smaller IT budgets relative to the US, investor focus on profitability etc).

Highest Return over a 5 Year Period

The table above shows the highest total shareholder return (assuming dividends are reinvested if applicable) over the last 5 years. It is difficult to derive a common theme. While +10 baggers exist in every market, the relative small cap nature of these companies and geographic dispersion makes it more difficult for retail or institutional investors to identify these attractive opportunities.

Investing in European tech requires access to and knowledge of several local markets (UK, Germany, Nordics) and a holistic sector knowledge (semis, gaming, software) as opportunities are spread across sectors and geographies. Absent the ZIRP state of the world, an optimist would argue that the complexity would perhaps makes it a compelling playground for sophisticated European retail and institutional investors, wanting to generate alpha on home turf. However, as long as the US tech keeps hitting ATHs, investors don’t need to do the hard work in European tech.

This article takes a first attempt at developing a scorecard / framework to better assess the impact of COVID-19 on enterprise software companies. While enterprise software stocks has fared better than rest of the economy, it is clear that various sub-segments will have a different exposure to the short-term impact of COVID-19 as well as the subsequent economic decline.

SaaS — Share Price Performance Over Time

The BVP NASDAQ Emerging Cloud Index has significantly outperformed the wider market over the last five years. While the index declined significantly in March-20 to levels last seen in Dec-18, it has rebounded strongly since then. The stellar performance of cloud companies is driven by the multi-decade structural shift from on-premise to the cloud as well as several advantages of the underlying business model.

The current pandemic and the subsequent recession will have a negative impact on the economy and the technology sector. Gartner’s recent forecasts imply a contraction of worldwide IT spending by 5% this year.

As not all SaaS companies are equal, they will be impacted differently by the current events. In order to better assess the potential threat of disruption, I have collated a framework to assess the short to medium term risk of companies in the SaaS universe.

Potential Framework to Assess Short to Medium Term COVID-19 Risk

The framework is built on 4 different factors (1. revenue resilience, 2. industry focus, 3. go-to market strategy and 4. segment exposure) to assess the resilience of the company’s business model and then puts it into the context of the key financial metrics, which ultimately drive valuation.

A short summary of the factors is provided below.

1. Revenue Resilience

Recurring revenue mix

Firstly, SaaS companies, with a high portion of recurring revenues, have a high degree of visibility and hence are more resilient to economic shocks. However, even such a prevalent relationship has to be scrutinized today. As Gavin Baker states in his recent post: “no revenue is truly recurring”. The quality of the recurring revenue will depend on other factors of the framework, including industry focus, go-to market strategy and segment exposure.

New logo wins

Secondly, the short-term impact of COVID-19 will be a significant reduction in new logo wins as customers defer/cancel new IT projects and implementation due to general economic uncertainty and travel restrictions. A recent Gainsight survey suggests that “from a new bookings perspective, most CEOs are contemplating a 20–50% decrease in bookings from a y-o-y growth perspective.” This implies that companies that rely on new logos wins as the main source of topline growth will struggle more than companies relying on (a) upsell and/or (b) “land and expand play”.

Pricing Model

Thirdly, pricing model will be key factor in determining revenue resilience. As Gavin Baker points out “seat based, transaction and workload based pricing models will obviously immediately feel the changes in the economy and naturally be more cyclical — one way or another”. As an example, Twilio’s usage-based revenue model allows companies to quickly ramp up its capabilities based on business demand. It’s pricing model, coupled with it’s customer footprint in travel vertical (Uber, Lyft, Airbnb), could potentially have a negative impact on its financials in the short to medium term. Another company with a similar pricing model risk is Shopify as c.60% of revenues tied to merchant GMV transactions.

Contract Duration

Finally, SaaS players with a multi-year contract duration are in a better position relative to players with shorter contracts. It should be noted that potential churn could be amplified by other factors of the framework such as when the SaaS solution is not considered mission-critical etc. However, all players would need to be prepared for contract renegotiation with existing customers, which will negatively impact the revenue base as well as liquidity, explored further in the financial metrics section.

2. Industry Focus

Horizontal vs. Vertical / Industry Exposure

We are already seeing contraction of IT spending in certain industries (e.g. airlines, hospitality, oil and gas) that are particularly hit during the crisis. As already mentioned, end-customers in these verticals are generally re-negotiating their existing software subscriptions to restructure their cost base. In the worst cases, customers have stopped paying software providers due to liquidity constraints. Overall, SaaS businesses in these verticals will be severely affected and their recovery will be dependent on the recovery in the respective end markets.

There are also categories within horizontal software, which will also be impacted more severely than the rest of the SaaS universe due to second order effects. Illustrative categories include payroll (lower interest rates affecting float revenue) and marketing automation (decline in overall marketing budgets).

Working from Home Benefit

There are some sectors that have experienced tailwinds due to COVID-19. Current enterprise IT spending is very focused on ensuring that organisations have sufficient remote access capabilities to operate in a seamless manner. Obvious beneficiaries include application and infrastructure providers in sub-sectors including collaboration software, video conferencing, identify and access management and VPN services etc. SaaS players in these segments will display strong topline growth during COVID-19 but the question will be if they can continue these newly formed relationships after the period of crisis. The positive impact will be amplified by other factors in the framework including product-driven growth, short implementation cycle etc. A great example is Zoom, which ticks most of the boxes in the rest of the framework.

3. Go-to Market Strategy

Sales Cycle and Implementation

While it is not easy to sell over the phone / Zoom / WebEx, companies with shorter sales cycles and lighter touch sales models will be more resilient during the period of uncertainty. They will be able to pick up new logo wins to support growth. Companies with product-led growth will do particularly well in the current environment. Illustrative companies with longer sales cycle include Guidewire, QAD and Veeva Systems.

Sales channel mix

There are two considerations in relation to sales channel mix: (a) field sales vs. inside sales and (b) direct vs. indirect channel.

SaaS companies, with a predominantly direct channel, will find it harder to sustain the current cost base as pipeline have naturally deteriorated and there are less logos to chase when people are adjusting to the new environment. This has already led to significant redundancies in the tech sector and companies will continue to right-size the teams, including the in-house sales force. In addition, businesses that rely on field sales representatives, coupled with heavy sales implementation, will particularly struggle due to the travel restrictions.

In relation to indirect sales channel, there has been an interesting development, which was highlighted by Coupa Software’s CFO in a recent interview. On a few deals, channel partners are paying the software fees while negotiating and arranging payment terms for its customers. This is part of channel partners’ strategy to adjust to the new environment and keep utilisation rates high within their organisations.

4. Segment Exposure

ACV — large vs. small deals

It will be challenging to get larger deals signed during the current period of uncertainty. Larger deals are typically accompanied by a go-to-market strategy that is unfavourable at the current time (long sales cycle, heavy implementation). Therefore, the ACV ($) can be used to confirm for the implications drawn in the previous section.

Revenue by segment exposure

SaaS companies with significant end-market exposure to SMEs will be at higher risk of churn as SMEs will be increasingly liquidity constraint. Based on the Gainsight survey, “Software companies catering to the SME are expecting churn to increase 19 points. Those selling to large enterprises are expecting, on average, a c.3 point increase in churn.” Illustrative examples of SME-focused vendors include Alarm.com, Avalara, Shopify etc.

Mission critical vs. underutilized software (shelfware)

I would distinguish between mission critical software as a stack that is needed to run the business in (a) normal times and (b) during COVID-19. Firstly, mission critical software in normal times will benefit from more resilient retention rates. However, other factors of the framework, including focus on affected verticals (hospitality etc.) as well as SME focus, will adversely affect even mission critical software providers.

Secondly, software that facilitates remote work, will be viewed as mission critical during the current crisis and will benefit from incremental demand. Clear beneficiaries include collaboration software, video conferencing, identify and access management, VPN. It will be interesting to see if there is a structural shift towards remote work and these companies can keep the incremental demand on the platform once the crisis is over.

Furthermore, customers will reassess the budget spent on under-utilised software (shelfware), which will lead to churn or increased payment renegotiation. Henry Ward, CEO of Carta, sums up the typical cost reduction strategy at firm level in his recent note: “once we modeled a slower growth rate in 2020, the first things we looked at reducing were non-headcount related expenses like non-essential software, AWS, travel, real-estate costs, and so on.”

5. Financial Metrics

Revenue Growth and Profitability

The resilience of a SaaS company, as analysed using the 4 factors, will be reflected in the KPIs and financial metrics (topline growth and margins) over time. These metrics should be used as an indicator to confirm the outcome of the analysis. It is expected that companies will preemptively right-size their cost base and shift from aggressive growth to profitability to reduce cash burn. However, SaaS companies with less attractive unit economics will particularly struggle during this shift as the weakness of their business model will be apparent.

Liquidity and Working Capital Cycle

Liquidity will be a critical factor that needs to be assessed as a separate point. It will be impacted by (a) leverage / cash as of today, (b) FCF over time. Cash is king — particularly as credit and equity markets have tightened in the past month. As I mentioned above, companies will aim to offset potential loss of revenue and decline in revenue growth by rightsizing the organisation.

In regards to leverage / cash position as of today — a net cash position puts companies in a great starting position. In contrast to that, companies with leverage, coupled with negative cash flow, will be particularly vulnerable in current environment.

In regards to notable FCF items to focus on — working capital will be particularly negatively affected by the current crisis. It is expected that software provides will need to offer customers flexibility on payment terms — this can be amplified by other factors in the framework, including SME and focus on certain verticals (hospitality, transport). More specifically, it will cause account receivable balances to increase and result in the days sales outstanding to also shoot up. Investors should pay close attention to how working capital evolves in the coming quarters.

6. Valuation

In public markets, software valuations have been principally driven by (a) topline growth and (b) profitability. This has led to the “Rule of 40”, which puts an equal weighting towards revenue growth and FCF margins. In reality, the weighting shifts with investor sentiment over time. Over the last twelve months, coinciding with the disappointing performance of the 2019 IPO cohort, investors have been increasingly focusing on companies that display profitability / clear path to profitability. The shift has been greatly accelerated by the current crisis.

Furthermore, investors are taking into account the resilience of SaaS companies into the investment decision — the proposed framework aims to provide a structured way to do so.

Due to the shift towards profitable growth as well as perceived resilience / vulnerability of a company in the face of COVID-19, valuation have recently reset for several high risk companies. However, fundamental value dislocations continue to exist and offer investors attractive risk-adjusted returns in the public SaaS universe.

Applying the Framework to HubSpot

As a small exercise, I have applied the framework to HubSpot for illustrative purposes. I will leave it to the reader to draw conclusions from the information provided. :)

Please feel free to follow me on twitter or LinkedIn of you would like to discuss anything tech-related!

Disclaimer: all views are my own. It is written purely for information only and is not intended to be investment advice.

I have collated resources that have helped me develop my knowledge of the digital marketplace space. Please feel free to comment with additional resources that are not included below.

Marketplace Primers

• Introduction to Marketplaces by a16z
• How to Kickstart and Scale a Marketplace Business — Series by Lenny Rachitsky
• A Guide to Marketplaces by Versionone VC
• 10 Marketplace KPIs that matter by Andrei Brasoveanu
• WTF is Marketplace Liquidity by PointNine
• Marketplace Liquidity by Borja Moreno de los Rios
• Service & Marketplace-model fit by Parth Sethi
• The Case For B2B Marketplaces by PointNine
• Marketplace Conference Video Series
• 2017 Platform Strategy Summit Videos

Current Trends in Marketplaces

• Marketplace Trends Predictions for 2019 at Market One Capital
• Marketplace: From Broker to Full Stack Operator by PointNine
• SaaS based Marketplaces by PointNine
• What’s Next for Marketplace Startups by a16z
• The Next 10 Years Will be About “Market Networks” by NFX
• Marketplaces: The Party is Not Over by FJ Labs
• The Evolution of Managed Marketplaces by Anand Iyer
• Can that SaaS business turn into a marketplace by Casey Winters

Investing Considerations

• Online Marketplaces — entering the next phase (Jun-20) by Dealroom
• State of Marketplaces by Menlo Ventures
• State of the Market — E-commerce Marketplaces (Sep-19) by Nfluence Partners
• Marketplace Index by Battery Ventures
• Sector Update — Marketplaces Q3 19 by GP.Bullhound
• Finding the next Billion dollar marketplace by Dave Lu
• The Marketplace Funding Napkin 2018 by PointNine
• 10 Factors To Consider When Evaluating Digital Marketplaces by Bill Gurley
• 10 Factors To Consider When Evaluating Digital Marketplaces — Case Study by Bill Gurley
• Freelance Marketplace 2.0: Where Future of Work Happens by Austin Yang
• How to calculate unit economics for platform businesses by Dr. Patrick Flesner
• How to Analyse Labor Marketplaces by Mike Ghaffary

Market Maps

• European B2B Marketplace Landscape
• List of Online Marketplaces Across the Globe by Linnworks

I recently took part in the BAPRAS healthcare hackathon, which was organised with the objective of developing ideas that improve the ways surgery is delivered in the UK and across the world.

I had the pleasure to meet Leonidas (#LBS4life!) at the event and we decided to team up to develop an idea within 48 hours. With no coding skills, we focused on the business case, product-market fit and the feasibility of product development and deployment across the NHS.

Firstly, we spoke to the doctors, present at the event, to understand what frustrates them most about their jobs. Based on these interviews, we mapped several pain points and narrowed down our list to problems that can be solved with existing technology solutions. We also paid attention to when the doctors were really passionate about a particular problem that bugged them.

Problem

I was very surprised to hear that no-shows / last-minute patient cancellation is a major issue for surgeries / general doc appointments. A doctor, who deals with cancer patients, mentioned that 1–2 out of 10 appointments per day do not show up or are late. Furthermore, patients, who do not follow pre-operative procedures, would be in this same bucket. This is an issue as (a) doctors sit their twiddling their thumbs, (b) affected patient have to wait longer for treatment (c) other patients could have been treated during that time slot and (d) NHS wastes millions of pounds per year. We drilled down to the root cause of the problem. At one extreme, patients are often overwhelmed with their health issues and the opaque ways appointments and diagnosis are communicated with them. At another extreme, patients. mostly with routine check-ups, tend to forget their appointments (I may be guilty of that…). In most cases, lack of continuous engagement is the common reason, leading to no-shows / last-minute patient cancellations.

Solution

We designed a simple multi-channel solution that interacts with patients through a combination of text, automated calls and a mobile app. Think of it as appointment reminder solution + pre-appointment to-do list + appointment guide. The goal is to reduce no-shows / cancellations and enhance patient experience by increasing engagement pre-surgery / procedure. Whilst the platform is sought to be automated, complicated cases can be easily escalated to the medical staff.

Our short pitch deck, that we presented at the end of the hackathon is below.

Current State of Appointment Reminders

While we did not build a functioning prototype during the hackathon, I believe that the idea is relatively easy to implement from a tech perspective. Appointment reminders (basic version of our product) such as Healthcare Communications (owned by IMImobile) already exist. Other communication as a service provider such as Messagebird also offer appointment reminder solutions. Furthermore, DrDoctor , a digital transformation specialist for NHS, also provides the solution for several NHS Trusts. The current product iterations are mostly basic and only serve as appointment reminders without allowing any interaction. Developing more features such as to-do lists, appointment guides and post-appointment to-do lists would be version 2.0 and a natural evolution of the existing solutions. In particular, the focus on interaction will have a significantly impact on appointment cancellations as doctors / NHS trusts will be able to gather useful data on why patients cancel etc.

Adoption is a Key Issue

It seems that widespread adoption seems to be an issue because doctors that I spoke to complain about the problem and had no knowledge of existing solutions. I presume existing solutions market trust by trust, similar to other healthcare providers. A potential new spin such as a bottom up sales strategy targeting doctors (who often move between trusts) or individual surgical departments may help increase adoption. Other growth hacking strategies include promotion at courses / conferences that target senior physicians / surgeons / decision markets at hospitals.

We would provide a free quota to test the solution and gather sufficient data on returns on investment to then convince the individual trusts to pay for the solution.

Next Steps

Overall, I would highly recommend participating in a hackathon as it allows you to go accelerate and compress the thought process of developing a business case in a very short time frame. Whilst I believe there is a clear need for a more advanced patient engagement product , current providers with appointment reminder products would be well placed to fill the gap. The question remains how the NHS can incentivise them to further develop their product and help them scale as well as achieve product-market fit.

Rethinking Corporate Philanthropy — The Do Good Investment Company

In order to encourage listed companies to pledge for charitable purposes, potential benefits of such an approach need to be communicated. It is obviously far easier to convince prospective companies (“donors”) if the financial and reputational benefits outweigh the financial cost of a pledge.

The idea is to create an umbrella investment vehicle, named “The Do Good Investment Company”, which serves as a ‘Charity of Charities’. Listed companies (“Donors”) pledge a portion [0.5%] of their share capital or cash proceeds (whichever is more tax efficient) to this independent entity.

High level mechanics

The Do Good Investment Company receives the shares by donors and is responsible for:

• Conducting due diligence on charities
• Distributing the funds based on the preference, selected by the donor
• Monitoring how the funds are deployed by the charities receiving the funds
• Providing regular updates and reports to donors on how their share capital was distributed for charity purposes (these reports can be seamlessly included in the donor’s Annual Report / website to support CSR efforts); and
• Raising awareness for The Do-Good Investment Company, acquiring new donors and identifying new charities

Donors can allocate their funds to specific purposes based on a list of charitable purposes such as (a) fighting poverty, (b) advancement of education, (c) community development, (d) advancement of arts, culture, heritage and science

In order to increase shareholder engagement, donors can potentially enable their shareholders to vote for charitable purposes at the Annual General Meeting

Key benefits to companies (donors)

• Consolidation and outsourcing of CSR / charity efforts

> This is a novel way for companies to consolidate their efforts in charitable purposes at Group level and effectively outsource part of their CSR initiative to an independent organisation with expertise in ‘doing good’

> Companies save employee hours and reduce cost while increasing the impact of the funds

• Enhancing transparency

> By consolidating charity efforts, companies can be more transparent with public and their shareholders on how they donate money

> Different companies have different ways on (a) how much and (b) how they donate money. Using a streamlined approach, companies can increase transparency of their CSR efforts

> It also reduces reputational risk which may come from distributing funds to controversial charitable purposes

• Increasing shareholder engagement

> Companies could potentially get their shareholder to vote how the pledged [0.5%] share capital or cash proceeds are distributed. This would help them to increase awareness of their CSR efforts and shareholder engagement

• Targeting millennial as shareholders / increasing brand loyalty

> Studies have shown that millennial care deeply about sustainability and whether companies are socially responsible in the context of investments

> By being part of The Do Good Investment Company, companies can demonstrate their commitment and attract millennial as shareholders

Governance

The Do Good Investment Company is governed by an independent Board, comprising of business people and celebrities with connections to charities with the objective to (a) govern independently and (b) advance the cause through their connections

• High profile business people with a track-record in philanthropy such as Richard Branson, Tom Hunter, Lord Sainsbury, Michael Spencer
• Celebrities with connections to charities and a track-record in philanthropy such as Elton John, JK Rowling

This blog post aims to discuss the current trends in the VC ecosystem in relation to capital flow and why the secondary market in VC may experience explosive growth over the coming years.

How Does capital flow in the VC ecosystem?

The graphic above illustrates the VC ecosystem. Limited Partners provide capital to VC funds, managed by VC firms (“General Partners”). The capital is deployed by General Partners to startups, which constitute the VC investment portfolio. Amid a liquidity event (IPO, M&A or secondaries), the VC fund exits its entire or partial stake in its investment and receives proceeds from the exit. The investment holding period (initial investment to exit) for VCs is typically 6–10 years and has increased over time.

In order to understand each trend within the ecosystem, it is important to view them as components of a wider system.

Relationship between Limited Partners and General Partners

Trend 1A: Capital provided to Venture Capital (“Contribution”) by Limited Partners Has Increased

The chart illustrates that the global VC cash flows over time. Since 2012, the global VC industry has received positive net capital inflow by Limited Partners of c.$151bn since 2012. In specific, the VC sector has received c.$441bn of new capital and distributed c.290bn to LPs since 2012. According to Goldman Sachs, VC dry powder reached a record level of more than $121bn in 2017. The level of investments into Venture Capital as an asset class are not surprising as the time period shown coincides with a global bull cycle, primarily driven by technology companies.

Relationship between General Partners and Investment Portfolio

Trend 1B: VC Investments Have Reached Record Levels

VC firms have been busy deploying capital, received by the Limited Partners. Since 2012, they have deployed c.$485bn in companies with a peak of $84bn in 2018.

Trend 2A: VC Exit Activity Has Declined relative to capital raised, partially driven by the availability of private capital

Due to (a) the availability of excess capital to VCs and (b) VC’s rate of capital deployment, VC-backed companies are able to raise late-stage funding rounds and so stay private / independent longer than in previous cycles. This has led to a reduction in exit activity over time relative to VC investments. Since 2012, the aggregate exit value on an annual basis is c.$89bn. The exit is predominantly achieved via IPO or acquisition with the composition changing over time.

Trend 2B: VC Investment Holding Period Have Increased

As companies stay private longer, VC investment holding period has increased significantly from 6.3 (4.2) years for exit via IPO (Acquisition/Buyout) in 2010 to 8.3 (4.9) years for exit via IPO (Acquisition/Buyout) in 2016. Whilst there is no data for 2017 and 2018, anecdotal evidence indicates that the holding period has increased since 2016.

What if Limited Partners / General Partners Become Impatient?

Despite increase in holding period, the dynamics between both LPs and GPs seem to be in tact as GPs are able to raise funds in just 2.4 years on average in 2018 vs. 3.3 years in 2006.

However, if the pressure to distribute returns increases in the future, VCs, confronted with ageing portfolio, would need to focus on achieving liquidity.

The primary exit options are (A) IPO and (B) M&A. Given the current stock market meltdown, driven by the tech sector, IPO and M&A activity are expected to cool down in the short to medium term. The third potential exit option would be (C) achieving liquidity through the secondary markets.

The Rise of the Secondary Market in Venture Capital

Rise of the Secondary Market

While secondary funds are common in Private Equity, its existence in Venture Capital has been “marginal” in the past. In 2018, capital invested in global VC secondary markets reached $10.8bn, primarily driven by SoftBank’s $8bn secondary transaction with Uber’s shareholders. Ignoring the activity in 2018, which is skewed by the SoftBank transaction, activity in the secondary market is very small relative to the traditional exit activity in the IPO / M&A market (see Trend 2A).

However, , secondary exits may become common in the near future as VC funds / LPs may as well as employees not patient enough to wait for another cycle to exit their investments.

Predictions for the Secondary Market

My predictions for the secondary market in VC are as follows. Driven by demand for liquidity by early investors and employees, we may see:

• Continued emergence of VC secondary funds and positive fundraising dynamics for secondary vehicles
• PE-focused secondary funds investing in the VC secondary market
• Secondary marketplaces such as Equidate, Equityzen, SharesPost may experience unprecedented growth and also expand to facilitate transactions among institutional investors
• Crowdfunding providers will further expand into facilitating secondary transactions. As an example, Seedrs has already started creating a secondary market to let its users buy or sell shares in private companies.

Key Stats

Notable Secondary Transactions (C)

• Jan-18: SoftBank / Uber (founded in 2009); $8bn secondary deal with existing investors including Benchmark Capital, First Round Capital, Menlo Ventures and management
• Mar-18: Silver Lake / Credit Karma (founded in 2007); $500m secondary investment to provide liquidity to investors and early employees
• Jul-18: Francisco Partners & GPI Capital / LegalZoom (2001); $500m secondary investment

Notable Fund Sale (D)

• Oct-17: Draper Espirit acquired Seedcamp’s Fund I & II for €20m, delivering 4x returns to Seedcamp’s investors
• Nov-18: NEA’s spin-out of NewView Capital with LPs including GS and Hamilton Lane

Notable Secondary Funds

• Balderton Capital: In 2018, it raised a $145m fund dedicated to secondary transactions in European companies
• Draper Espirit: very active as secondary tech investor in Europe
• 137 Ventures: US-based secondary fund, invested in Wish, SpaceX, Flexport, Gusto, DiDi
• Industry Ventures: US-based secondary fund with investments in ventures funds such as Battery Ventures, Draper Espirit, Lightspeed Venture Partners as well as companies including Alert Logic, Cambridge Display

In this short blog, I would like to summarise my key observations and provide some visual clues of stores/concepts that are representative of the overarching trends observed.

Please note that I am not a retail expert so that all these observations represent an “outside-in” view on the sector.

OBSERVATION 1: THE RISE OF EXPERIENCE STORES

Experience stores are a useful tool for companies with products that need to be experienced offline to fully grasp the potential of the products. This helps win over customers, who are less inclined to purchase online and reduces product return rate. Furthermore, it provides the brands with an opportunity to physically interact with its customer base.

The main purpose of the Sonos store is to let potential customers experience the sound of Sonos devices. The store has several closed cabins that are decorated as living rooms/bedrooms with different mood lights and themes. Furthermore, the sound system integrates various Sonos products (speakers, home sound systems), which can be turned on/off with a tablet so that potential customers have an opportunity to experience individual products but also the whole Sonos experience.

The Casper store utilises a similar concept. There are several little ‘houses’, which showcase different Casper mattresses that customers are encouraged to try. When you walk into a store, you are greeted by friendly employees, who give advice on how to ‘experience’ the mattresses. As an example, they explain that you have to lie on the mattress for at least three minutes to fully register the difference of the Casper mattress and provide advice on the suitability of the mattress product line. I obviously took the opportunity to test the mattress and it was definitely more comfortable than my current mattress! Finally, Casper has also expanded its product line, which now also includes pillows, bed frames, and bedding products.

OBSERVATION 2: INTELLIGENT CURATION DRIVEN BY DATA ANALYTICS

With the explosion in SKUs (Amazon has 400m+ SKUs), the need for curation has also increased. Online stores have the ability to curate potential product purchase ideas based on user behaviour, leveraging AI/ML. The use of analytics is now also penetrating the offline world, enabling intelligent curation of products.

In Sep-18, Amazon launched its 4-star store, “a physical store where everything for sale is rated 4 stars and above, is a top seller, or is new and trending on Amazon.com”. In my opinion, this store is a good place to purchase gifts as well as various Amazon devices (echo, kindle, ring products etc.). Furthermore, customers can pay with Amazon App, linking the offline world with Amazon’s online capabilities.

b8ta is a software-powered company, designed to make physical retail accessible for all. It was founded in 2015 and has received c.$38.5m in funding to date. Its investors include Macy’s and TriplePoint Capital. The company is “focused on building a new retail-as-a-service model with stores that let people experience products the way their makers intended.” They enable manufacturers (i) get into physical retail, (ii) manage the brand’s identity and (iii) capture live insights into capture rates, dwell times, discoveries and demos.

I visited b8ta-powered shop-in-shop at Macy’s. The products offered were primarily tech gadgets including smart GPS dog collars, robo temi and Snapchat’s spectacles.

OBSERVATION 3: PHYSICAL PRESENCE FOR MANAGED MARKETPLACES

Managed marketplaces, especially pre-owned goods as well as rental platforms, are booming. However, given the service/value-add aspect of these types of marketplaces, a physical presence can be highly beneficial. It provides a physical touch point for both sellers and buyers.

The RealReal is a leader in authenticated luxury consignment marketplace, where you can buy and sell luxury goods from top designers. The company matches sellers with buyers and provides authentication services. The company was founded in 2011 and has received c. $288m in funding to date. Notable investors include Great Hill Partners, Springboard Growth Capital, Sandbridge Capital and PWP Growth Equity.

The physical store is huge and is spread across two floors. The products shown are curated and representative of their online offering and include clothes, watches, jewelry etc. Given its marketplace role, it also has meeting rooms and a coffee shop in the basement. The physical store also services as a physical drop-off for users to bring in their goods for consignment and have advice sessions with staff.

In case you are in New York, its worth visiting some of the emerging retail concepts. I have mapped some selected stores on Google Maps. To follow the list, please click here: https://goo.gl/maps/zM4tpHPzka92

Originally published on cmodi.com https://www.cmodi.com/blog/2018/11/29/notable-observations-in-physical-retail-in-newnbspyork