I'm excited to see Instructure file for its IPO. The EdTech space which I have written about in a previous blog post is in dire need of more successful outcomes. Instructure should start trading in the coming weeks so let's peruse their S-1 to see how their business stacks up.
Instructure provides a learning management system (LMS) for academic institutions and corporations. Their main LMS apps are Canvas, for the education market, and Bridge, for the corporate market. Millions of students, teachers and employees use Instructure's software to help manage face-to-face learning in an interactive and accessible way. Instructure sells through a direct sales force and charges customers a licensing fee based on the number of users. Today, they serve 1,400 customers in more than 25 countries with contract values ranging from thousands of dollars to several millions of dollars.
The company sizes the market for academic and corporate learning software at $4.1B in 2015, projected to grow to $7.8B in 2018. I would characterize the academic learning software market as highly fragmented with several incumbent providers. The image below really sums it up. As you can see, BlackBoard is the heavyweight while companies such as Instructure (Canvas) and Desire2Learn have been quickly growing their market shares.
In terms of revenue, Instructure tripled in 2013 to $26M of revenue, then slowed to 70% growth in 2014 to $44M of revenue. The S-1 provides the first nine months of 2015 and annualizing that gets us to $69M of 2015 revenue. They will likely come in higher than that if they have a decent Q4, but they are basically looking at roughly 60% growth in 2015. Like most SaaS busineses, there is a services component but it is relatively small. Gross margins are also fairly typical for a SaaS business at 71%.
By going further down the P&L we can better understand the company's operating leverage. Sales and marketing, general costs, and R&D are all fairly flat as a percentage of revenue. Most importantly, sales costs are coming down over time which is a good thing. However, the costs are high enough to generate significant operating losses. Annualizing their 2015 numbers yields a (78%) operating loss, or a loss of $53M for the year. This may sound bad but it is typical of high growth SaaS businesses since the revenue is recurring and all but guaranteed each year. Many customers will also grow their spend over time while the costs associated with supporting those customers will go down. Thus, it makes sense to spend a lot of capital early on to acquire these accounts. The best way to understand operating leverage in a business like this is to look at sales efficiency metrics like the Magic Number or CAC ratio but the associated data is not provided in the S-1, unfortunately.
While the $50M+ operating loss in 2015 is severe, it does not mean that the company is burning $4-5M per month. Take a look at the quarterly metrics below. Non-GAAP income is derived by adding back non-cash expenses such as stock-based compensation, and free cash flow is calculated by making additional adjustments from working capital, depreciation, etc. In the trailing 12 months, the company burned about $27M, or a little over $2M per month (better than the $4-5M per month if you were just looking at operating loss). As a side note, it appears that in Q3 of each year the company is able to collect much of their accounts receivable which gives them a large cash infusion.
Instructure should be comped against other high growth SaaS companies. That means 5-8x NTM revenue on average. While Instructure is growing a bit faster than some of these companies, it is also growing off of a much smaller base. My guess is that Instructure will trade at the low end of their peer group based on their relative size, growth and operating metrics. The simple table below illustrates the possible trading trading values, most likely in the $400-600M range.
Selling learning management systems to universities is a particularly challenging task, but Instructure has been executing well. I'm looking forward to their IPO in the coming weeks.