Datto Holding Readies $561 Million IPO (Pending:MSP)


Quick Take

Datto Holding Corp. (MSP) has filed to raise $561 million in an IPO of its common stock, according to an S-1 registration statement.

The firm provides an infrastructure platform for managed service providers to sell services to small and medium businesses.

MSP is well-positioned in a growing industry, is doing a fine job of retaining its MSP partners and the IPO appears reasonably priced, so is worth consideration.

Company & Technology

Norwalk, Connecticut-based Datto was founded to create an integrated IT platform for managed service providers [MSPs] to deliver their software and services to small and medium businesses [SMBs] worldwide.

Management is headed by CEO Tim Weller, who has been with the firm since May 2017 and was previously interim CEO at Wonga, a financial technology company based in London, UK.

Below is a brief overview video of Datto:

Source: Datto

Datto’s partners or major customers include:

The firm counts more than 17,000 MSP partners on its platform.

The company’s primary offerings include:

  • Networking

  • Business Management

  • Security

  • Unified Continuity

  • Cloud Management

Datto has received at least $1.1 billion from investors including Vista Funds and Austin McChord.

Customer/User Acquisition

Datto utilizes a marketing and inside sales team to pursue MSP partners via all forms of online communication including SEO, paid search, online events, demos and email outreach.

Sales and Marketing expenses as a percentage of total revenue have been dropping as revenues have increased, as the figures below indicate:

Sales and Marketing

Expenses vs. Revenue

Period

Percentage

Six Mos. Ended June 30, 2020

23.7%

2019

24.1%

2018

25.3%

Source: Company registration statement

The Sales and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Sales and Marketing spend, has remained stable at 0.6x in the most recent reporting period, as shown in the table below:

Sales and Marketing

Efficiency Rate

Period

Multiple

Six Mos. Ended June 30, 2020

0.6

2019

0.6

Source: Company registration statement

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth trajectory. MSP’s most recent calculation was 28% as of June 30, 2020, so the firm has some improvement in this regard.

Management says its dollar-based net revenue retention rate was 115% in the most recent reporting period.

A figure above 100% means that the firm is earning more revenue from the same cohort of customers, i.e., negative net churn, and is a positive signal that its ‘land and expand’ sales and marketing approach is working well.

Market & Competition

According to a 2020 market research report, the global managed services market is expected to grow from $179 billion in 2019 to $309 billion by 2025.

This represents a forecast CAGR of 9.6% from 2019 to 2025.

The main drivers for this expected growth are the continued transition of businesses of all sizes to greater reliance on IT software and services and toward cloud environments.

Also, many firms prefer to use managed services to simplify their in-house IT operations as they focus their limited attention on achieving their other business goals.

Major competitive or other industry participants include:

  • Barracuda

  • StorageCraft

  • Acronis

  • Veeam

  • Cisco Meraki

  • Ubiquiti (UI)

  • Aruba

Financial Performance

Datto’s recent financial results can be summarized as follows:

  • Growing top-line revenue

  • Increased gross profit and gross margin

  • Increased operating profit and operating margin

  • A swing to net income

  • Strong growth in cash flow from operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue

Period

Total Revenue

% Variance vs. Prior

Six Mos. Ended June 30, 2020

$ 249,126,000

15.9%

2019

$ 458,752,000

18.4%

2018

$ 387,355,000

Gross Profit (Loss)

Period

Gross Profit (Loss)

% Variance vs. Prior

Six Mos. Ended June 30, 2020

$ 177,593,000

24.0%

2019

$ 301,445,000

21.8%

2018

$ 247,484,000

Gross Margin

Period

Gross Margin

Six Mos. Ended June 30, 2020

71.29%

2019

65.71%

2018

63.89%

Operating Profit (Loss)

Period

Operating Profit (Loss)

Operating Margin

Six Mos. Ended June 30, 2020

$ 29,995,000

12.0%

2019

$ 29,225,000

6.4%

2018

$ 8,418,000

2.2%

Net Income (Loss)

Period

Net Income (Loss)

Six Mos. Ended June 30, 2020

$ 10,120,000

2019

$ (31,188,000)

2018

$ (37,723,000)

Cash Flow From Operations

Period

Cash Flow From Operations

Six Mos. Ended June 30, 2020

$ 23,975,000

2019

$ 11,235,000

2018

$ (10,559,000)

(Glossary Of Terms)

Source: Company registration statement

As of June 30, 2020, Datto had $60 million in cash and $673.1 million in total liabilities.

Free cash flow during the twelve months ended June 30, 2020, was negative ($6.7 million).

IPO Details

Datto intends to raise $561 million in gross proceeds from an IPO of 22 million shares of its common stock, offered at a midpoint price of $25.50 per share.

Entities affiliated with Dragoneer have indicated a non-binding interest to purchase up to 20% of the shares offered in the IPO. This is a strong signal for the proposed valuation.

Assuming a successful IPO, the company’s enterprise value at IPO would approximate $4.5 billion, excluding the effects of underwriter over-allotment options.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 13.96%.

Management says it will use the net proceeds from the IPO as follows:

We expect to use […] the net proceeds of this offering […] to repay outstanding borrowings under our term loan facility (the “Term Loan Facility”) and our $50.0 million revolving credit facility (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Credit Facilities”) and the remainder of such net proceeds will be used for general corporate purposes.

Management’s presentation of the company roadshow is available here.

Listed bookrunners of the IPO are Morgan Stanley (NYSE:MS), BofA Securities, Barclays (NYSE:BCS), Credit Suisse (NYSE:CS), Citigroup (NYSE:C), Jefferies, RBC Capital Markets, Evercore ISI, BMO Capital Markets, Macquarie Capital, Mizuho Securities, William Blair, Ramirez & Co. and Siebert Williams Shank.

Commentary

Datto is seeking public investment capital to pay down debt and to fund its expansion plans.

The firm’s financials show moderately growing top-line revenue and positive growth across all other major metrics.

Sales and Marketing expenses as a percentage of total revenue have been dropping; its Sales and Marketing efficiency rate is stable.

MSP’s dollar-based net retention rate of 115% is a good result. This metric is an important indicator of the health of the firm’s sales and marketing efforts and product/market fit.

The market opportunity for providing infrastructure for MSPs is large and expected to grow at a strong rate in the coming years, so Datto has positive industry dynamics in its favor.

As to valuation, a partial comparison to Ubiquiti indicates the IPO appears reasonably priced.

Datto is in a growing market segment as small and medium businesses continue to move or grow their IT systems in the cloud.

Developing a 17,000-strong MSP marketplace and related infrastructure systems is not an easy task and the firm is retaining its MSP partners at an impressive rate, so the IPO is worth a close look.

Expected IPO Pricing Date: October 20, 2020.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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