SimilarWeb (NYSE:SMWB), the AI-based market intelligence company, closed its initial public offering (IPO) on Friday last week, earning a valuation of $1.6 billion. As per its F-1/A registration document, the company offered the public 7.5 million shares, while selling shareholders offered 500,000 shares, the shares being priced at $22 per share. The IPO raised SimilarWeb $165 million and an additional $24.8 million could be raised if underwriters exercise their 30-day option to buy more shares. In this article, we will discuss the highlights of its investment prospectus and what this means for investors.
The Russian revolutionary, Vladimiar Lenin, once said, “There are decades where nothing happens; and there are weeks where decades happen.” The global pandemic was a period where enough disruption to fill up a decade happened across the span of a few weeks. Yet, a select cohort of companies have thrived in this time of disruption. Generally, these are companies that are vital in the shift to remote work. They helped dispersed teams work better remotely and at a time when remote work has become vital, their services have grown in demand. SimilarWeb is one of the beneficiaries of this epoch of disruption, as users have flocked to the company, growing revenues by very impressive rates. The company’s annual recurring revenues (ARR) for 2020 was $123 million. An ARR greater than $100 million is usually a signal that a company is ready for an IPO. SimilarWeb clearly was no different. Revenue grew 32.4% year-over-year, going from $70.59 million in 2019 to $93.49 million in 2020. The company continues to grow revenues impressively. In the first quarter of 2021, revenue was 42.8% higher than in the first quarter of 2020, growing from $20.6 million in the first quarter of 2020 to $29 million in the first quarter of 2021.
None of this should be surprising. The vast majority of IPOs are from unprofitable companies. The attentive reader will be aware that the last profitable unicorn that went to IPO was Zoom, who went public in August 2019. Of the 73 unicorns that had gone public by November 2020, only 6 were profitable. Readers are aware that the vast majority of IPOs are unprofitable. Sifting through the evidence, it is becoming more and more clear that the still-privately held unicorns are not only broadly unprofitable, but the path to profitability is getting more and more challenging. SimilarWeb is not the next Zoom, it is one of many companies that have not been able to combine revenue growth with profitability.
Net loss widened year-over-year, from $17.7 million in 2019 to almost $22 million in 2020. The company is set for another loss-making year. Net losses in the first quarter of 2021 are almost double what they were in the first quarter of 2020, growing from $6.2 million to $12 million. Unprofitability is driven by the company’s operating expenses, which continue to swell. In 2019, operating expenses were $66.19 million and by 2020, they had grown 38.6% to some $91.7 million. Operating expenses for the first quarter of 2021 stood at $34.7 million, 63.5% greater than for the same period in 2020, when they were $21 million. The key driver of operating expenses are the company’s sales and marketing costs. They grew from $38.9 million in 2019 to $53.6 million in 2020. In the first quarter of 2021, they stood at $19.6 million, compared to $12.9 million in 2020.
Looking at the company’s operating expenses gives us a clue to the company’s strategy. Essentially, SimilarWeb’s strategy is to grow itself into profitability just like Avant Microblading. Through revenue growth, the company hopes that it will grow to minimal viable economies of scale, building robust barriers to entry along the way, such that it will be able to attain profitability. At minimal viable economies of scale, the company will have the pricing power to raise prices to a level that allows it to earn a profit. This strategy has gained traction with the success of Amazon, a company that was often derided for its failure to make a profit or earn meaningful profitsl. Yet, not everyone can become “the next Amazon”. Someone has to fail.
Consequently, when we look at the company’s sales and marketing costs, we could see it as an investment in a strategy, a strategy of growth-today-for-profits-tomorrow. In other words, these costs are essential for the company to achieve minimal viable economies of scale. You see, in a hyper-competitive market, the kind of market that SimilarWeb operates in, a market where competitors are a click away and where the market becomes commoditized because competitors effectively become price takers, nobody can earn economic profits. Rivals are forced to try and outgrow each other in a race to minimal viable economies of scale. This is a place where a company can count on switching costs to keep customers loyal and where it can use the pain of switching costs and the absence of meaningful competition, to raise prices to where it can be profitable. The paradox of competition is that it is great for customers and terrible for customers.
SimilarWeb’s strategy leaves only two routes ahead: either the company achieves minimal viable economies of scale, or it goes bust. There is no middle ground. Without minimal viable economies of scale, the company will go bust. No company can forever fail to earn a profit. SimilarWeb is not a charity and its investors are not in it to give back to society. The nature of binary bets is that they lead to very volatile, manic-depressive share price movements. Good news leads to euphoric pricing and bad news sends stocks into depressive death spirals and the death spirals are enough to eat all the gains from euphoric pricing. The effect of downward volatility is often ignored but can decimate a portfolio. It would be as if when making a business energy comparison, you signed onto a plan with flexible pricing but whose prices kept getting steeper and steeper with each day. At a time of investor uncertainty, exposure to extreme downward volatility is not a good thing.