SuccessFactors IPO??? I’m going short . . .

OK, I’m technically not working in this space any more – or else I might refrain from commenting on this, but looking over the SuccessFactors IPO (thanks Jason) just makes me cringe.

Gravity defying claims of success, shrinking client size, profligate management spending and serious questions about SF’s ability (and track record) to produce financial statements consistent with GAAP and compliant with SarBox really make me wonder.

SuccessFactors sv1

SuccessFactors numbers are just ugly. And not just in a “we’re growing really fast” kind of way. The faster they grow, the more money they lose. Right now, Their annual loss > annual revenue. Breakeven is not even contemplated.

And it isn’t just sales and service costs driving the loss, but G&A grows faster than revenue. In ’06 and ’07 SF opened offices in Denmark, the United Kingdom, France, Germany, Australia, Hong Kong, Korea, Italy, and Singapore. These offices (combined) managed to contribute managed to contribute 3.6% of sales. Spend, spend, spend.

No disclosure on revenue by segment – my guess is they are selling 2 of the 8 claimed suites – goal management and performance management and really struggling with the other 8. (Gotta love this quote from the sv1 on why they do not report segment information: The Company’s chief operating decision maker is its Chief Executive Officer, who reviews financial information presented on a consolidated basis

Customer size? Went from 1.3 MM users @ 400 customers (thanks to Joshua Greenbaum) to 2.0 MM users @ 1,300 customers. Average client size dropped from 3,250 users/client to 1,358 users/client. Or, if you assume the old clients stayed, the new clients averaged 778 users/client. This is a pretty radical turn in client size, and I can’t imagine SF can possibly support a global, high comp direct sales model selling to customers with only 778 users each. Just doesn’t make sense.

Not to mention the holy grail of HRO, which is profitable (well, for the rest of us) implementation and service delivery for clients with less than about 3,000 or so users. My experience is that more smaller customers is very hard to do profitably – and impossible with a direct sales model. I think Employease is the only company that has really been successful implementing HRO technologies for smaller clients profitably, but they did it with channels. (SF reports only 10% of revenue comes from channel partners.)

Then you look at financial controls – their auditors cite material weaknesses relating to revenue recognition, stock-based compensation, deferred commissions and accrued liabilities (2005) and similar material weaknesses for year ending 2006 – and I think it should be enough to put anyone off of this IPO.

Put me down for a short on this one if it ever comes out.

TO’B

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15 Responses to SuccessFactors IPO??? I’m going short . . .

  1. Steve says:

    Here are some quick observations. Given the coverage on the IPO (Goldman and Morgan Stanley etc) I feel that this will be a very strong offering. A few points many of the HR types are not cathching .

    o What percent of the current deferred $57 revenue come in 2007? Without understanding this you cannot make a call on the company. The majority of current deferred could all recognize in 2007 depending on accounting polices
    o If you add the change in deferred revenue back to the prior 12 months revenue, they are doing about $60mm in “bookings”. That means they are growing bookings more than 100% a year for the past few year. A $120mm number in bookings for 2007 bookings sounds doable
    o SuccessFactors is focused on growth at all costs. I think it’s a good play but they will have to pull out of the dive shortly. Everyone today is rolling out a performance management application. Sumtotal, Taleo, Workday. SuccessFactors is locking the space up before anyone has a competitive product.
    o Many other HR applications have to hang off of the Performance Management Application. How do I know what training people need to take in the LMS application? Look at the deficiencies in the Perf Management app. How do I know what to pay people for Bonus and Raises? Look at the PM app. How do I know what skills sets do best in certain roles so I can recruit and screen the right people. Look in the PM app.
     Taleo, Sumtotal, Plateau all started with the non core HR application and are now working there way back into the real driver of their applications. Performance Management
    o R&D is a very large percent of revenue when compared to any other players out in the HR or on-demand space 33% in 2006 (SalesForce 9%, Netsuite 21%, Kenexa 7.7%, etc). SuccessFactors is spending its cash on recruiting, and building the apps that naturally hang off of Performance Management allowing them they can attack the market from its strength and lock the other players out.
    o The SuccessFactors PM application is cheap! I just purchased it for my company and rolled it out in a month and spent less that it would cost me to do a few day business trip. Hence Gross Margins are not strong. Performance Management is a loss leader.

  2. tomob says:

    Hi Steve – thanks for the thoughtful comment – and you may be right, but I simply can’t get my head around global expansion when you are bleeding – and no way I invest in a company with such significant financial reporting and control issues. (Good luck making sense of revenue recognition in that environment.)

    PM is one of several core HCM applications – but not the center of the universe – so it is hard for me to see how their alleged dominance in PM will enable them to block out competition in the HCM application space. There are some really good new vendors out there and this market is anything but easy to dominate.

    Finally, the shrinking customer size is a huge red flag to me. If they are that good (better application, 50% of the price, 50% implementation time) they would be going upmarket – not down.

    We’ll wait and see who is right!

    TO’B

  3. Jack says:

    That was the worst looking S1 report I have ever read. SuccessFators went from being a “hot company” to a very risky one in my mind. The CEO has a lot of guts putting his financials out. Must be nice to get paid a million dollars a year for losing 32 million in revenue… wow!

    Jack

  4. Jamie says:

    Another reason the SF current strategy looks dangerous, is that they are spending their money on buidling recruiting software? That market is rapidly being commoditized by Taleo who has suffered the same shrinking client size experience refefrenced above. While there are more of the smaller companies to be had, servicing them profitably is tough as usually vendors take a loss on implementation, hoping to make it up over several years of recurring ASP fees. In a tight credit market, overextended SAAS vendors may well run out of runway…

  5. Ian Cole says:

    If you would like see another company in the same space (but primarily European for now) you should take a look at StepStone. Our solutions business (e-recruitment and talent management) is also growing organically at around 50% pa organic, Q1 2007 revenue was $12m but the business is profitable and generating cash. This is a great business to be in and one that, even at this early stage of the market, can generate profits and cash.

    For more information go to http://www.stepstone.com/EN/IR/

    Ian Cole
    CFO, StepStone ASA

  6. tomob says:

    Ian:

    Maybe SuccessFactors needs you as the CFO! I agree that this is an important, growing and profitable business – but not the way SF is doing it.

    TO’B

  7. Josh Bersin says:

    I agree with this analysis, i’ve developed our own analysis in our blog (bersin.wordpress.com). Lots of growth and lots and lots of spending… at any cost. I see a great product here, but not a sustainable business quite yet…http://bersin.wordpress.com/2007/07/23/successfactors-files-for-public-offering/

  8. Gary says:

    A successful IPO… and I have to stress the word successful… in the on demand HCM-talent management market will be good news for the category as a whole. This is a growing market with leading analysts projecting the market size in excess of $3 billion by 2010. Workstream stands to benefit as much as any company, given that we offer a unified on-demand talent management suite of solutions used by hundreds of customers, many of whom are Global 2000 companies. Just this week we announced the close of a $20 million financing round which will help us become much more visible in this growing market, drive our sales and marketing and amplify our efforts to deliver what we believe is the best-of-breed on demand solution for talent management. I say good luck to all companies trying to build this market. It is quite exciting.

  9. Excuse my lapse in blog etiquette with the blog just added. My full name and link added…

    A successful IPO… and I have to stress the word successful… in the on demand HCM-talent management market will be good news for the category as a whole. This is a growing market with leading analysts projecting the market size in excess of $3 billion by 2010. Workstream stands to benefit as much as any company, given that we offer a unified on-demand talent management suite of solutions used by hundreds of customers, many of whom are Global 2000 companies. Just this week we announced the close of a $20 million financing round which will help us become much more visible in this growing market, drive our sales and marketing and amplify our efforts to deliver what we believe is the best-of-breed on demand solution for talent management. I say good luck to all companies trying to build this market. It is quite exciting.

  10. tomob says:

    Gary:

    I agree – a successful IPO in the space is a good thing for everyone – but I also believe the reverse is true – and it could sour both the financing and buyer markets on SaaS HCM products/vendors.

    TO’B

  11. thanx for the writeup

  12. Tom says:

    Hi there,

    First, thanks for the good read. To go back to Steve’s comment, I have to agree with a lot of the things he says. Some of the financials do look scary, but that is in part due to deferred revenue, meaning as customer numbers go up, losses actually increase short-term, as the costs of the deal incure immediately, while the revenue is deferred over time.

    It also helps that I have worked with some SuccessFactors executives in the past (including some in their much-criticized EMEA organization), and that I have gotten the opportunity to witness their strategy first-hand (I work for an executive search firm). From a recruitment point-of-view, it’s an easy pitch. Trust me: a lot of blue-chip execs want in.

    These execs believe they can consolidate the market with a superior product (and given the constant improvements to the products resulting from user feedback, it’s a good product). In order to do so, they must beat everyone else to it, especially in EMEA.

    This is definitely a high risk/high reward thing. I like to think that every once in a while, you have to bet on people rather than numbers. And the people at SuccessFactors definitely are worth believing in. I’m in.

  13. Steve says:

    TO’B

    Hope you shorted a boat load and now need to cover so you can continue to drive up the price of my very nice long position even further.

    Thanks for the help

    Steve

  14. tom obrien says:

    Steve:

    It has been a nail-biting few weeks, but I am IN THE MONEY!

    SFSF trading at $9.30 today.

    TO’B

  15. Steve says:

    TO’B

    I would hope all bears are in the money at this point.

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