There is no denying that Elastic’s IPO could not have gone any better. Despite raising the price from an initial value of $26 to $36, the company surpassed all expectations on Friday. Fortune reported that “Elastic NV almost doubled in value on its first day of trading in New York,” as its stock nearly doubled by closing at $70. Elastic raised $252 million and finished with a market cap of nearly $4.9 billion.
Elastic (NYSE:ESTC) had a good beginning, and plenty of analysts seem to believe that while it will likely eventually fall in value after the initial IPO buzz, this will be a great stock for the future. But this is not a company free of problems. I think that Elastic could potentially be a great company, but there are questions about its competition and finances which should concern investors. Here is a comprehensive look at this company, and why it might be necessary to pump the brakes a bit.
Can Open-Source succeed?
As of right now, Elastic portends to be one of if not the most successful IPOs ever from an open-source software company. Elastic is an enterprise search company which is closely associated with private tech giants like Uber and Tinder, and it is not unreasonable to believe that investor hype for Elastic is partly based due to this association as well as the allure of investing in search companies.
But the most important thing for investors to understand is that Elastic is an open-source company. It offers its software for free, as well as a paid subscription for those who want additional features. A major avenue of discussion for tech IPO enthusiasts is whether open-source software can succeed as a profitable business model. What is to stop other companies from copying their open-source software without paying Elastic a dime?
The argument is that since Elastic knows its own software better than its customers, it can offer more and better services while businesses will not want to make the effort to make their own search engine and data analysis. And we have seen open-source companies like Hortonworks (NASDAQ:HDP) or Twilio (NYSE:TWLO) go public. Twilio’s stock today is at $76.62 compared to its initial price of $26.30 in June 2016, while Hortonworks is at $23.28 compared to $21.02 at the beginning of the year. Neither did as well out of the gate as Elastic, so why can it not do better?
Elastic could do better, but its potential is limited to some degree because of Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN). In its S-1 report, Elastic notes Google Custom Search Engine as a competitor for its app search, and also points out that Amazon Web Services offers SaaS products based on Elastic’s open search software. Investors cannot avoid all tech IPOs just out of the fear that they may be crushed by these tech behemoths, but Google is more closely tied into Elastic as a fellow search competitor. At the very least, the threat of competition should be a concern which investors should note as they talk of Elastic’ massive potential and how companies will continue to invest in search.
Financial Questions
Like many tech IPOs, Elastic eschews making a net profit in favor of promoting growth, and its financial numbers are in many ways better than other IPOs. Revenue increased from $88.2 million in 2017 to $159.9 million in 2018, while net losses stayed consistent at around $52 million instead of rising. In fact, Elastic reported a positive cash flow of $5.1 million in the first quarter of the 2019 fiscal year, and does not have a major debt problem as shown by the fact that it does not intend to use the net IPO proceeds to pay off debt.
These are all good signs, but it does not justify a valuation of $4.9 billion that would justify its online betting USA win.. How much can Elastic continue to grow and how much has it grown? I would have liked to see how much the company, which released its first commercial plugins in 2012, grew in 2017 compared to the previous years. And whatever the upside Elastic has as a company, its share price value has extremely limited upside.
Important Concerns and Questions
I do not want investors to think that Elastic is a company which should be avoided entirely, or that it is doomed to fail. Elastic offers a great product, has financial numbers which should intrigue investors, and has attracted a great deal of interest from institutional investors like Goldman Sachs (NYSE:GS), J.P. Morgan, and Barclays (LON:BARC) according to Benzinga. Its initial success is to be celebrated. But that does not mean that it is a good buy at its present value of $70, and investors should at the very least wait until it falls in value in the near future. Tech IPOs always carry a degree of risk, and Elastic is no sure thing. Only by understanding potential risks such as its cash problems and how it might be threatened by competition can investors make a prudent choice.