Thoughts on the upcoming Lightspeed IPO…
As a passionate advocate of both Canadian tech and the SMB software market, I have been waiting for some time for Lightspeed POS to go public. So, it was with great anticipation that I poured through their 211 page prospectus filing. Here are the highlights for me.
As we have written in our SMB software market thesis, most SMB markets are large and evergreen. Lightspeed shares some stats on their market that absolutely reinforce this.
According to Lightspeed, there are approximately 226 million SMBs around the world, including 47 million retailers and restaurants (these are their two core vertical markets).
In aggregate, SMBs worldwide generated an estimated $59 trillion in revenue in 2018 according to research cited by Lightspeed. Large companies may get all the press, but our economy is very much dominated by small business.
At an annual ARPU (average revenue per user) of $200, Lightspeed has a total addressable market (TAM) of $9.4B annually. They are approximately 0.1% penetrated towards that TAM today. This brings me back to our thesis. They could literally go after this market opportunity forever and not run out of addressable market.
Because the opportunity is so vast, there are many player going after it from different angles. Lightspeed is focused on two core verticals: Retail and restaurants. Let’s look at each.
In retail, the big trend is omnichannel — enabling customers to buy in store, online, in marketplaces — basically anywhere and everywhere. A small company named Shopify is very focused on omnichannel as well.
For much of its history Shopify focused on e-commerce. This is the fastest growing part of retail, however, most retail still happens “offline” in physical stores. Shopify, as a result, is going after offline retail. Lightspeed has gone in the opposite direction, starting with physical retail. There is no end to Shopify’s ambitions. They are and will continue to be a formidable competitor for many years to come.
In the restaurant vertical, we see companies such as Toast, Upserve, Touchbistro and others. All 100% focused on that market. These three companies alone have raised over $400M to tackle the restaurant opportunity.
These four companies are only a small subset of the competition. Whether it’s other POS (point of sale) software companies, such as Vend & Shopkeep, or the vast number of large payments companies are companies that combine both, such as Square, Lightspeed will be playing in a crowded market.
When we look at these numbers as a % of revenue we can draw some conclusions.
- Improving revenue mix with more revenue coming from their core SaaS and payments offerings over time.
- As a result, gross margins are improving
- I wish that they would break out the SaaS and payments businesses separately since they have very different levels of profit
- Operating expenses are coming down quickly, though they continue to generate losses
- Top line growth is pretty consistent, but declining. They grew 39% in 2017 and 34% in 2018
One line item you probably are not used to seeing is the large expense coming from redeemable preferred shares. In the last 12 months alone this expense equaled 89% of total revenue! Their institutional capital has been raised in the form of preferred shares with a redemption feature (where the investor can basically ask Lightspeed to buy those shares back in the future). Under the terms of those prefs, they need to be bought back at the greater of cost of fair market value. The expense you see here is capturing the increase in market value of the company as it grows.
The good news is that expense will disappear after the IPO as those prefs will be converted to common.
Digging deeper into key metrics, I note the following:
- Lightspeed has a scalable revenue model: This is quite hard to achieve in SMB, but Lightspeed is actually growing its revenue per customer each year. This bodes well for the future. That growth is coming from up-selling additional modules and through payments. As a result of this revenue is growing faster than customers, which puts less pressure on them to spend on sales and marketing.
- Revenue/ person is lower than I would like. For the last 12 months, this was $103K. It’s really difficult to scale SMB. But I hope this number comes down over time. This will be key to them achieving profitability.
- Rule of 40 is a key SaaS metric. If you’re not familiar this it basically states that revenue growth + your profit or — your loss should be 40 or more. Lightspeed is well below this aspirational target with results of -4 for 2018 and -41 for 2017. I calculated this using operating losses since the actual net loss is overstated due to the redemption expense noted above.
The Bottom Line
Notwithstanding the concerns noted above, Lightspeed has built a great business. I believe in their team, vision and opportunity.
Their revenue scale and operating losses, coupled with the fact that this is a Canada-only IPO could lead to weak trading volume and demand. The Canadian public markets still have work to do before they are truly a warm and receptive place for tech companies. I love that Lightspeed is blazing a trail here.
I will be doing my part and buying shares! (note: I’m probably not allowed to make investment recommendations, so this is just my personal opinion).