Four months ago, Israeli software company IronSource decided that it would go public on Wall Street via an initial public offering. Its business metrics would enable it to do so and neither its top managers nor its board saw any reason not to go the traditional IPO route as opposed to the increasingly popular alternative of merging with a special-purpose acquisition company, or SPAC.
But then at the beginning of February, Orlando Bravo, the managing partner of Thoma Bravo, whose funds are the dominant private equity investors in the software industry, asked Israeli-American billionaire Haim Saban to introduce him to the top people at IronSource. Saban’s investment fund has a 0.5% stake in the Israeli company.
That meeting gave birth this week to one of the biggest deals ever in the history of Israeli high-tech – an exit worth $1.5 billion for IronSource shareholders, an investment of $2.3 billion and a valuation for the merged company of more than $11 billion.
IronSource reached this point through a long and winding journey that began with its founding a decade ago. Along the way there were a series of mergers that created a company with eight founders, repeated launches and closures of different businesses, generous dividend payouts, the spinning off of its personal computer business last year and finally the about-face on going public.
A SPAC is a shell company that raises money through an IPO and then searches for an operating business to merge with. When IronSource announced it was merging with the SPAC, Thoma Bravo Advantage, it also released an investor presentation. More details will follow later in other documents akin to the prospectus that is published with an IPO, but the presentation already gives the public an unprecedented look at IronSource’s business.
In its current iteration, IronSource targets the mobile internet market, mainly game apps. The company’s technology is used by tens of thousands of apps to incorporate targeted advertising into games or advertise their own products. The platform offers two packages of services called Sonic (which is used by app developers to help them with their launch and generate revenues and growth) and Aura (which is used by telco operators to help smartphone buyers to choose apps for their device).
The coronavirus year generated phenomenal growth for mobile games as homebound people spent more time with their smartphones but telcos themselves had a difficult time. How that played out between IronSource’s two business segments isn’t spelled out in the presentation, but on the whole 2020 was a fantastic year for the company: Revenues rose 83% to $332 million, operating profit reached $74 million while earnings before interest, taxes, depreciation and amortization came to $104 million.
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Growth accelerated in 2020 as the year progressed, so that in the fourth quarter revenues were up 107% year on year. According to CEO Omer Kaplan and Chief Financial Officer Assaf Ben-Ami, growth was boosted by a product launched during the year for small developers to help them launch, distribute and monetize their games and analyze their performance in the market.
IronSource evaluated the games and chose 19 of the most promising to launch at its own expense in exchange for sharing revenues with the developer. In addition, IronSource generated growth by increasing marketing and sales spending 3.5-fold.
One slide in the presentation is entitled “IronSource is One of a Kind.” What that means is that among 3,647 publicly traded tech companies, only one (IronSource, of course!) has revenues of over $300 million, growth of more than 50%, gross margins of 80% and an EBITDA of more than 30%. The message: Simultaneous growth and profit margins like this is something unique.
Without question, IronSource has performed very well – the combination of growth and profitability is very rare. But no company is valued based solely on its past performance but on its future outlook – and that is not as impressive as the past year.
Naturally, as a company gets bigger, it gets harder for it to maintain a high rate of growth. But in 2021 IronSource is forecasting revenue growth of 37%, so that its 2020 performance raises the question of whether it was a one-time event.
Kaplan and Ben-Ami say this year’s forecast is conservative and assume that the market will be returning to normal. If so, is a $11.1 billion valuation justified for a company with revenues of just $332 million? It’s hard to know because the stock market is assigning inflated values all over.
IronSource’s new product will help it diversify its revenue sources. While today it counts some 4,000 customers, 94% of its revenues in 2020 came from just 291 of them. On the other hand, its customers are loyal (churn is just 3% to 4% a year) and increase their spending from year to year (in 2020, 291 generated $100,000 or more of revenues for the company, up from 189 in 2019). For the past eight quarters spending per customer has risen 49% from period to period.
Because last year was so good for IronSource and its rate of growth is expected to slow, it is important for investors to get a look at its 2019 metrics. The presentation, however, doesn’t provide any 2018 data for which to compare 2019 and that won’t appear in future, more detailed documents either.
IronSource isn’t violating any disclosure standards, but it would serve investors better if it volunteered the information. No one can properly evaluate a company on one or two years of figures and forecast, but rather by its performance over time, its cost structure and other factors.
An example of that is another Israeli company, the social-trading platform eToro, which released a similar presentation last week that showed revenue was down in 2019. That shines a different line on the company and raises questions about its ability to grow over time when the cryptocurrency and capital markets in general are less frothy.
IronSource has reportedly enjoyed growth in the tens of percent in 2019, but there’s no reason why it shouldn’t be providing investors with complete and official data.
In recent years, there’s been a trend on Wall Street to issue shares with inferior rights. Investors who held shares before the public offering retain control after it has gone public. At IronSource, it was decided that each old share will be equal to five new shares.
“In recent years, most technology companies have gone public with a structure of two classes of shares,” said Kaplan. “That gives the founders the ability to continue controlling and managing the company in the years ahead without the intervention of activist investors. This has been well-received by investors, especially at the most successful companies.”
Of the 10 Israeli companies (including overseas firms founded and led by Israelis) that have announced SPAC mergers in recent months, IronSource is the only one that has chosen a structure like that. That reflects the strength and attractiveness of the company vis a vis investors, even if some might argue that two classes of stock undermines the checks and balances of publicly traded companies.
Activist investors often employ problematic practices, but they have the knowledge and resources to understand and identify management shortcomings. Clipping their wings only hurts the interests of investors.