Freshworks IPO Filing: Key Insights & Analysis

Freshworks IPO: A Deep Dive into the S-1 Filing

Freshworks, a company specializing in customer engagement software, is preparing for its initial public offering (IPO). Founded with a dual presence in California, USA, and Tamil Nadu, India, the company’s S-1 filing reveals a period of significant growth. Its financial performance is also showing signs of increasing profitability as it reaches a more mature stage.

A comprehensive understanding of Freshworks’ financial data requires a careful examination of its cost structure. Certain expenses need to be analyzed to gain a truly accurate perspective on the company’s performance.

Recently, The Exchange had the opportunity to interview Girish Mathrubootham, the CEO of Freshworks. This conversation, occurring a few weeks prior to the IPO announcement, now appears particularly timely. Insights from that discussion will be utilized as we analyze Mathrubootham’s IPO filing.

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The success of Freshworks’ IPO is crucial, given the substantial amount of venture capital invested in the company. According to Crunchbase data, Freshworks secured hundreds of millions of dollars in funding while operating privately. This includes a $150 million Series H round completed in late 2019, which established a company valuation of approximately $3.5 billion.

Notable investors in Freshworks include prominent firms such as Accel, Tiger, Sequoia, and Capital G.

Analyzing Freshworks’ Growth and Profitability

Today, we will examine the company’s historical growth trajectory. We will also track the evolution of Freshworks’ profitability and assess whether the quality of its revenue is improving over time.

This analysis will provide a clearer understanding of the company’s financial health and its potential for future success in the public market.

An Overview of Freshworks’ Product Line

Prior to examining the financial data, it’s important to understand the evolution of Freshworks’ product offerings.

Initially, Freshworks launched with a single software solution known as Freshdesk. This product originated from the personal experience of the company’s CEO, who encountered difficulties with inadequate customer support during a television return.

According to Girish Mathrubootham, the founder, he recognized an increasing number of channels through which customers could contact businesses. This shift in the business landscape empowered customers and significantly impacted brand perception. Consequently, Freshdesk consolidated various customer communication methods, notably including social media, which was still an emerging platform at the time.

Freshworks subsequently observed that a segment of its user base was leveraging its customer service software to provide internal IT support. This insight led to the development of Freshservice, a tailored iteration of the original product designed for internal deployment.

Further expansion included the creation of sales-focused tools and, most recently, a centralized database for customer information. This unified database enables businesses utilizing Freshworks’ software to maintain a single, comprehensive record for each customer across both marketing and sales engagements. The company plans to integrate support communications into this unified view as well.

This progression demonstrates Freshworks’ ability to cater to both small businesses requiring individual software components and larger enterprises seeking a comprehensive suite of solutions. The company can effectively upsell additional products to its existing customer base.

Now, let's analyze the company’s performance within the market.

Key Financial Figures

For those following closely, here's a review of Freshworks' income statement as detailed in its S-1 filing:

A quick analysis reveals that Freshworks experienced substantial growth between 2019 and 2020, with revenue increasing by 45% to reach $249.7 million. During this period, the gross margin also saw a slight expansion, moving from 78.8% to 79.0%. The modest improvement in gross margin isn't a concern, considering the already high level established in 2019.

More recently, Freshworks’ revenue increased from $110.5 million in the first half of 2020 to $168.9 million in the first two quarters of 2021, representing a growth rate of 53%. This indicates accelerating revenue growth, which is a positive indicator of the company’s business health; typically, growth rates diminish as companies expand, due to the impact of larger revenue bases on percentage calculations.

Let's now examine Freshworks’ historical profitability. While the company’s net loss increased in 2020 compared to 2019, it remained at an acceptable level. Currently, investors – both private and public – are generally receptive to companies that modestly increase their losses, provided that growth remains robust and the percentage of revenue lost doesn’t significantly worsen.

Freshworks’ net loss as a percentage of revenue rose from approximately 18% in 2019 to just under 23% in 2020. However, this metric has since shown improvement. The company’s loss for the first half of 2021 decreased significantly to $9.8 million, or less than 6% of revenue, compared to $57.2 million in the first half of 2020.

The S-1 filing also details other expenses that we aren't currently factoring in, including the frequently cited “Accretion of redeemable convertible preferred stock.” However, for companies demonstrating accelerating growth, these non-cash costs related to share value fluctuations are less critical to understanding their core economics, and are therefore being temporarily disregarded.

If we are minimizing concerns about costs associated with convertible preferred stock, why are we maintaining a strict focus on Freshworks’ net losses when evaluating its profitability, rather than relying on adjusted profitability metrics? This is because the company’s adjusted profitability metrics show only marginal improvements over its Generally Accepted Accounting Principles (GAAP) metrics – and this is actually a positive observation.

For instance, Freshworks’ non-GAAP net loss in the first half of 2021 was $7.7 million, a difference of only $2.1 million from its complete GAAP result. Simply put, Freshworks doesn’t require significant leniency in its evaluation, unlike companies where adjusted EBITDA figures might necessitate greater consideration. It is prepared to operate under standard, rigorous financial scrutiny.

This situation is favorable for the company’s prospects.

Freshworks: A Review of Quarterly Performance

Analyzing the quarterly growth of software businesses is a valuable practice for assessing the stability of their net revenue gains over time.

Below is a breakdown of Freshworks’ revenue performance, quarter by quarter, from Q1 2020 to Q2 2021:

• $54.0 million
• $56.5 million
• $66.2 million
• $73.0 million
• $80.6 million
• $88.3 million

These figures demonstrate an increasing trend in revenue additions each quarter. The increase moved from $2.65 million in Q2 2020, to $6.8 million in Q4 2020, and then to $7.7 million in Q2 2021.

However, the financial picture isn’t entirely positive. Freshworks achieved a positive net income in Q3 2020, reporting $1.4 million. Subsequently, the company experienced three consecutive quarters of net losses.

These deficits have steadily increased, reaching $7.4 million in the most recent quarter. While Freshworks previously demonstrated a strong profitability record, recent results indicate a decline in net margins.

Despite these losses, the company maintained positive free cash flow throughout 2020 and the first half of 2021. This is likely to reassure investors regarding its recent net loss performance.

Let us now shift our focus back to a discussion of the company’s products.

Understanding the Factors Behind Growth

Earlier, we highlighted Freshworks’ product diversification not simply as background for its revenue increase, but to analyze the mechanisms fueling its top-line expansion.

Our primary focus is to determine the influence of the company’s broadening product portfolio on its net dollar retention rate. Essentially, we aim to ascertain whether Freshworks successfully increases sales to its current customer base over time, a process facilitated by its expanding range of offerings.

To assess this, let's examine the company’s historical net dollar retention figures dating back to the beginning of 2019:

• 2019: 115%
• 2020: 111%
• Q1 2020: 113%
• Q2 2020: 107%
• Q1 2021: 112%
• Q2 2021: 118%

This data demonstrates Freshworks’ consistent ability to upsell and cross-sell to its existing customers. This suggests that its product development efforts are positively impacting the growth of established accounts.

The improvement in its net dollar retention is a significant indicator. According to its S-1 filing, Freshworks’ 53% revenue growth during the first half of 2021 was attributable to both new and existing customers.

Specifically, 38% of the 53% growth rate stemmed from acquiring new customers (representing 20% of the total growth), while a substantial 62% (or 33% of the 53% growth rate) originated from increased revenue from customers who were already onboarded as of June 30, 2020.

Net dollar retention is a crucial metric for evaluating the success of a software company’s expansion strategy.

Determining the Company's Value

We have observed a robust SaaS enterprise demonstrating enhanced profitability and a consistent record of cash flow. This represents significant value. The central inquiry, naturally, concerns the precise extent of that value.

It’s important to remember that Freshworks held a valuation of $3.55 billion in 2019. With Q2 revenue totaling $88.3 million, the company achieves an annualized revenue run rate of $353.4 million. This places its final private valuation at approximately 10 times its revenue run rate, a relatively conservative figure. Therefore, Freshworks is positioned to exceed this valuation upon its public listing.

Revenue Multiples and Growth

Freshworks exhibits a growth rate slightly exceeding that of the highest-performing public SaaS companies. These leading companies typically trade at revenue multiples around 28x, according to the Bessemer Cloud Index. A simple calculation, using this multiple, suggests a potential valuation of $9.9 billion for Freshworks.

The software industry has experienced valuation increases since 2019, making this scenario plausible. Market conditions support the possibility of a higher valuation.

We are not predicting that Freshworks will secure a $10 billion valuation at its IPO pricing. However, this preliminary estimate indicates the company should comfortably surpass its last private valuation when it becomes publicly traded. This outcome promises substantial returns for its investors, particularly those who invested during earlier stages.

Further details will become available once the initial price range is established.

• Key Metric: Annualized revenue run rate of $353.4 million.
• Valuation Comparison: 10x revenue run rate at final private valuation.
• Potential Upside: Possible valuation of $9.9 billion based on comparable SaaS companies.