I was excited to be able to look at the D2L prospectus today. (Nerd alert, lotsa numbers in this post.) They have been on the Narwhal List since inception and clocked in last year in 15th spot. Many years ago they and Hootsuite were the darlings of the Canadian tech industry, expected to go public any day so seeing the D2L prospectus is great news for them and the KW community. The reason I was excited was that I was interested to understand their economics and whether I could figure out why they hadn’t gone public all those years ago when everyone expected they would.
I can’t tell what happened to D2L before 2019 but if current results are any indication I suspect they were growing too slowly to generate much interest in an IPO. Their current growth rate is 15.6%, up from 5.8% on 2020 and rumours are that pandemic fuelled spending on educational software has increased caused this increase. Even their current growth rate is not usually enough to list on Nasdaq but can get a company to the TSX. The average annual growth rate of 160 plus software companies that went public in the US in the last 8 years was over 60% (median of 44%).
That begs the question, why is their growth rate only 15.6% in the last year? Obsessing over numbers as I do, I have a few ideas. First off is capital. They had about $225 million of capital to fuel their sales growth to $126 million. At 1.78 times, their capital to revenue ratio is bang on the 1.76 times median of 160 plus other software IPOs (average of 2.27). So, they had enough capital but how did they spend it?
D2L’s ratio of marketing and sales spending (M&S) to research and development (R&D) of 1.2 times is drastically below market medians (1.9 times) and averages (2.1 times). Another indication is their spending on general and admin (G&A). It is very low compared to R&D (41%) when for the typical firm, G&A is much closer in size to R&D. It looks like their strategy was to spend more on R&D and less on M&S than typical firms do. One final indicator of this is their spending on M&S as a percent of revenue which sits at 25% of revenue and trails industry medians of 44% (average 48%.) It may be a gross oversimplification of the issue but it looks to me as if they have been a product focussed company rather than a market focussed one, interested more in building product than driving revenue.
Are you bored yet? There are still more numbers.
Setting spending as they did may have been the right decision though, as they may have been limited by their market size. Their prospectus shows their market size to be $13.6 billion in 2019 with a pandemic fuelled CAGR of 21%. This is less than half the median market size of the 160 plus companies I’ve looked at which is $29 billion. (The average is $202 billion but then this is affected by companies like Airbnb with a market of $3.4 trillion and Uber with $2.5 trillion.)
The average penetration of the market by the time of an IPO for software companies is 0.82% (median 0.55%). D2L with revenue of $103 million in a $13.9 billion market actually got to 0.74% of their market. Not bad so maybe more money on M&S wouldn’t have juiced the growth rate much further. What is exciting though are their plans for entering adjacent markets. They say in the prospectus:
“We continue to invest in our core platform and deepen our partner ecosystem to capitalize on a technological shift toward learner-centric models. We expect to expand our addressable market to include opportunities in additional areas of the broader Education Technology market, which HolonIQ expects will grow from $183 billion in 2019 to $404 billion by 2025”
This strategic shift should enable them to ramp revenue to a much higher level, if only they devote more money to M&S. And with raising $150 million they’ll have enough capital to grow revenue to $200 million hopefully at a fast enough pace to warrant a US listing.