Description

Instructure was founded in 2008 and provides a cloud-based learning management system (LMS) to the educational and corporate sector.  Company started out in the educational space and over the last couple of years expanded into the corporate sector.  The LMS on the educational side is basically focused on managing any aspect outside of the in-class lecture (i.e. syllabus, assignments, calendars, taking a test, grading a test, discussions groups, calendars, group work, etc.).  The company began in the higher ed domestic market where it first introduced its Canvas product in 2011.  In 2012, it re-configured its software code base and entered the K-12 market via Canvas K-12 as they realized that market had similar needs. And in 2013, they took their products global via Canvas K-12 and now have offices in London, Sydney, Germany, Austria, Switzerland, Spain, HK and LatAm.  In 2015, company entered the corporate LMS market through Bridge.  Within higher ed, it is used by 7 Ivy League schools and includes schools such as Harvard, Stanford, Brown and Dartmouth and internationally by schools such as London Business School.  K-12 product is used by school systems in 49 states. Corporate clients include Tesla and McKesson.

INST has very visible and recurring revenue due to the sticky, high margin, subscription based model with ~90% of the revenue base recurring in nature.  Visibility is enhanced through multi-year contracts that usually last 4-5 years with a sales cycle of 6-9 months. INST’s backlog + deferred revenue accounts for 2.0x following year’s revenue.  INST has a high quality customer base that spans ~3,000 customers across categories.  Revenues have grown from $26MM in 2013 to $156MM with the educational segment making up a large proportion of the revenues today.

One key differentiating factor leading to INST’s high success rate and market share gain is its technology platform and applications sit on native cloud, multi-tenant architecture designed to scale to millions of users.  Multi-tenant platforms main benefit is scalability as all users on the platform share the same source code and database.  During software upgrades or new releases, software packages are typically installed in one single server and distributed to all customers at once.  On the other hand, in single instance or hosted software platforms, there is one server machine per customer - as such, software updates have to be installed on each individual machine. Blackboard, who is the largest player in the higher ed pace, uses the single instance model and we believe is the root cause for the dissatisfaction in its customer base which has led INST to gain market share at such a fast pace.  Blackboard in 2006 owned ~90% of the market and today has ~40%.  Blackboard, which is owned by Providence, has largely relied on an acquisition model trying to integrate or in other cases, completely shut the acquired company’s products and push existing Blackboard products.  As such, company has not invested enough on innovating its core products and has a fragmented technological offering that is hard to scale given its platform model.  Another factor leading to INST’s market share gain is its distribution model.  INST has a direct sales force vs. reseller model with majority of sales reps under a direct quota-based model.

INST has grown revenues at a CAGR of 55%+ since 2013 - from $26MM to $156MM.  Despite the rapid growth rate experienced to date, INST is still only less than 10% of the estimated $1.5Bn global ed LMS market with the US higher ed market estimated at ~$700MM. INST has been the leader in win rates - it is estimated that of the new projects/contracts that came up in the educational space, Instructure won 70% of the deployment.  In addition, INST has a large potential in the K-12 market, a $300-400MM market.  We estimate this sector has been a big driver of recent revenue growth and now makes over 1/3 of the revenue.  In addition, INST recently entered the corporate LMS market of which the addressable market is estimated at over $5Bn.  If INST is able to expand and diversify into the HCM market, potential addressable market could double in size. 

Currently, INST’s gross margin is ~72% with operating margins of -22%.  Most of the negative operating margin is due to company’s investment for growth, in particular its direct sales team. 2017 YTD as of Q3, sales and marketing represented 52% of revenues, R&D at 27% and G&A at 17%. Like most pure-play SaaS companies, INST has the potential to generate high profit margins and cashflow as the business matures and builds scale.   Company’s long-term goal is to generate gross profit margin of 75% and operating margin of 20-25%.  We believe this is achievable given the recent positive trends coming from the business model – between 2015 and 2016, INST had a 1,800 bp improvement in operating income (non-GAAP basis) and they have guided a 1,300 bp for 2017 and 2016. And it is expected that they’ll be cash flow breakeven by end of 2017.

We believe INST can reach a revenue base of $500MM in ~5 years and EBITDA of $145MM conservatively.  In 2010, Blackboard was acquired for $1.6bn by Providence at a valuation of ~16x EBITDAx.  Blackboard in 2015 generated ~$200MM in EBITDA and Providence was exploring a sale for $3-$3.4Bn, implying a 15-17x EBITDA multiple.  Using the same multiple ranges implies a potential value of $2-$2.5bn for INST vs. today’s EV of $1Bn. 

INST is led by Joshua Coates, a highly competent CEO who only takes $1 in salary and owns over 9% of the company. He began his career in distributed systems research at Berkeley and Microsoft's Bay Area Research Center. He founded Berkeley Data Systems (Mozy.com) in 2005 which was later acquired by EMC in 2007.  

Catalyst

- Continued market share gain in the higher ed and k-12 space + expansion in the corporate market

- Business matures and scales leading to profitability