Marketing automation software startup Marketo (Nasdaq:MKTO) went public May 17. Its stock closed up 77.7% in its first day of trading. Time to sell your shares and move on? I'll have a look at what this huge opening means for investors.

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Why So Popular?
In its second day of trading it closed up 5.3% at $24.33, $1.67 from doubling its IPO price of $13. Marketing automation is all the rage these days but no one could have imagined this kind of start for the San Mateo-based software company; at least no one unfamiliar with the company's products. According to TechCrunch, Marketo's software has enabled drug distributor McKesson (NYSE:MCK) to become more efficient in its sales operation, adding $2 billion in revenue. With that in mind I would't be surprised if some of McKesson's management team bought the IPO. Having seen first hand what Marketo has been able to do for it, it would seem like a no brainer for anyone in the organization with money to invest.
In December, just four months after its IPO, Marketo's rival Eloqua announced that it was acquired by Oracle (Nasdaq:ORCL) for $871 million or 9.5 times revenue. When Eloqua went public it was valued at 4.8 times revenue. Marketo's IPO valued it at six times revenue or 25% higher than Eloqua. If another organization with the financial might of Oracle were to make a play for Marketo in the next year, we might assume that the same difference in valuation would remain in place. Therefore, if we double Marketo's value to 12 times revenue, its market cap would be $948 million or $25.84 per share; exactly where it currently trades.

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The Rest of 2013
If you weren't able to buy shares in the Eloqua IPO, they closed up a modest 12.1% in the first day of trading. If instead you bought the next day at the high--$14.95--you would still have made a 131% annualized return on your six-and-a-half month investment. When Eloqua went public Bloomberg compiled a list of 14 other companies selling software-as-a-service. According to its data, the 14 firms averaged a price-to-sales ratio of 8.1 times, almost double Eloqua's at 4.4 times revenue. I've calculated a P/S ratio of 4.8, but you get the picture. Whether or not Oracle came along, Eloqua was priced to move.
IT consultant Gartner (NYSE:IT) estimates that web-based software will grow from $12.3 billion in 2011 to $22.1 billion by 2015. Given this statistic, it's not unreasonable to assume that the valuation for SaaS-related businesses has increased since August 2012 when Eloqua went public. With that in mind, it wouldn't be out of line for the industry as a whole to be trading at 12 times sales, which is what I based Marketo's P/S ratio at the high-end of its valuation.
The big question is whether Marketo's got anything left in the tank beyond $25. If we ratchet up Marketo's share price from a multiple of 12 to 16, its share price increases to a fair value of $34.45, more than 42% above where it's currently trading despite the huge run up. While anything's possible, the fact that it's losing more than $3 million per month suggests to me that it's going to have to reduce its losses before it goes too much higher.

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Bottom Line
Ultimately I think Marketo will follow the same path and be acquired by a bigger fish. Many in the industry see (NYSE:CRM) as a natural because it recently issued $1 billion in debt meant specifically for acquisitions and it competes directly with Oracle. Others aren't so sure believing the price paid would be too high. Those people see SAP (NYSE:SAP) as a more likely candidate. Whomever pulls the trigger, I'd expect a deal announcement before the end of the year. If both Salesforce and SAP wade into the bidding, things could get interesting.
Over the next five or six months I'd watch its stock price. If it drops below $20, I wouldn't hesitate to buy its shares. Above $25, I'd be extremely reluctant unless the takeover scuttlebutt heats up. And even then I'd be wary because we're still talking about a company that's never made money. 

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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