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TheStreet Open House

Castlight Health IPO Illuminates Bubble Discussion

NEW YORK (TheStreet) - Castlight Health (CSLT) is one of the more controversial $200 million initial public offerings, according to one IPO expert, given the company's $3.9 billion day-one market cap, its meager $13 million in annual revenue and negative gross margins. But before pundits use Castlight as a proxy for a new bubble, the offering may shed light on the businesses that investors are willing to pay for in current markets.

Ted Tobiason, a managing director in the equity capital markets division at Deutsche Bank, said in a Wednesday client note that Castlight Health should give investors "sufficient reason" to seriously question an IPO bubble. Tobiason, however, also said Castlight's IPO was indicative of a willingness to invest earlier in a company's life-cycle if it possesses  a new solution to a large addressable market.

Deutsche Bank wasn't listed an underwriter of Castlight's IPO. Tobaison also didn't directly dispute the notion that the deal's pricing could be indicative of a bubble.

Castlight Health provides enterprise healthcare cloud software that could allow employers to lower their overall healthcare costs, which have spiraled upwards in recent decades and hit corporate bottom-lines. The company priced its $200 million IPO at $16 a share, valuing Castlight at about $1.4 billion. Shares more than doubled in Castlight's first day of trading.

Currently, shares are trading at around $30 a share. That valuation comes in spite of the company's marginal 2013 earnings, and forecasts of $120 million in 2016 revenue and a $50 million net loss, according to Tobiason. "To some the fact that a company with only $13 million in 2013 revenues and negative gross margins can get a $1.4 billion valuation at IPO only to trade to a $3.9 billion IPO its first day is an indicator that we're in another IPO bubble," Tobiason wrote. "There are sufficient reasons to look at this seriously," he said.

But the market may be not that crazy.

Tobiason said Caslight Health's roadshow emphasized the size of the company's addressable market and the solution the company may offer to employee plans. Employer healthcare spending is at $620 billion, with 30% being waste and a majority of chief financial officers citing that spending as their primary cost concern.

Castlight estimated in its roadshow that the company's addressable market would be $5 billion, possibly a low estimate according to Tobiason, given its cost solutions for employee health plans. An expenditure of 1% of a company's overall healthcare costs on Castlight could lead to savings of 15% of total costs, something that investors keyed on, according to Tobiason.

The company also stressed its management experience. Co-founders Bryan Roberts and Giovanni Colella were instrumental in building AthenaHealth (ATHN), a rising star in the industry, helping to buoy investor confidence in the company.

Castlight's emphasized its cloud-focused business model. "Get used to hearing 'cloud,' we're going to hear that word a lot this year," Tobiason said of possible 2014 IPO roadshows.

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The company priced at a multiple of over 18 times 2015 sales forecasts and 11 times 2016 sales forecasts, a premium over comparable software-as-a-service (SaaS) companies in the software sector.

"High growth SaaS/Cloud multiples have been climbing for the last several years and in many ways Castlight has set a new valuation benchmark," Tobiason said. He added that Castlight's IPO in many ways was similar to the share offering of Workday (WDAY), a company that's seen its stock rise over 100% since its IPO to a market capitalization of nearly $18 billion.

That experience may have caused some investors to project a $5 billion-to-$10 billion market capitalization for Castlight, and caused some to buy into the IPO for fear of missing out.

"The pricing and performance of the stock certainly indicates that public investors are willing to pay a substantial premium to get exposure to companies with enormous growth potential and the big dream... As for Castlight, they now have a $3.2 billion market valuation and with that will come a great deal of pressure to perform to the expectations that come with that," Tobiason concluded.

What is clear is that Castlight's current valuation doesn't represent some type of fundamental analysis, but instead the expectation on investors'' behalf that the company's management has built a compelling product that addresses a large market. Amazon (AMZN), Google (GOOG) and many other current tech heavyweights have IPO'd with a similar lack of fundamentals.

But not every company is the next Amazon or Google.

Bottom Line: Investors may have gotten carried away on Castlight's IPO. That's probably not going to slow IPO markets down.

-- Written by Antoine Gara in New York

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