Nearly every week seems to mark the birth of at least one new tech IPO star, but a close look at recent debutante Constant Contact ( CTCT) shows that not all are burgeoning with the same promise. Constant Contact has spent years building up a strong business and market footing in an overlooked sector. Its reliance on a Web-based, on-demand product seems to resonate among not-so-tech-savvy clients who want an easy way to keep in touch with their own customers. Like iMergent ( IIG), whose stock has been volatile over the past couple of years, Constant Contact offers a hand-holding relationship to small companies, from wine stores to individual "power sellers" on eBay ( EBAY), allowing them to use a browser to send email updates and newsletters to contact loyal customers. And that, combined with the popular on-demand model, seemed to be enough to drive the company's stock to $30 the day after its debut last week, nearly double its offering price of $16. It's only the latest in a host of tech companies to have gone public since August and see their stock rise more than 50% on the first day. The stock was trading recently at $26.19, off 2.8%. But there are some factors that make the high post-IPO valuation seem puzzling: Despite its lengthy history, the company is still posting losses, and rather than benefiting from the economies of scale that other on-demand companies are seeing, some costs are rising.
Revenue in the first six months of 2007 was up a healthy 78% to $21.1 million. That rate was below the 84% growth in customers, because of a dip in revenue per customer to $33.44 from $34.46 in the year-ago period. That's not a huge drop in money per customer, but it's never good when this metric isn't trending higher. Constant Contact's cost of revenue remained at 28%, which was flat with the year-ago ratio, because of "an 84% increase in the number of average monthly email marketing customers which resulted in increased hosting and operations expense and customer support costs." This is notable, as Constant Contact has yet to see the benefits of economies of scale created by other recent on-demand companies that have gone public. Athenahealth ( ATHN), for example, also focuses on small operations -- in its case, doctors' offices and clinics -- but it's profitable and seeing margins rise. Constant Contact is also seeing other expense items grow as a percentage of revenue. Sales and marketing expenses notched up to 61% of revenue in the first half of 2007 from 60% of revenue in the first half of 2006. This isn't surprising because the company relies on marketing to snag new customers. But it also saw a rise in general and administrative costs to 11% from 9% in the same periods as these costs surged 120% to $2.4 million. It's not clear why hiring is happening faster here than in R&D or marketing. The company only says it needs more administrators as its business gets bigger and more complex.
What's more, given the low barriers to entry in this industry and the growing competition, the level of customer discontent is a little worrying. The prospectus lists an array of current and potential competitors, from small players like Vertical Response and Broadwick to bigger players like Acxiom ( ACXM) and Experian and potential entrants like Microsoft ( MSFT), Google ( GOOG) and Yahoo! ( YHOO). Constant Contact says that fewer than 3% of subscribers cancel in a given month, so any discontent has yet to manifest itself in significant churn. The company spends $300 to acquire each customer (three of every five dollars it makes goes to marketing alone), so a customer has to stay with CTCT for nine months for them to break even. Constant Contact takes great pains to avoid being seen as an Internet spammer. Not only would such a designation tarnish the company's brand, it would cause Internet service providers to filter out its emails. As it is, 97% of emails sent out from Constant Contact to its clients' own customers make their way through existing spam filters. But keeping spammers away isn't easy, and Constant Contact's own message boards show some customers wondering what they did to be labeled spammers; other forums echo these complaints. Of course, there are many positive comments about Constant Contact as well. But at least some of them are from people who work at Constant Contact. Some of those have in turn been busted by bloggers who noticed that the raves were coming from IP addresses that were identical to the company's. Investors might want to keep an eye on two things at Constant Contact: how long it will take for costs to come down, and whether these customer complaints remain in the minority. It will be only too easy for competitors to lure them away.