Larry Ellison Controls NetSuite's Destiny Despite IPO

Oracle CEO Larry Ellison's nine-year experiment to develop an on-demand software company is about to get market tested. NetSuite, co-founded by Ellison in 1998 to deliver business apps via a software-as-a-service model, on Monday launched the bidding process for an initial public offering of its stock.

NetSuite is offering 6.2 million shares of its stock with a suggested price range of $13 to $16 a share in the hopes of raising $99 million to pay off some debt and make new investments. Bidders will determine the actual price in an open online auction, or "Dutch auction," expected to wrap up on Dec. 19. Google used a Dutch auction, which is intended to make shares available to more investors beyond the Wall Street regulars, in its 2004 IPO.

Ellison remains the majority shareholder of NetSuite, with his share of the company expected to drop from 61% to about 55% following the IPO. A few of his family members will keep control of another 11% of the company after its IPO. Ellison, however, plans to transfer his shares to a "lockbox" limited liability company to eliminate his voting control over NetSuite directors, and also to "avoid potential future conflicts of interest that might otherwise arise," according to NetSuite's prospectus.

NetSuite is run by CEO Zach Nelson, an Oracle alum, and CTO and Chairman Evan Goldberg, who co-founded the company with Ellison. Ellison has had little involvement in the day-to-day operations of NetSuite for more than a year, Nelson said in a previous interview. Still, Ellison controls NetSuite's destiny. According to the prospectus, he has control over "significant corporate transactions," including a sale or even liquidation of the company.

That control gives Ellison the ability to react based on which way the SaaS market blows, including even the option of absorbing NetSuite into Oracle by essentially selling the company to himself. Even after nine years of majority ownership of NetSuite, Ellison admitted to analysts in Oracle's most recent earnings call that no company has figured out how to make the kind of money off of SaaS that's become expected in the software industry.

NetSuite can be a much more affordable option for customers compared with licensed software, since they simply pay for a one-year subscription for software NetSuite hosts and delivers over the Internet. But what's good for the goose isn't always good for the gander. With traditional licensed software, customers may pay thousands or millions of dollars up front, which the vendor can funnel into sales and marketing costs, personnel costs, or even research and development. In the SaaS model, the revenue trickles in at a much slower rate, and is often out-paced by operational costs.

NetSuite's goal, with the help of an IPO, is to grow revenue quickly enough to start turning those losses into profit. One of the biggest dangers NetSuite faces, its prospectus acknowledges, is that if its SaaS model takes too long to gain interest among business customers it could become difficult at some point for NetSuite to survive. On the other hand, if NetSuite's growth takes off in the next few years or Oracle begins to face pressure from SAP's upcoming SaaS offering, Oracle could easily acquire the company.

So far, demand has grown steadily for NetSuite's SaaS offerings of such things as accounting, payroll, order management, and customer-relationship management software. Its sales grew from $3 million in 2002 to $67.2 million in 2006, up 85% over 2005. Revenues for the first nine months of this year were $76.8 million, up 63%.

Yet, NetSuite has never posted a profit. It had a net loss of $35.7 million for 2006 and $20.6 million for the first nine months of this year, and as of Sept. 30 it had an accumulated deficit of $241.6 million. Even SaaS's pioneer and most successful company in the area, Salesforce.com, exists on small profit margins as it approaches an annual revenue run rate of $1 billion.

This uncertainly over SaaS's future is probably why Oracle is consistently unclear in its own strategy about the delivery model. The company has said it will offer customers software on demand if they want it that way, but it's never put big-guns marketing behind a cohesive product offering or developed across-the-board subscription prices. Oracle executives also have pooh-pooh the notion, as promoted by Salesforce.com, that real SaaS requires a multi-tenant architecture of hosting many customers from one server (which could require Oracle to make some changes to its own software).

Still, with SAP bringing to market a SaaS offering for small and midsize businesses, Ellison likely wants to keep his options open with both NetSuite and Oracle. In its prospectus, NetSuite names its primary competitors as Epicor, Intuit, Microsoft (Dynamics), SAP, The Sage Group, and Salesforce.com. Oracle -- even though as recently has Oracle World executives were talking about SaaS as an option -- was not mentioned as a competitor.