It's been a busy couple of weeks for the technology sector. Fresh off an earnings season sprinkled with artificial intelligence (AI) players, some private unicorns are looking to take advantage of positive investor sentiment.

Semiconductor company Arm Holdings and grocery delivery app Instacart both recently completed initial public offerings (IPOs). While I generally shy away from IPO stocks, there is one that has me bullish: Klaviyo (KVYO 4.39%), a software-as-a-service (SaaS) platform geared for marketing automation.

Let's look at Klaviyo to see if buying some shares following its IPO makes sense.

What does Klaviyo do?

If you've ever signed up for a loyalty or rewards program, or subscribed to a brand's newsletter, odds are you've received promotions and discounts through digital channels. Marketing teams measure the success of these campaigns based on metrics such as number of clicks, emails opened, cancelled subscriptions, and more.

This is where Klaviyo comes in. The company develops tools built on the backbone of AI and machine learning that allow marketers to track these data points in an effort to hone their business strategy and reach more potential customers.

The marketing automation landscape is full of competition, and one of the longest-active players is HubSpot. A number of private players have been gobbled up by big tech: Mailchimp was acquired by Intuit in 2021 for roughly $12 billion, Twilio acquired SendGrid in 2019 for $3 billion, and Adobe bought Marketo for $4.8 billion in 2018.

The sheer volume of mergers and acquisitions in this industry underscores two key themes: Marketing automation tools are in demand, and these companies command hefty price tags. This could bode really well for Klaviyo, and while I am not insinuating that the company is a takeover target today, I think it's reasonable to believe that the historically comparable acquisitions could serve as a useful basis to determine where the company's valuation could be headed. But more on that later.

A person analyzing data on a dashboard.

Image Source: Getty Images.

How is Klaviyo performing?

As a SaaS business, Klaviyo highlights a number of adjusted measures in its filings. Two key performance indicators are annual recurring revenue (ARR) and net revenue retention (NRR). ARR is important because it provides investors with an idea of how much recurring business the company has and how it's trending.

On a traditional income statement based on generally accepted accounting principles (GAAP), recurring revenue might be reported under a category called software licenses. While this is useful on some level, due to some of the intricacies of GAAP, it can understate the true reflection of the company's entire book of recurring revenue since it won't take into account multiyear contracts or built-in price increases. As of June 30, Klaviyo had almost 1,500 customers generating over $50,000 in ARR, which represents 94% growth year over year.

In conjunction with ARR is the equally important measure NRR, which takes into account revenue growth from existing customers. Therefore, the most successful SaaS businesses like to see NRR of over 100%, as that implies that the company is coming out ahead in its churn rate. As of June 30, Klaviyo's NRR was 119%.

The combination of strong ARR and NRR has helped Klaviyo build a robust financial profile. For the year ended Dec. 31, 2022, the company reported revenue of $473 million, up 63% year over year. Through the first six months of 2023, Klaviyo has increased revenue 54% year over year.

While there is a lot to like here, there are some risks investors should take into account.

Should you buy Klaviyo stock?

Through the first six months of 2023, Klaviyo has reported $321 million in revenue. Assuming its current annual run-rate, the company is on pace for $642 million in total sales this year, which implies 36% growth year over year, a far cry from its 63% figure last year.

On a brighter note, free cash flow (FCF) has improved dramatically. In 2021 and 2022, the company burned a combined $79 million in FCF. However, through the first six months of 2023, Klaviyo posted positive FCF of $53 million, a massive improvement over the last couple of years.

According to PitchBook, a database of private companies, Klaviyo's most recent valuation before going public was $9.5 billion as of 2021. At the time of this writing, its market capitalization is $8.4 billion. While it might seem like now is a time to scoop up some shares at a discount, keep in mind that the company has been public for only a few days. As more news comes out following the IPO, the stock could begin to climb, or drop, pretty dramatically.

From my perspective, Klaviyo presents a compelling investment opportunity. Given historical acquisitions made by big tech, coupled with the company's solid financial picture, it's hard to pass on the stock.

The company is already valued significantly higher than what some of its cohorts were acquired for just a few years ago. In a sense, this could imply that in just a few years, marketing automation software is already commanding even higher premiums due to its importance to big tech. By the same token, Mailchimp's price tag is far above Klaviyo's and could represent an indication of potential upside. 

While revenue growth is slowing, keep in mind that companies of all sizes are still operating on tight budgets as executives navigate the impacts of complex variables such as inflation and rising borrowing costs. I view the company's slowing growth as more of a factor related to the broader economic picture.

Furthermore, companies do eventually reach inflection points whereby triple-digit or high double-digit growth simply isn't feasible. To me, the more important trend is that Klaviyo is generating positive cash flow, which it can use to reinvest in the business.

While there is little trading history, I believe Klaviyo is worth a buy due to its long-term potential driven by encouraging secular demand trends.