As lockdown stretches on globally, 3 companies are at the forefront of enabling the primarily remote working environment most people find themselves in. You guessed it, Slack, Zoom and Microsoft (via Teams and MS Office online).
Our team has been working remotely since December 2019 so we had a bit of experience before remote was forced on most of the world. We use tools provided by all 3 of these companies, and as legendary investor Peter Lynch said – look at your every day life to guide you on what companies may be worth investing in! This is of course just a start, the research is of equal importance! Post 1 of 3 focuses on: Slack!
Slack is a chat tool that enables effective communication throughout organizations. Our own IT team have been using Slack since 2017 and got the business team on board in 2019 – we find we use less and less email internally as Slack is easier and more effective. The ability to make groups for specific projects or teams, as well as status (for example online, which we insist the whole team is during every day), are just some items making Slack more convenient as a collaboration tool than traditional email. Their goal is for Slack to completely replace email. We use the free version of the tool, for now. Their share price is currently hovering around $28 per share after listing for $26 in June 2019. Slack was founded in 2009, so this ‘overnight success’ has been 11 years in the making now.
Slack has grown its user base to 660,000 organizations, with 110,000 of those paying as at 31 January 2020. Their conversion strategy to paid is fairly long term, essentially requiring a person to use up their free space and then only giving them access to the most recent 5GB’s of data, unless they pay. There is also a user cap. While not aggressive as a conversion to paid strategy, this deep pipeline should keep converting users for many years to come, as users will be very entrenched in the product by the time they reach their space limit.
Revenue grew from $100 million in 2017 to $630 million for the year ended January 2020, with an incredible gross profit margin of 85% – important to note this excludes the impact of COVID-19! Their quarterly results show $200M for Q1 ended 30 April 2020 (vs $135M Q1 prior year). Given COVID I would expect this growth to accelerate into 2020. Their total number of organizations using Slack grew from 660,000 at end Jan to 750,000 by end April. However total paid organizations only increased to 122,000 by end April 2020, highlighting that their conversion to paid strategy is probably not aggressive enough.
The net loss for the year amounted to $570 million, largely driven by stock-based compensation being paid out as a result of their listing, amounting to $426 million of the loss. Excluding this cost (a true once-off) Slack is not very far from profitability, although their strategy will almost definitely be to use all cash generated to pursue further growth and improve their competitive advantages. This is a similar model to lots of start ups who turn into big businesses, such as Nike (who now pay dividends). Very important is that their revenue is largely recurring revenue, as they follow a subscription model (annual or monthly). As these results exclude the impact of COVID-19, which has forced people to consider Slack, I believe their growth in revenue will not slow down anytime soon.
One very positive aspect about Slack is that their product is extremely sticky, meaning moving away from it once using it would be painful. Their spend is positioned spend to maximise their advantages, with almost half of gross profits going back into R&D, essentially spend to improve the offer and increase ‘stickiness’. Almost 60% of gross profit is spent on sales and marketing, so Slack have really dialled in on what they need to a) grow revenue and b) retain customers. Anyone who has used Slack will understand just how much better their product already is compared to traditional email.
I have gone with 31 Jan 2020 figures to be comparable to the income statement and cashflow headings – all ratio’s have improved by end April 2020.
Slack have just short of $1 billion current assets, $500M being cash. Burning 12 million a year on operations, Slack have more than enough liquidity to see them through many years of unprofitable operations to drive growth. Current liabilities equate to $520M of which $375M relates to deferred revenue – revenue received in advance is recognised as a liability as cash received now for future services implies future expenses related to this. In Slack’s case, operating at an 85% gross profit margin, this can pretty much be ignored (technically it should be reduced by 85%), leaving $145M in current liabilities that expect a cash outflow equal to the amount recognised. All this means this already very liquid company is extremely liquid when excluding deferred revenue from current liabilities.
Slack’s cash flow very closely matches their expenses, with cashflow in 2020 being negative 12 million, compared to negative 41 million in 2019. This is primarily driven by research and development and sales and marketing costs which as mentioned are strategic expenses, meaning their unit economics are strong – also evidenced by the strong gross profit margin. For annual subscriptions they also receive payments in advance which helps strengthen cash flow. Overall Slack have shown great conversion of revenue to cash, which makes sense given their model. With a pipeline of 550,000 active organizations not yet paying (and 628,00 by April 2020), there is plenty of space to generate cash from existing ‘free’ users, with current revenue fairly certain to continue given their subscription model.
At this point one needs to consider a risk – customer churn. This refers to customers that fall off the subscription model. Slack measure this by looking at what they call net dollar retention rate, being cash they made from paying customers 12 months ago vs how much they make from those same paying customers today. Sitting at around 130%, this means Slack are increasing the revenue they make off their existing customer base, before even considering new customers. This shows their revenue is truly recurring and the model is working.
Slack are currently valued at 15 billion dollars, pretty eye popping compared to traditional business (15 times revenue)! Being a growth stock this is expected – Slack actually only listed for roughly 15 Billion dollars, so despite the improvement over the course of their short listed life you can still buy them at their listing valuation. They have already gone up to as much as $21 billion and as low as $11 billion in that short space of time.
If Slack continues to grow at around 50% plus over the next 3 years the share would be great value for money – however, as with many growth stocks, and especially a tech growth stock, a lot of growth is being priced in, meaning the risk is fairly high. Slack is not the craziest tech valuation around though, not by a long shot (for that see Lemonade).
Slacks’ goal is to essentially replace email globally – if they come even close to succeeding with this goal then this is a great time to get on board. The market has been comparing Slack to Zoom and similar for growth expectations, but on a valuation of less than a quarter of Zoom, Slack looks decent value for money, relatively speaking.
|Year end 31 January 2020|
|Year ended||Market cap||Revenue||Gross profit %||Cashflow from operating||Number of customers||Number of paid customers|
|31-Jan-19||15 Billion||400 Million||87%||– 42 Million||Not availabe||88,000|
|31-Jan-20||11 Billion||630 Million||85%||– 12 Million||660,000||110,000|
See part 2 of 3 next week – Zoom!
This article is not to be considered as financial advice, investors should do their own research before making investment decisions. The author owns an immaterial number of shares in Slack.
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