By Beth Kindig
Of course, we can name a long list of cloud-software companies with comparable price-to-sales or higher, but the difference is that Slack has not won over sell-side analysts, whereas Shopify /zigman2/quotes/209033712/composite SHOP +2.86% , Zoom Video Communications /zigman2/quotes/211319643/composite ZM +0.01% and Okta /zigman2/quotes/210420951/composite OKTA +2.86% have. Certainly, returns are healthier if you can beat sell-side analysts to a winning stock. (For instance, my newsletter subscribers beat sell-side analysts to Roku /zigman2/quotes/205087179/composite ROKU +5.19% for much higher gains.)
We are also seeing some slight exhaustion in the market with regard to cloud-software valuations. Last week, a few companies beat on both top-line and bottom-line estimates, such as Veeva Systems /zigman2/quotes/202850210/composite VEEV +1.11% and Workday /zigman2/quotes/201157610/composite WDAY +1.63% , yet the stocks dipped as much as 6%.
One thing to consider with Slack is that the potential market is nearly impossible to predict as the company is carving out a new category. The global enterprise collaboration market is expected to grow from $34.6 billion to $59.9 billion, with a growth rate of 11.6%.
This is a sizable market for a company with $600 million in revenue. However, it’s hard to determine where Slack’s product fits. Slack CEO Stewart Butterfield alludes to owning 2% of the software market as a force extender for the other 98% of the software market, and that would equate to a market worth $12 billion in annual enterprise software sales.
Okta is a great example of a company that has similar numbers on its profit-and-loss statement, yet Okta earned its market cap through a series of strong earnings reports and gaining the trust of public investors, whereas Slack demanded a record-breaking price-to-sales right out of the gate. Twilio /zigman2/quotes/205796518/composite TWLO +3.42% also has a similar profit-and-loss statement, but is trading at 16 forward price-to-sales. Slack not only priced itself too high for a new company with slowing growth, but it’s also likely the direct public offering didn’t help.
In August 2018, Slack was valued at $7 billion in its last venture round and listed at nearly double that in June 2019 when it was listed on the public market.
Herein lies the problem with direct public offerings, which are heralded as a way of cutting out middlemen and fees: The lack of a lock-up period allows the company to price high on the public markets for the benefit of insiders rather than fairly price the stock with the understanding that insiders will lose if the company is overpriced and the stock attracts downward momentum.
Many investors are aware that IPOs can be risky, although tech companies have a penchant for proving these risk-averse investors wrong with many recent triple-digit success stories. In this case, however, both Slack and Spotify /zigman2/quotes/207488629/composite SPOT +0.27% have proven that DPOs are not ideal for public investors as the opening valuations have not been sustained in the long term. This could be due to a lack of consequence for listing too high.
There are some valid points on the more bearish side of the debate, but using Microsoft /zigman2/quotes/207732364/composite MSFT +0.16% Team’s 13 million users as the primary weak point is not of them. As with most David and Goliath battles in tech, the market has this backwards.
Slack is a small, relatively unknown brand that has managed to keep pace with one of the world’s most recognized brands — Microsoft. The fact they are almost equal in users at 10 million for Slack and 13 million for Microsoft is a boon for Slack, not the other way around. This proves that Slack is a serious contender and able to attract users with a hundredth of a decimal point in revenue compared with Microsoft’s trillion-dollar market cap.
Slack is a stand-alone app compared with Microsoft’s legacy enterprise software suite, which is now sold as a subscription in the cloud as Microsoft Office 365, yet was originally launched in 1990. Microsoft Outlook has an estimated 400 million users, primarily enterprise.
To say that Microsoft launched Teams in 2017 and has quickly caught up to Slack is not exactly accurate. Microsoft has owned business communications for nearly 30 years and has spent $35 billion in acquisitions to own the messaging space pre-emptively with the acquisition of Skype for $8.5 billion and LinkedIn for $26.2 billion. Those acquisitions occurred around the same time that Microsoft considered acquiring Slack for $8 billion .
Microsoft then leveraged its hundreds of millions of enterprise software customers and copied Slack’s approach. Yet, somehow, Slack should be afraid of Microsoft? I disagree. Investors should be asking themselves why 600,000 organizations are downloading a separate app to hold their business discussions with many being Microsoft Office users.
More importantly, the word Slack is becoming synonymous for business messaging. Like what Kleenex did for facial tissues, “to slack someone” means to send a coworker a message. I do not foresee anyone using Microsoft Teams in this manner, and this is the best free marketing a company can have.
The main product differentiation is Slack’s customization. There are over 1,500 standard integrations with Slack, such as with Zoom video-conferencing and Google Drive. However, there are over 450,000 applications developed internally by Slack customers, according to the CEO. Those applications come from developers who want a more advanced alternative to the closed ecosystem that Microsoft provides.
There is a healthy debate on Slack, and both sides have valid arguments. On the one hand, you have a company with slowing growth, and on the other, you have a product with strong industry key metrics and a highly engaged user base.
When looking at valuation for companies that have similar profit-and-loss statements, it becomes clear that Slack came on too fast and too strong with its valuation. This is a mistake the company has paid for, as the momentum is now downward. Better to have listed at a $10 billion market cap and earned the $14 billion market cap than the reverse, as many public investors can be myopic with tech products and are easily scared off.
For opportunists and visionary investors, however, the downward momentum on a product that is becoming synonymous with business messaging is welcomed for an attractive entry.
Also by Beth Kindig:
Disclosure: Subscribers to Beth Kindig’s premium service may have positions in the securities mentioned in this article or may take positions at any time. Kindig offers exit and entry scenarios for the stocks she covers.
Beth Kindig is a San Francisco-based technology analyst with more than a decade of experience in analyzing private and public tech companies. She publishes a free newsletter on tech stocks at Beth.Technology and runs a premium research service.