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Slack Technologies (WORK: $27)
483 million class A shares and 87 million class B shares

Coverage initiated October 1, 2020, at $27 in the Special Opportunities portfolio.

Company Overview

Slack Technologies is used by businesses to allow workers to communicate with each other quickly, securely, and efficiently.  Its goal is to replace people sending internal e-mail messages. Rather, sending an instant message via Slack allows groups to do their work more efficiently since messages are organized into channels. Hence, if you are discussing a job opening or a particular task, you would have individual groups in different channels. Slack also makes it easier to track past messages.

The benefits to the employees and organizations are simple and important. This includes improving communication, transparency, and speeding up decision making

Slack offers two basic plans: a paid subscription and a free service. At the end of January, 660,000 organizations signed up for the service. Importantly, 110,000 actually paid for it. These are typically larger organizations. At the end of fiscal 2020 (ended January 31), there were nearly 900 paying customers that each produces more than $100,000 of annual recurring revenue.

If you’re thinking this is a great company for these times, as people are working remotely, we couldn’t agree more. We also expect companies will continue permitting their employees to work outside the office once the pandemic passes. Certainly, many firms are finding out they are just as productive, and the employees save time and money since they don’t have to commute.

Competitive Analysis

The market is fragmented and evolving. Microsoft has offered an instant messaging platform, Teams, for some time and solidified its place after it purchased Skype in 2011 for $8.5 billion. Bundling it with its other programs, notably Office 365, Teams is free for most of its services, which allows you to video chat, make calls, send messages, and collaborate at no charge. A potentially formidable competitor, you should keep an eye out for how the situation develops.

Other competition comes from e-mail providers like Google. As mentioned earlier, this is a popular service, and we aren’t predicting companies will do away with it anytime soon. It’s just that it has limitations on communicating with large groups. Slack makes it easy to track the conversation in the group discussion. In an e-mail, you have to scroll through past messages, and workers don’t always reply to everyone.

Facebook and Apple have communication apps that have traditionally been focused on the consumer market.

There are smaller companies that offer more niche solutions. For instance, there are ones that might specialize in one area, such as voice, video, or instant messaging. Slack has a clear advantage over these companies with its broad-based solutions that can handle a large number of users and data.

Financial Analysis

Even before the pandemic struck, this was a company with strong revenue growth. Its top line rose six-fold in just four years, from $105 million in fiscal 2017 to $630 million last year. For the first three years, management did a nice job controlling costs, and losses stayed in the $140 million range.

Last year, revenue grew more than 50%, and the company doubled operating expenses from $505 million to $1.1 billion. It spent more on items like R&D, Sales & Marketing, and General & Administrative. If this were a mature company, we’d say management didn’t have a hold on costs.  That’s certainly not the case here. With the company in fast-growth mode, these expenses will lead to further revenue gains. They are spending money to make money.

The number of paid customers increased from 59,000 in 2018 to 110,000 last year. It also continued to attract large clients – those that spend over $100,000. These went from 298 to 893. It is not just getting new customers. Most importantly, since it shows the value of Slack’s service, its dollar retention rate* was well over 100% for the last three years. It was 132% last year.

* Dollar retention rate is the monthly recurring revenue from paid customers over the period vs. the prior period. So, paying more (higher prices, added services) will result in over 100%.

This year’s growth was stupendous. 2Q21 revenue increased 49% to $215 million. This was led by a 30% year-over-year increase in paid subscribers to 130,000. It also saw a spike in the number of big customers, with a 37% increase to 985.

The bottom line moved in the right direction, too. Slack lost $75 million in the quarter, much narrower than last year’s $360 million loss.

Management’s guidance confirms our strong outlook. They expect FY21 revenue to grow 38% to $870 million.

Turning to Slack’s balance sheet, they have $1.5 billion of cash, with debt of $845 million. So, this is manageable.

Stock Performance

The stock has been flat over the last year, but has its ups and downs. Four months ago, it hit an all-time high of $40. Then, September’s market swoon caused Slack to fall 26%. It is now roughly the same price as last year’s direct listing. When results are strong and the stock declines, this creates an even more compelling valuation.

Slack has some powerful investors. There are two classes of stock, and Silicon powerhouses like SoftBank (11% voting power) and Accel (27% voting power) are still involved. Better yet, the co-founder and CEO, Stewart Butterfield, holds a 22% voting interest.

BMR TAKE:

Slack Technologies has been growing fast. Having just begun to scratch to the surface, its growth trajectory remains strong. We don’t see the company’s ability to win paying subscribers slowing down anytime soon.

We are initiating coverage with a $34 Target Price and a $21 Sell Price.