Slack Technologies (WORK) continues to struggle a bit, at least in terms of the share price. By mid-March, I looked at the investment thesis for the company as I concluded that there was room for improvement.

I noted that Slack should see continued and actually solid growth as it is a prime beneficiary in the COVID-19 crisis, yet the company continues to cause dilution for investors through large losses (driven by stock-based compensation expenses). Nonetheless, I liked the relative low sales multiples and the potential, yet some real operating leverage would be required, as the mantra of simply growing for the sake of growth and ignoring the cash burn is no longer working.

The Thesis

Slack claims to replace the way in which people work through replacing the traditional usage of e-mail. The company and users believe that channeling of individual e-mail inboxes halt communications and progress for teams to work together, as sharing through Slack should become more efficient.

In June 2019, when Slack went public it shares saw a momentum induced rally to a high of around $40 per share. By October of last year, shares fell back to $20, and amidst heightened volatility during COVID-19, shares hit a high around $35 in May before now falling back to $28 per share.

Around the time of the IPO, the 525 million shares outstanding traded at $37 per share which translated into an operating asset valuation of around $19 billion, equivalent to roughly 50 times sales which ran at $400 million in 2018. While 80% growth looked compelling, valuations looked rich, certainly as the company reported an operating loss of $150 million that year.

First quarter result for 2019 revealed 67% sales growth to $135 million, with billings up 47% to $150 million. Second quarter revenues rose 58% to $145 million, although growth was hit by some sales disruptions. As it turned out, the story of disruptions was credible as third quarter sales rose 60% to $169 million. During the COVID-19 crisis in March, the fourth quarter results were released. Sales rose 49% to $182 million, with full year sales up 57% to $630 million, in a year in which billings came in at $765 million.

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The company reported a net loss of $1.43 per share, equivalent to $571 million based on GAAP accounting. While the company reported a modest adjusted loss of $0.28 per share, almost the entire discrepancy stems from stock-based compensation expenses, which is a real expense (for shareholders). To be fair, this expense was a bit inflated last year by the public offering. For the final quarter, a net loss of $89 million was largely caused by a somewhat more normalized stock-based compensation expense of $67 million combined with an adjusted loss of $21 million.

With shares down to just $18 in March, I pegged the enterprise valuation around $9 billion, or about 9 times forward billings. This multiple came down a great deal, yet after looking at (forward) billings, this multiple was still expensive in a market which was experiencing great turmoil, while the company continues to bleed money and growth would slow down in 2020.

For the first quarter of 2020 the company guided for 38% revenue growth with sales seen around $186 million and adjusted operating losses of $40 million. For the year the company guided for sales around $852 million, or about 35% growth with adjusted losses seen around $125 million.

This guidance was a bit underwhelming in my book as the company should be a prime beneficiary with people either temporarily or structurally working more from home. On top of the non-impressive sales growth, I was not necessarily impressed with the lack of operating leverage on the resulting sales growth.

What Happened?

Early June the company reported strong first quarter numbers, at least compared to the guidance. Revenues were up 50% to $202 million, approximately $16 million ahead of the expectations. Billings rose 38% to $206 million, resulting in a low book-to-bill ratio, arguably as conversion was strong in this environment, with few longer-term sales trajectories being started.

The adjusted loss of $17 million was far better than the guidance as well, roughly $23 million better than guided for, and actually better than the beat in terms of the revenue number. The issue is that GAAP operating losses came in at $75 million as a result of large stock-based compensation expenses. These expenses of $53 million fell compared to the fourth quarter of 2019, yet it still results in big losses in the meantime.

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Second quarter sales growth of around 43% is sound, with sales seen around $207 million, with adjusted losses guided at around $20 million. For the year, the company upped the full year guidance to $855-$870 million, with adjusted losses now seen around $105 million.

The 557 million shares outstanding, which now trade at $28 per share translate into an equity valuation north of $15 billion, and an enterprise value of a little less than $15 billion. Valuation multiples have risen to roughly 17 times anticipated sales this year, as the multiple might come in a bit lower if we consider that the guidance might be conservative, as based on billings the multiples will come in a bit lower.

I am impressed with the slight sales acceleration displayed on the first and second quarter, as the company is delivering on some adjusted operating margin improvements, while stock-based compensation is slowly being curtailed. That said, a realistic loss rate of around $300 million remains elevated, yet by no means high enough to potentially cause financial concern, yet it only adds to the enterprise value in the meantime while losses are reported.

A Final Thought

With the business now valued at a 17 times forward sales multiple, while growth rates come in around 40-50%, the valuation starts to look somewhat reasonable, especially as the company sees growth accelerate, and losses start to come down.

The big question mark dominating the investment thesis is that there is a lively debate whether Teams might be the true winner in this market driven by product superiority, but mostly by the networking effects provided by its parent. If reality is that networking is not as important, as independence of Slack and functionality are more important, Slack could thrive, and even operate together with Teams in such an environment (as is the case currently).

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Problematic is that within technology inferior products have long thrived as distribution and networking is key and based on this count, Slack is at a big disadvantage vs. Teams, being the standard option for Microsoft (NASDAQ:MSFT) products.

This makes it very important to generate scale in the initial phase of expansion, which is exactly what Slack is doing as superior quality prevents its users from perhaps running to Teams. That said, the characteristics of Slack are much more diverse and broad as that of Teams, as a key reason why both products cannot be compared one-on-one. Nonetheless, Slack is quite concerned about the fight as well, as it is having conversion with authorities on the behavior of Microsoft with Teams offering, both at home and over in Europe.

Not having a clear point of view, or insight which way this fight is going to go, I believe there is room for multiple product offerings in this market, certainly as large corporations might benefit multiple independent offerings, as Slack’s offerings are more diversified and quite effective.

With 50% revenue growth I see relative appeal at 15 times sales, and hence I am willing to test and initiate a small position at the $24 mark, adding on potential dips from there onwards.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.