Slack’s shares are set to fall sharply this morning, down around 16% in pre-market trading. As the company beat analyst expectations last quarter and guided within range, the selloff might feel a little surprising.
Perhaps it shouldn’t.
I spoke with a VC last week about what the new benchmark results are for private SaaS companies, and to my surprise, he said software startups don’t have to grow at 100% to be fundable in today’s market. Given what I’d heard from other venture capitalists about how so much of their portfolios had found a COVID-19 growth bump, the perspectives felt incongruous.
The Exchange explores startups, markets and money. You can read it every morning on Extra Crunch, or get The Exchange newsletter every Saturday.
Startups wanted to grow at a pace of more than 100% pre-pandemic, and some have accelerated since. So how could a startup growing less than three figures yearly be attractive? Throw in Zoom’s impressive earnings results and some warning signs from earlier this earnings cycle that cloud growth hasn’t wound up being quite as fast as expected felt diminished.
Slack’s earnings help sort out what’s going on.
Reading the company’s SEC filing related to earnings this morning, it’s hard to miss Slack’s notes about COVID-19. The enterprise communications company describes early benefits from the pandemic, along with lingering pain associated with its economic impacts. In short, the software-related COVID bump could wind up leaving a hangover in the short- to medium-term.
This helps us understand why a software startup could be VC-attractive in 2020 without a 100% growth rate. Perhaps more SaaS and cloud startups than we’ve been led to believe are struggling, which means slower revenue expansion is palatable provided that other indicators are flashing green.
To understand what could be happening to your favorite startup, let’s tease apart Slack’s COVID-19-related business notes, starting with the good news, before turning to what I’ve penciled in as the bad news — and the even badder tidings.
Slack’s quarter and the cloudy COVID-19 outlook
Slack reported $215.9 million in its most recent quarter, the second of its fiscal 2021, up 49% from the year-ago quarter. While Slack lost $74.8 million in the quarter, on an adjusted basis it broke even. Both the revenue and the $0.00 in adjusted earnings per share beat expectations of around $209 million in revenue and a roughly $0.03 per-share loss.
Often when a company beats analyst expectations, its shares go up. In today’s market, public investors are valuing some tech companies like they are going to grow much more quickly than the average analyst’s expectation. So, when those companies “beat,” they actually “miss,” as they have been priced against a different set of results. This can lead to strong trailing results, like Slack’s in its most recent quarter failing to generate a share-price benefit, and, instead, seeing a huge reduction in corporate value.
It isn’t too hard to figure out why some investors might have expected Slack to catch a wave and ride it all the way to growth-town. Everyone’s at home! They need to communicate! No one is going back to the office! The future is now! You’ve heard the arguments.
But let’s have Slack walk us through COVID-19 from its perspective, starting with what was an early COVID-19 bump before turning to a look at today, and then the future.
From Slack’s Q2 fiscal 2021, the good:
At the beginning of the COVID-19 pandemic, we experienced a significant increase in demand and usage of Slack, including an increase in our number of Paid Customers […] we have experienced an acceleration in our Paid Customer growth during the six months ended July 31, 2020.
This is the pandemic-related bump that some software startups and public companies saw. Investors decided that the moment was not a fluke, and that it would persist it appears, given cloud stock prices. Next, the bad news begins.
From Slack’s Q2 fiscal 2021, the bad:
However, the rate of growth of total organizations on Slack has reverted to a level more in line with trends we experienced prior to the COVID-19 pandemic. In addition, we have experienced an increase in paid customer churn and a decrease in expansion within existing paid customers during the six months ended July 31, 2020. We expect these paid customer churn and expansion trends to continue due to the effects of the COVID-19 pandemic.
This paragraph could describe a series of present-day conditions that are net-negative for Slack’s business, compared to the pre-COVID days. Of course, extra paid customers snagged during the start of the pandemic who don’t churn should spend more money over time, helping Slack grow. Still, there’s more bad news to come.
From Slack’s Q2 fiscal 2021, the badder:
This outbreak, as well as intensified measures undertaken to contain the spread of COVID-19, have decreased IT spending for many organizations, adversely affected demand for Slack, attrition rates, the ability of our salespeople to travel to potential customers and of our customer success team to conduct in-person trainings and consulting work, negatively impacted expected spending from new and existing customers, increased sales cycle times, negatively impacted collections of accounts receivable, caused certain of our paid customers to file for bankruptcy protection or go out of business, and harmed our business, results of operations, and financial condition. We expect these negative impacts will continue due to the effects of the COVID-19 pandemic.
Yeesh.
Still, Slack grew at around 50% while public and is racing toward a $1 billion run rate. It’s a great company to watch, though its GAAP net losses are slightly irksome, even if SaaS-heads will defend its spending given that Slack’s operations generate cash and the company is breaking even when we use adjusted metrics.
What we can see in the above pieces from Slack’s earnings is the story after the wave of sign-ups, and what came next was churn problems, falling-budget issues, limited upsells and more.
Returning to the top of our chat this morning, this is probably why some startups can get away with growing at less than 100% on a yearly basis right now; the macro headwinds that you would expect to see in this economy have not been waved away by talk of an accelerating digital transformation, and, more to the point, a lot of companies are still reducing IT spend, not boosting it. It’s hard to sell into such a company, or, really, such a trend.
Therefore, some startups that are still great shops will simply grow more slowly than before COVID hit, until its economic impacts lessen.
All this is a tough lesson for traders who bid Slack shares higher than they were perhaps fairly valued despite a fine quarter from a company that will continue to do well. But the situation does provide a good set of notes for you and I, to help us understand what startups might be enduring behind the closed doors of private business.
Comment