Network Effect Will Propel Slack Adoption, Outperforming Stock Performance To Follow (NYSE:WORK)

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Investment Thesis

Like several other platforms, such as Facebook ( FB ) and Pinterest ( PINS ), Slack ( NYSE : work ) has not had the best IPO, selling off on investor concerns about rival from Microsoft Teams ( MSFT ) and growth deceleration ( given its generous 60 % growth pace ) coupled with the company ‘s high gear valuation. however, Slack ‘s focus on growth is paying off thus far. specially in the near-term, the caller is prioritizing the enterprise. Both the buckets of $ 100,000 and $ 1,000,000 annual tax income customers have been growing at twice the clip of its overall user base growth. furthermore, in the third draw, Slack launched shared channels out of beta, a significant fresh and alone sport that allows different enterprises to share a channel, as the name suggests. Slack says this merchandise will be difficult to replicate by others who are more stiffen by bequest code bases that were not designed to allow this feature, as it places the divided transmit at the core.

There are many ( new ) manipulation cases for shared channels conceivable, and Slack says that its borrowing has surpassed its expectations, although the party says it is arduous to forecast how it will play out precisely, and the party itself is n’t even modelling it in at this point. The top from shared channels is clear, though. Shared channels introduces a clear network campaign : the value of the network/service increases with each extra user that joins it. Slack has indeed confirmed that the ‘distance ‘ between any two users has decreased, and the overall network has become dense, well-defined indicators that the feature is already paying off. adoption in particular has been stellar in large enterprises, at 80 %. additionally, shared channels allows for extra ways of monetizing the user base over prison term, although this is not a near-term precedence. This is a further opportunity to expand within a customer. Slack already has a goodly > 130 % final dollar retentiveness rate. clearly then, a compel product ( Slack ) with differentiated features ( shared channels ) combined with a large expansions opportunity and a large user base that is still untapped, makes for an excellent company. A bearish market consensus makes Slack an even more compel investment. In the third gear quarter, Slack ‘s tax income grew 60 % to $ 169 million. Customers greater than $ 100,000 climbed to 821, up 67 % YoY as that is where the company ‘s investments are aimed at. Companies exceeding $ 1,000,000 in tax income for Slack amounted to 50, up from 30 a class ago. This compared to growth of the general paid user base by 5,000 QoQ to 105,000. Slack expects this drift to continue as it invests chiefly in enterprise sales. Gross margin is about 90 %. Of the company ‘s gross, 37 % comes from international customers. Slack continues to invest in its sales, opening new offices in Chicago, Osaka, Munich, Paris, Sydney, etc. final dollar retention was 134 %, indicative of the big opportunity Slack silent has to expand within customers. While some are already wall-to-wall, Slack said that this is hardly the encase for most large customers, and sees a 3-5x opportunity there. presently, R & D accounts for ~40 % of tax income, sales and marketing ~50 % of tax income, and early expenses will swerve towards ~20 % of gross and lower over time. Stock-based compensation is besides expected to decline over time. The company operated at a passing, but free cash flow was roughly directly, and the caller expects to continue this poise going forward.

Shared Channels

Shared channels is a paid-only have that launched in the third base quarter. It allows two companies to create a distribution channel that is shared between them. This is not a easy as it sounds, as versatile management features are required. Adoption is already at 25 % of the paid customer base, and at 80 % of the $ 100,000+ customers. “ Shared channels allows customers to securely collaborate with external partners, suppliers and their own customers in channels, while still maintaining their inner controls and compliant to policies ”, Slack says. The caller besides says that the average number of partake channels in use, angstrom well as the size and concentration of the largest network bunch has increased as more customers joined the course of study. Shared channels besides increases overall customer retentiveness. Shared channels is a alone feature of speech that no early rival has, according to Slack :

“ I would point out that we ‘re starting from a relatively new code base. We ‘re not carrying a bequest of technical debt. And I think if we were strapped to half a twelve different products that were all, on modal, about 20 years old, it would be very, very unmanageable to replicate this. ”

I think shared channels gives the company a clear, singular sell point that might be underestimated as of yet by analysts and investors. The company is already seeing the benefit of the shared channels sport, saying that customers sometimes tied go arsenic far as paying the other end of the shared channel to adopt it. Giving an exemplar :

“ We even saw a boastfully media streaming overhaul requiring its creative agency to adopt Slack so that they could use shared channels to collaborate. ”

To that end, shortly after its introduction, it is already a driver of paid conversion and the company is investigating second- and third-order effects of people invited to shared channels inviting others, etc. Slack besides says that it hopes shared channels will accelerate wall-to-wall expansion within companies, as the officiate is apt for many new, non-technical use cases : “ There ‘s a hale set up of modern use cases available in Slack because of share channels. So we think it ‘s not alone a competitive advantage. It’s a competitive moat because once people do their work through shared channels, it’s really hard to go back to and do anything differently. ”

In short : “ Slack gets more valuable as more people are on it. ” This has become even more true with the introduction of shared channels. Shared channels introduces a whole newfangled network effect to the product. Slack expects shared channels to foster unlock major new opportunities in the coming years, so this is a feature that will be important for the merchandise and caller in the long run. In terms of features, the company is looking at shared channels between more than two parties. But it besides has the electric potential to result in ARPU ( average gross per user ) uplift in the longer run. The company does n’t plan to charge for the shared channels at give, but shared channels involve advance features such as secure joining, digital passing prevention, on top of the diverse customer use cases it enables such as for suppliers, customer service, etc.

“ [ Shared channels ] is like a driver for the business at scale three to five years out a opposed to something that ‘s going to make a dispute following week. ”

To sum up :

  • Differentiated (unique) feature, paid-only
  • Difficult to replicate
  • High customer value: high adoption rate among large customers
  • Increases retention and paid conversion rate, with second-order effects
  • Enables new use cases for the product (TAM/adoption expansion opportunities)
  • Enables new monetization (ARPU uplift) opportunities, with a long-term tail
  • Strong network effect because it requires two (or more) parties, driving the user base towards one common product… placing Slack in pole position to become the de facto standard in its category (similar to Facebook in social media, etc.) – obviously, sharing channels between Teams and Slack isn’t possible.

Workflows

slack is besides investing in low or no-code workflows, which will increase the handiness for non-technical users of the platform. The caller launched Workflow Builder in early Q4, which allows, indeed, non-technical users to create and manage dim-witted workflows.

Risks and Competition

The chief gamble for Slack has been deemed rival from Microsoft Teams. As I have explained, I think this is a dead letter given Slack ‘s solid product with distinguish features. Slack ‘s own reaction is that it expects Microsoft to soon announce adoption of 50 million and then 100 million users, as those users migrate from Skype for Business and Lync, which already had that many users. Slack besides points to the differences in usage ( time ). Slack besides says that 70 % of its lead 50 customers are Office 365 users. slake has provided respective examples during its earnings calls of customers.

“ This is another Office 365 customer, and they chose Slack because lone Slack ‘s open platform integrates with the full compass of internally and externally develop tools they use. With more than 1,800 apps in our app directory ranging from partners like Atlassian, Salesforce, SAP and Zoom, to Slack first services like LaTeX, Guru and Troops, our open platform continues to play an important function in enterprise adoption. We besides see customers creating their own apps, integrating Slack into their inner systems and workflows. In a typical week, more than 500,000 of these customer integrations are actively used. ”

In more firm terms : “ We entirely win if people choose Slack, and they merely choose Slack if it provides real value to them. There is no other way. We ca n’t rely on bunch or victor distribution or dip cost of entrench products. ” To that end, Slack says customers use Slack 90 minutes per day and adoption is often spurred by users who say Slack makes them more productive ( e.g. compared to electronic mail ).

Valuation

With gross guidance of ~ $ 750 million for the year and a market detonator of $ 11.6 billion, Slack is n’t the cheapest ship’s company about at 17.7 P/S. however, compared to alike SaaS companies, and given the party ‘s increase, Slack ‘s current evaluation is n’t all that strange. For some comparisons of P/S ratios, Salesforce ( CRM ) trades at 9.4, DocuSign ( DOCU ) trades at 13.5, Twilio ( TWLO ) trades at 14.8, Zoom ( ZM ) trades at 31.9, and MongoDB ( MDB ) trades at 20.7. For some investors, those valuations might look chilling, but given those companies ‘ growth numbers, they are n’t probably to fall all that much. For investors seeking to hold one of those names for years, the near-term submission degree should not be a beguilement from the implicit in fundamentals of the company in consideration, in my opinion ; I saw a valid argument recently saying that compound growth ( growing at > 40 % for several years ) is easily undervalue, and besides that some blockbuster growth companies were besides trading at high valuations already at their early stages. Given Slack ‘s sell-off death year, a 17.7 P/S proportion does n’t seem very overvalue compared to its other high-growing peers, so there is a authoritative likelihood that it has bottomed, similar to a Pinterest possibly which has started recovering recently, after Pinterest failed to meet possibly besides high expectations last year.

Takeaway

I view Slack as an excellent commercial enterprise with an excellent product, delivering excellent growth. In other words, the company has all the expect of a big investment, as there seems to be a lot of room for expansion entrust. As Slack said itself, shared channels is giving the company not good another competitive advantage, but a competitive moat, providing increased memory, adoption and conversion rates, increased use cases for the product, and down the road increased ARPU monetization possibilities.

And that ‘s ignoring the strong net consequence that it may bring to the product, which basically requires everyone to use Slack to make use of this differentiate have and realize all of the value it offers. This will ( could ) establish the intersection as de facto standard, making competition pretty much a dead letter. Slack will be considered both the better and more useful product, even if Slack ca n’t rely on pack or other strategies, as the company admitted. In short, share channels to me is the strongest argument why the bearish competition argument falls flatcar, and hence why Slack may be considered the market leader in its category, and therefore why Slack may have a similar stock operation as for example Twilio down the road. Given all of the company ‘s characteristics, it is so far again interest how the Street has dismissed the stock, given how it has fallen since its IPO. possibly it was merely a valuation exit. In that case, the current price should give the broth a capital entrance point .

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