Slack: Awesome Company, But Wrong Price

Oct. 15, 2019 7:52 PM ETSlack Technologies, Inc. (WORK)26 Comments2 Likes

Summary

  • Slack has substantial underlying potential and is set to benefit from strong network effects.
  • Slowing down growth on a 'rapid growing tech company' is the number one problem.
  • Ultimately, why Slack's shares are best avoided.
  • Looking for a helping hand in the market? Members of Deep Value Returns get exclusive ideas and guidance to navigate any climate. Get started today »

Investment Thesis

Slack (NYSE:WORK) has the right narrative but the wrong valuation. On the surface, its numbers are sizzling hot, but on deeper analysis, a very different story emerges.

I highlight many of the positive aspects but why, on balance, investors should avoid this investment.

(Source)

Investing in 2019

Slack come out of the gates sizzling hot, and its shares soared on the first day of trading. Why? Because it all the buzzwords which investors were salivating over: SaaS, recurring revenues, asset-light, 'workflows' - by now, you probably know the spiel too.

And its timing for IPO was impeccable too, I must say. It was before WeWork (WE) came to the fray, with all those pesky issues which have surfaced. It was before Cloudera (CLDR), Salesforce (CRM), and ServiceNow (NOW) all saw their shares lose some steam.

Then, we witnessed its very first earnings release as a public company, and a very different sort of company started to emerge.

Q2 2019 Results

Heavy losses are one issue - nobody enjoys big unexpected losses, but Slack could have probably got away with it if it were not for the graph below.

Source: author's calculations

Furthermore, we should bear in mind, that Slack became a public company at a time when it was expected to have huge underlying momentum, so what you see above is pretty much as good as it's going to get.

To be clear: I'm not a doom-and-gloom investor! I simply consider myself an investor who employs a little common sense, when I go about deploying my hard-earned capital.

What's more, if Q2 2019 results surprised anyone, we should bear in mind that management probably held back some bad news. What makes me say so? Again, common sense.

Strong Value Proposition

It is not all bad with Slack. In fact, I can easily acquiesce that Slack has huge potential, easily evidenced by the fact that its churn rates are close to non-existent.

Specifically, we can see that for Q2 2020 Slack boasted of having net dollar retentions of 136% - which means that not only are customers staying on the platform, but they are actually adopting more services from Slack.

Furthermore, Slack's co-founder and CEO Stewart Butterfield describes how Slack is extremely well-positioned to be a beneficiary from large network effects, as vendors invite their partners to join them on the platform.

The problem though is even if Slack was correct in identifying the need for modern workplaces to do away with emails, which create 'fragmented silos of inaccessible information', there is little to ensure that Slack will not simply fade away as the market becomes increasingly crowded and competitive.

Valuation - No Margin Of Safety

Source: author's calculations

Investing is never easy. What savvy investors attempt to do, in the best-case scenario, is slightly tilt the odds in their favor by not overpaying to participate in 'hot' issues.

And I understand all the appeal of investing in Slack. It is new, its boast of having growth rates which approximate 50% and is extremely entrepreneurially minded. But is it really worthwhile paying more than 26x times its trailing revenues?

Said another way, is it actually worthwhile paying more for Slack's unprofitable 'revenues' than it is worthwhile paying for Microsoft's (MSFT) cash flows (from operations) at less than 21x?

Let's bear in mind that Microsoft is no pushover. In fact, Microsoft has a very long and colorful history of 'copying' and adopting competitors' software onto its own packages. Out of all the companies which Slack might be able to disrupt, I hazard a guess that Microsoft is not one of them.

The Bottom Line

To me, it's obvious that the winner has to be very selective. It's been obvious to me since very early in life. I don't know why it's not obvious to very many other people.

Through the quote above, Charlie Munger reminds us that those looking to do slightly better than the average investor must in the first instance be incredibly selective.

In summary, I'm not saying that Slack is not likely to become more entrenched and specialized and even rewarding towards its users. My only assertion is that investors are evidently overpaying for the stock.

High Upside Returns!

Slack is an awesome company! But numerous studies have shown that it is difficult to beat the market with popular names.

Meanwhile, by being extremely selective and investing in less popular companies, your chances substantially improve.

If you're looking for a deep value investing approach inspired by Buffett, Icahn, and Greenblatt that can help you generate between 50% and 200% potential upside in just a few years, then sign up for your two-week free trial with Deep Value Returns today!

This article was written by

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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.

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