- Yext reported strong revenue growth, but losses widened, and subdued revenue growth guidance heading into Q4 resulted in shares getting crushed.
- The company is investing in growth, notably in sales.
- The company believes it doubled its addressable market from $10 billion to $20 billion by introducing its Yext Answers solution.
- At a forward price/sales ratio of 5, Yext is one of the cheaper unprofitable SaaS plays in the market, but it has increasing losses due to labor costs.
- I initiated a small position after the Q3 selloff.
Yext (NYSE:YEXT) reported another quarter of strong revenue growth, but losses continue to widen and the company has issued tempered revenue growth guidance heading into Q4.
That said, the market potential for Yext appears to be ample. The company may continue to face cost challenges in the near term, but if it can continue to grow revenue in excess of 30% and get a handle on costs at some point and turn a profit, the current valuation of 5 P/S and a market cap of $1 billion may look like a gift a couple of years down the road.
While I wouldn't bet the farm on Yext or any other unprofitable SaaS company, I don't see the harm in buying a basket of SaaS stocks with hyper-growth potential that could pay big rewards down the line. Yext appears to be one of those stocks. I initiated a small position after the steep Q3 selloff.
Q3: Investing In Growth
As happened in Q2, Yext's margins took a hit in Q3. Gross margins were down from 74.7% last year to 73.3% this year, though the company notes that it believes it can consistently maintain gross margins in the 73-77% range.
Yext posted a net loss of $42.7 million on $76.4 million in sales. This time last year, the company lost $22.9 million on $58.7 million in sales. In short, the company is increasingly spending a lot more than it's taking in. Yext continues to invest in people, notably sales and marketing, which totaled $62 million in the quarter, up 42% yoy. As of Q3, it had 250 sales reps, which is up 45% from the beginning of the year. The company has aggressively invested in hiring to support its growth ambitions.
Costs may continue to rise and the stock might experience more pain before the expected strong revenue growth and, hopefully, improving margins in coming quarters justify the increased investment in sales and marketing. The company will give guidance on anticipated additional labor costs for 2020 on the Q4 call.
The company recently launched a new solution called Yext Answers, which turns any brand’s website into a search engine capable of answering consumers’ questions directly with brand-verified answers. Yext launched Answers in Q3 and believes the new solution doubles the company's addressable market from $10 billion to $20 billion. On the recent call, the company noted that a large financial institution client saw its conversion rate increase 25% thanks to the institution adopting Yext Answers on its website.
Big Potential Upside
Given the Yext's small size and its now-$20 billion market opportunity, the company looks like a compelling long-term bet. It has limited competition and is on pace to generate $300 million in revenue this year. While cost controls will remain an issue to watch, any substantial acceleration in revenue growth in coming quarters thanks to the expanded TAM could result in a pop in the share price.
Prior to the launch of Yext Answers this quarter, the company's business was solely focused on Digital Knowledge Management (DKM). Under DKM, Yext acts as a conduit between companies (Yext clients) and the search engines - Google, Amazon Alexa, Apple Maps, Facebook, etc. - that consumers use to find information about companies.
Yext provides its customers with a technology platform that enables customers to control the information obtained by consumers when the consumer is searching for information about the company. Yext simplifies the process of a company controlling its messaging across multiple platforms.
Yext is agnostic, and its advantage is that its platform isn't owned by one of the search engines. Instead, it partners with all of the search engines to provide customers with the ability to engage with all search engines simultaneously. If Facebook owned Yext, or offered a competing solution to Yext, Google might see little benefit to helping Facebook and vice-versa. Yext is the middleman between companies and search engines.
(Source: Yext Investor Summit Onward 2019, October 30, 2019)
Unprofitable Yext is trading at 5x next year's sales. While some may be ambivalent about investing in an increasingly unprofitable growth stock, I think it helps to compare the company's valuation and growth prospects to other SaaS players. Most unprofitable SaaS players in hyper-growth mode with massive markets are trading at much richer premiums. I think Yext's long-term prospects are solid. The depressed P/S valuation is a result of increasing labor costs, which may get worse before they get better, but I suspect stronger sales growth as a result of these investments could change shareholders' minds about valuation for the company. Yext, at a P/S of 5, looks like a pretty reasonable bet.
I initiated a small position, and Yext is one of several bets I've included in my SaaS basket. One recent relevant comparison is DocuSign (DOCU). Like Yext, DocuSign is an unprofitable hyper-growth SaaS stock that investors had bludgeoned after some lumpy billings growth a few months ago. The stock saw its valuation depressed to a P/S of 8 before the company reported a blowout quarter, followed by another blowout quarter, and has since seen its valuation expand to a P/S of 14, nearly double the valuation we saw just months ago. Like DocuSign, Yext is a leader in its space and has substantial growth potential and could see sentiment shift in its stock price if the increased labor expenses result in stronger revenue growth and/or if margins see sharp improvement in coming quarters.
At a P/S of 5, Yext looks like a reasonable bet for a fast-growing company with a large addressable market. I initiated a small stake. If shares get crushed again, I may add to my position.
This article was written by
Analyst’s Disclosure: I am/we are long YEXT. 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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