Smartsheet: Highly Versatile And Consistent

Summary

• Smartsheet's versatile and flexible cloud offering enables over 2,000 use cases ranging from project management to expense tracking.
• Product adoptions across SME and enterprise segments have been solid. Revenue has consistently grown by 50%, while large accounts have grown by +5x over the last two years.
• The versatility also allows cross-division/function market penetration. This has had a positive impact on its best-in-class 135% net retention.

Overview

Smartsheet’s (NYSE:SMAR) product is unique in that it is highly versatile. As its CEO Mark Mader mentioned in the Q4 earnings call, Smartsheet works as an orchestration layer that sits either on top of or below the existing enterprise cloud products. In practice, we are seeing how Smartsheet’s versatility allows it to unlock various use cases, such as project management, employee onboarding tool, expense tracking, or campaign management. Such a unique product positioning is disruptive and hence a long-term catalyst for the stock. As a result, the stock offers an interesting growth investment opportunity. Since its IPO in 2018, the share price has more than doubled as key metrics have strengthened.

Catalyst

Due to its versatility and flexibility, Smartsheet’s offering is highly generic and offers a lot of use cases. The company’s 10-K indicates that there are over 2,000 use cases that it has unlocked so far. The expansion/upsell opportunities occur as users demand more premium features, such as visualization of live data and premium application connectors and apps. Based on our observation on the Standard pricing plan, the data visualization feature, reporting, and group management appear to be some of the triggers for upgrading from the $14/month to the $25/month tier. The larger ACV (Annual Contract Value) deals happen on the Enterprise plan, where premium support, apps, and connectors to other enterprise offerings such as Tableau, Salesforce (CRM), or Jira (TEAM) are available.

(Source: Company’s 10-K)

So far, the adoption and expansion across the low- to high-ACV clients have been impressive. The company has been able to maintain a solid ~80% gross margin, which reflects efficiency in go-to-market, while increasing the number of high-ACV clients by over 5x in just over 2 years. The company also grew its full-year revenue by 52% YoY to $270.9 million in 2019. Furthermore, the typical enterprise plan clients have also boosted the dollar-based net retention rate, which has increased by 500 bps within the same period. The trend continued in Q4 2020, where the company achieved a 135% net retention rate as a result of user growth and higher attach rates for the capability-based offering. As Smartsheet moves all of its activities online and targets 300 new sales hires in 2020, we believe that sales execution will remain less affected by the COVID-19 disruption in the near term. Moreover, 90% of the quota-carrying salespeople at Smartsheet are inside sales that convert customers remotely and traditionally do not spend time physically at customers’ sites.

Risk

The COVID-19 outbreak, however, may potentially disrupt Smartsheet’s annual customer conference event, ENGAGE. The company enjoyed significant traction in 2019 due to the strong adoption of its content collaboration feature that it launched during ENGAGE. As its CPO Gene Farrell mentioned, the content collaboration feature worked well with Smartsheet’s marketing accelerator capability and ended up driving the sales for the quarter:

Literally seen thousands of customers start to adopt those capabilities and we're seeing double-digit increases week-over-week, usage in creation of proofs and using that capability to collaborate around content. And those are built into our marketing Accelerators as well, which are some of the fastest growing accelerators we've seen that were - we sold - all three of the marketing Accelerators sold in the fourth quarter and contributed to our best quarter for Accelerator sales.

The sales of accelerator, or a pre-packaged module for specific use cases, made up almost 12% of revenue in Q3. Due to the COVID-19 outbreak this year, there is a possibility of the event being canceled or moved online, in which case it may create uncertainty around its effectiveness to land new deals and repeat the 2019’s success.

Valuation

Despite having no material impact on the business so far, company management has taken the uncertainty around the COVID-19 outbreak into account in the full-year projection. In 2020, Smartsheet will expect revenue between $373 and $378 million, which is a 38-40% forward YoY growth.

(TEAM vs. WORK vs. SMAR vs. PLAN vs. DDOG. Source: Stockrow)

At 21.3x P/S, Smartsheet is the second-most expensive stock in its peer group. We believe that the consistent 50%+ top line growth, stable and best-in-class 80%+ gross margin, and visibility to near-term profitability justify this high multiple. All of the cloud software companies in the peer group, except Atlassian, are still bottom line unprofitable and in a negative FCF / Free Cash Flow situation given their considerable investments to expand the TAM. Slack (WORK), for example, has to burn ~10.61% of its revenue to maintain its impressive ~57% growth. In general, however, there is a premium to consistent progress towards a healthy balance of growth and profitability. Despite the TAM potential, Slack’s growth rate has decelerated much faster, and as such, it trades at a lower multiple than Smartsheet.

(Source: Stockrow)

Smartsheet’s relatively stable P/S fluctuation reflects its execution consistency. It reached the YTD-high at ~23.4x P/S in January 2020, and now is trading at 21x P/S after going through the COVID-19 selloff phase a few weeks ago. Following the solid Q4 last month, the stock has appreciated by ~16% as of today. There may be a possibility of a better entry point at 19x-20x P/S, though we have a longer-term bullish view that the stock will eventually maintain its multiple towards the end of the full year given the strong track record of execution. At ~118.8 million shares and expected revenue of ~$371.5 million, we came to a target price of ~$66 by the end of 2020.

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.