Kahoot: With Huge Growth Comes Huge Risks

Summary

• Already extremely popular, Kahoot! will benefit from presenters' growing willingness to use technology to engage their audiences.
• It was cash flow and EBITDA positive in the most recent quarter (Q4 2020), and significant insider ownership is encouraging.
• However, its valuation seems high as of now, especially considering the significant risks involved.

Kahoot! (OTCPK:KHOTF) should be a familiar name for anyone who has been inside a classroom in the last five years. Over 1.3 billion participants played one of the 100 million user-generated quizzes on the iconic platform in 2019. While we generally believe that Kahoot! will continue its strong growth trajectory, we believe that the risks outweigh the potential rewards at current prices.

Company Overview

Kahoot! is a game-based learning platform headquartered in Oslo, Norway. They have several primary offerings:

• Kahoot!: An intuitive online quiz platform that purportedly increases audience engagement in lectures and presentations. This is the company's flagship offering and the source of its brand recognition.
• Poio (acquired in 2019): An app designed to teach kids how to read, headquartered in Scandinavia.
• Dragonbox (acquired in 2019): A math gaming platform designed for young children.
• Actimo (acquired in September 2020): A digital internal communication, onboarding, and employee training app for remote, mobile-first workers.
• Drops (acquired in November 2020): A visual language learning application with support for over 41 languages, promising to teach users how to speak a language in short, 5- minute sessions.

Much of the following analysis will focus on Kahoot!, as the newly acquired products generate less than 15% of revenues as of Q3 2020. We believe that Kahoot! will continue to remain the firm's focal offering and that the acquired products will likely be used as cross-selling opportunities.

The company makes generally makes money through a freemium model, charging for access to extra features and typically targeting large organizations such as schools and corporations. For example, Kahoot!, the iconic quiz platform, has pricing which ranges from free to $6 as of January 5, 2020.

Exhibit I: Kahoot! Pricing Model for Quiz Solution

(Source: Kahoot! Website)

Kahoot! is relatively small but has experienced significant growth in recent years. They had $45 million in revenue in 2020, up from virtually 0 in 2016. They have also been cash flow positive since Q4 2019, with cash flow from operations at $17 million for the full year 2020. This trend demonstrates increasing cash returns from scale. However, it is essential to keep in mind that Kahoot! is not yet profitable from a bottom-line perspective and has not outlined any plans to do so.

Kahoot! also has a strong balance sheet. Their debt to capital ratio is below 25%, and the firm has no interest-bearing debt. Their large cash balance ($72 million) should position them well for further acquisitions and investments in growth, especially given capital expenditure-light nature of the firm's operating model.

Exhibit II: Kahoot! Balance Sheet as of September 30, 2020

(Source: Kahoot! Q3 2020 Quarterly Report)

Finally, Kahoot! has significant insider ownership as well as high quality of shareholders. 15% of the company is owned by management and employees, which greatly incentivizes the company's human resources to focus on driving shareholder value first and foremost. Further, Microsoft and Disney are early investors with significant stakes in the company (5% and 3%, respectively).

Exhibit III: Kahoot! Shareholder Overview as of December 31, 2020

(Source: Kahoot! Q4 Trading Update)

Kahoot! Will Capitalize on the Digitization of the Classroom

Kahoot! initially caught on with teachers in North America - still the firm's largest market. Teachers would create quizzes to engage students in lectures, testing them in a fun way that gamified learning. The results of these quizzes would be immediately processed, then shown to the entire class. This created competitiveness among students who would vie for the top spot. Roughly 50% of American K-12 teachers use Kahoot! in a given year, with an average frequency of 1 game per month. At the post-secondary level, 87% of the global top 500 universities also use Kahoot!.

While North American education systems are not world leaders on many metrics, they stand out in terms of their success with digitization. North America is the world's only region to see an increase in PISA (an international student assessment) scores through teacher-student technologies (technologies used by both teachers and students). McKinsey, a global consultancy, hypothesizes that this discrepancy is because North American school systems use technologies more effectively, being further along in the education technology learning curve than peer nations worldwide.

Exhibit IV: Impact of Digital Technology Usage on PISA Scores by Region

Source: McKinsey

The benefits that North America reaps are significant - 34 PISA points or roughly ¾ of a year of learning. We believe that as educators around the world begin to progress along the EdTech learning curve, greater adoption globally will follow, significantly increasing Kahoot!'s total addressable market. Through looking at recent news coverage of the product, we can already see inklings of this spread. India Today and The Hindu both recently published articles about the importance of innovation in learning that mentioned Kahoot!. The product was recently also highlighted in Asia Times as a "key element of education" in Hong Kong. It seems very likely that gamification and real-time competition, used correctly, can help improve learning outcomes significantly. Thus, as developing world school systems continue to evolve, usage of Kahoot!, one of the best-known EdTech brands around the world, will likely increase. Note the size of the potential opportunity through looking at the difference in revenues across regions for Kahoot!.

Exhibit V: Kahoot! Invoice Revenue Segmented by Region

Source: Kahoot! Q4 Trading Update

Kahoot! is Catching on at Home and in the Workplace

Kahoot!'s initial success in education has also spread into the workplace. 97% of Fortune 500 companies use Kahoot!, primarily to increase employee engagement with long corporate presentations and onboarding sessions. In a virtual world, employee engagement with these events is harder and harder to gauge and ensure. However, Kahoot! has been lauded as a potential method of increasing employee presentation engagement by Salesforce and Forbes' Tech Council.

Its pre-made quizzes have also started to catch on at home. With travel bans preventing families and groups of friends from gathering, a significant number of people in the developed world have turned to online games. The BBC named it a game to try during virtual Christmas gatherings, and House Beautiful also suggested it as a game to try for virtual parties.

The qualitative trends explained above have also begun to manifest themselves on the firm's top line. While most of the firm's users are still educational, there have been dramatic upticks in both "Work" and "School" subscriptions in recent quarters. Overall, we feel that this year has been an exceptional one for Kahoot! and wonder about how sustainable core home revenues will be (excluding Drops). However, in general, retention has been solid, with a 90-100% net dollar retention rate according to the firm's latest trading update.

Exhibit VI: Kahoot! Revenues Segmented by Target Audience

Source: Kahoot! Q4 Trading Update

Be Wary of the Risks

We presented the rosy bull case above. However, we believe that several risks could likely derail the company's trajectory. These include:

Risk #1: Limited Barriers to Entry

Kahoot!'s products are very simple and easily replicable. Its core offering is an uncomplicated quiz platform, and none of the products it has acquired have much more complexity. The value of its capitalized research and development is less than $2 million as of Q3 2020. It also only has roughly $190,000 in licenses and domains. Should a large tech firm wish to imitate and incorporate Kahoot!'s platform, they could likely build a very similar looking and functioning competitor without much difficulty or relative cost (like Instagram copied Stories and Reels). This not only threatens future growth but present monetization ability. If it raises prices too high, a low-cost competitor will undoubtedly emerge to replace it.

Risk #2: Fad Risk

As much as Kahoot! has been lauded as a splendid tool for education, it remains to be seen whether the platform will have the same appeal to children in the next decade as it did the last. If Kahoot! becomes overused in classrooms, it may fail to have the same impact on student satisfaction and engagement, causing it to be less popular with teachers. Its usage in the corporate sector is even more prone to falling out of fashion, especially if most meetings started employing Kahoot! quizzes. Finally, we believe that growth in Kahoot! "Home" revenues will drop significantly as COVID-19 gradually recedes and traditional get-together activities become feasible for people again.

Risk #3: Monetization

While Kahoot!'s free services have achieved significant penetration globally, we are unsure if Kahoot! has a clear path to growing paid sales as quickly. Due to its focus on kids, it will be unlikely to add advertising to its platforms (since targeted advertising is unlikely to be allowed in schools). While its paid subscription features offer compelling services for some teachers and organizations, its free version works just fine for most applications. This means that many teachers and corporate presenters will likely stick with it.

Risk #4: Disclosure

The trading updates Kahoot! posts on its Investor Relations site are nowhere as detailed as typical 10-Qs, 10-Ks, or S-1s. As a result, investors may not have as full of a picture of firm financial performance compared to when they invest in US-listed companies.

Valuation

The main issue we have with Kahoot!, however, is its current valuation. We decided to use an enterprise value to sales (EV/Sales) ratio to judge the firm's performance since it does not currently generate net income or have significant enough EBITDA to base multiples off. This is consistent with industry best practices for fast-growing software-as-a-service companies, as the assumption is that profitability will eventually occur at enough scale. We also conducted the analysis both on a last twelve months (LTM) and a next twelve months (NTM) basis to show the impact of forecasted growth on this ratio.

At present, its LTM EV/Sales ratio is roughly 122 times, while its NTM ratio is approximately 55 times. This is incredibly expensive. For Kahoot!'s EV/Sales multiple to align with the software industry median, sales would have to grow seven times from their expected 2021 levels, assuming no upwards price movement.

Exhibit VII: EV/Sales Multiple Calculations

Source: Kahoot! Q4 Trading Update, Damodaran (NYU Stern)

Conclusion

While Kahoot! may someday generate $700 million in revenues, we do not have full conviction that Kahoot! can achieve this growth. Despite strong tailwinds for the industry overall, low barriers to entry, the "fad-like" nature of the product, and potential monetization issues hold us back from investing. Technology investors with greater risk tolerances than us may find it attractive but should do further due diligence, especially given the firm's relatively sparse public disclosures.

Analyst’s 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.