Slack’s Value Proposition Remains Attractive For Long-Term Investors But Not At Current Price Level

Summary

• Investors pouring money into the Slack Technologies Inc. (NYSE:WORK) stock will likely be disappointed.
• Slack’s User Growth Did Not Translate into Revenue Growth.
• Slack is Facing Fierce Competition from Industry Giants.

Investors pouring money into the Slack Technologies Inc. (NYSE:WORK) stock will likely be disappointed, as its recent surge in market valuation does not correspond to underlying fundamentals. Buying stocks of Slack based on superficial statistics like growing popularity in internet search figures or hype around mere user growth is a perversion of empirical valuation metrics. The latest surge and subsequent plunge of Slack’s stock price over the last few months demonstrated why investing in companies in hopes of turning a quick profit without paying attention to underlying fundamentals could lead to disastrous outcomes.

The Hype Around Slack’s User Growth Did Not Translate into Revenue Growth

The pandemic-induced shelter-in-place measures taken by governments around the world prompted corporations of all shapes and sizes to start leaning on remote work technologies. Consequently, platforms and technology solutions that facilitated shopping, home-based entertainment, and remote work gained traction. While the major stock indices were taking a beating in March, stocks of companies like Amazon, Zoom, Netflix, and Slack started climbing as demands for the services provided by these companies went through the roof.

After falling to $15.10 per share in March, Slack’s stock made a miraculously fast rebound over the next few months. On June 3, 2020, it reached as high as $40.07, gaining over 165% market capitalization compared to March’s low.

Most of the companies benefiting from the lockdown had solid fundamentals to support the surge in their respective stock prices. Slack’s initial user growth figures also warranted a higher valuation of the company.

Figure 1: Daily Active Users vs. Paid Users of Slack

The CEO of Slack, Stewart Butterfield, posted on Twitter earlier in March saying the platform had 2.5 million more users on March 25, 2020, compared to 10 million on March 10. The hype around surging user growth prompted investors to bid up Slack’s stock price. But there was a caveat. Statista reported that Slack had nearly 12 million active users back in October 2019, which means the surge in work from home did not have as much positive effect on Slack’s daily active user growth in March as investors imagined.

Compared to Slack’s modest revenue growth, other companies seeing their stocks surge during the lockdown posted almost monumental revenue growths. For example, during the same quarter, Zoom, the video conferencing software, posted a revenue growth of 169%, which justified the surge in its stock price. By contrast, after Slack reported its Q1 2021 earnings on June 4, it became apparent to investors that the 50% revenue growth did not correspond to the massive hype around user growth as its Q4 2020 revenue growth was 49%.

Slack Is Facing Fierce Competition from Industry Giants

Slack has a range of patents to claim its uniqueness. However, the reality is the company offers a collaborative platform that aggregates a set of remote work features that other companies provide. With Slack, you can integrate over 2,000 different software programs and apps to keep you organized. Sure, it is a great platform to integrate remote workflow. However, the moat around Slack’s business model is easily replicated.

Google already has a product in the pipeline that would combine the features of its Gmail, Drive, and Google Hangouts to create an online collaborative platform. Also, Microsoft Teams is competing against Slack’s core collaboration features and often beating it at its own game. Back in November 2019, Microsoft said that Teams had over 20 million daily active users when Slack had only 12 million daily active users. Also, Microsoft offers Teams for free as part of its immensely popular Office 365 framework, which has over 200 million users. Hence, its Teams users who only represented 10% of the potential users which were more likely to stick with a familiar interface than switch to Slack.

Both Slack and Microsoft Teams offer free plans for small businesses. But getting free users does not generate revenue, as we found out in Slack’s Q1 2021 earnings. When it comes to paid users, Microsoft offers its Office 365 Business Essentials Plan for $5 per user/month compared to $6.25 from Slack.

Slack is still operating at a loss. In Q1 2021, it posted a GAAP operating loss of $76.2 million, which is 37.8% of the $201.7 million total revenue. The non-GAAP net loss per share came out at $0.02. Going forward, fierce competition and a potential price war against a large company like Microsoft with deep pockets would certainly cut into Slack’s bottom line, which could become an existential threat to its market leadership.

Bullish Rally Amid COVID-19 Hype Did Not Last Long

The great expectations about Slack capitalizing on the COVID-19-induced remote work boom has failed to meet expectations. If a company positioned for remote collaborative work cannot keep up growth against its key rivals during a perfect market opportunity, it prompts the question: What would it take for the company to deliver the results investors were expecting?

Figure 2: Daily Stock Price Chart of Slack

The IPO of Slack was one of the most anticipated back in June 2019. As a direct listing IPO, its valuation was determined by the first trade of $38.50 per share, which valued the company at $23 billion. However, by October 2019, it plunged below $20. Even during the hype around massive user growth last quarter, Slack’s stock never went above all-time highs. As soon as the Q1’21 earnings were released and it became clear that the sudden surge in initial user growth did not translate into revenue growth, Slack’s stock fell from above $40 to below $30 per share, which acted as a psychological pivot over the last year.

Takeaway

The competition from Google and Microsoft could continue to push Slack into a corner in the coming years. Nonetheless, with double-digit revenue growth, it would likely maintain market share as a dominant provider of the collaborative work platform and likely keep a large chunk of the market share in the long-run. Despite the recent fall and subsequent minor bullish trend fallback to the $30 per share support level, the short-term downside risks are still at play. Therefore, long-term investors employing a buy and hold strategy should wait for a more favorable entry point instead of having exposure to Slack at the current price level.