FLASHBACK | Best Idea Short --> $MDLA

09/06/19 10:03AM EDT

FLASHBACK | Best Idea Short --> $MDLA - z12

Editor's Note: Our Tech analyst Ami Joseph added Medallia (MDLA) as Best Idea Short on July 25, 2019. Shares were trading around $41.50. The company reported last night and the stock fell 14% after hours. Right now the stock is ~$35. We think fair value is in the $15-22 zone.

For the record, there are 12 sell-side analysts covering MDLA. 10 of of those 12 have a buy rating on the stock. 

Incidentally, Ami wrote an Early Look just a couple weeks ago outlining his concerns about MDLA. Below is a recap from that particular note. If you are an institutional investor interested in accessing Ami's research email sales@hedgeye.com.

FLASHBACK | Best Idea Short --> $MDLA - z ff

“Mama says that alligators are ornery because they got all them teeth and no toothbrush”
-Bobby Boucher Jr. (Adam Sandler) in The Waterboy (1998)

A company called Medallia (NYSE: MDLA) completed its initial public offering of equity in July 2019. Despite being a ~19-year-old company, Medallia showed just two years of financial results to prospective investors in its S-1. Only in the recent investor frenzy for enterprise software IPOs could an omission of this magnitude be dismissed. Even Slack (NYSE: WORK), which was a ~6-year-old company at the time of its’ listing (June 2019), shared more years of financial disclosure in its S-1.

We don’t have any bankers here at Hedgeye and no one to please by looking the other way. So, we investigated and filled in the years of revenue disclosure missing in the company’s registration statement. We found decelerating annual revenue growth on both percentage and incremental dollars bases.

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That got us curious, and suddenly, a lot of other items started to take shape:

  • a strange legal disclosure on the risk of volatility of growth rate in the “Risks” section,
  • go-to-market dependent on long time to value,
  • overly reliant on a handful of large contracts,
  • a company conducting layoffs during a period of “acceleration,”
  • bringing in a known carnival barker as CEO in the hopes he could pull another fast one on Bill McDermott,
  • one co-founder completely removed herself from the company + the other kicked himself from CEO to the chairman role (they are husband + wife),
  • neither founder appeared on the roadshow, and
  • both founders selling into the IPO…and on and on.

How do you think the IPO fared? They offered the stock at $16-18 and the stock is currently $37. How badly is this going to end?

Maybe it’s the fault of excess liquidity, but we have been in a market where the facts haven’t mattered…until they do.

“Alligators are aggressive because of an enlargement in the medulla oblongata. It's the sector of the brain that controls the aggressive behavior.”

“That is correct! The medulla oblongata!”

-(The Waterboy) 

Before MDLA, we studied Pluralsight (NASDAQ: PS) and presented our Best Idea SHORT Deep Dive to institutional subscribers on June 24, 2019. Investors were long Pluralsight because the company had above 40% annualized billings growth, 46% in the key B2B category, and within software this growth was relatively cheaply acquired at 12-13x revenue. The problem? PS isn’t a software company, it is a content company. At first, we thought either we were on cuckoo land or everyone else was.

Then we found something striking.

The company had presented historical Fortune 500 cohort billings as a group in their 2018 IPO S-1 and again in their 2019 Secondary Equity offering S-1. A close comparison of both presented graphics indicated that the historical cohort of Fortune 500 customers had only grown 1-3% in 2018. 

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How could this be? Either PS’ most important customers weren’t expanding on the platform, or there was some mathematical error in the S-1, or there was a disclosure omission such as a forgotten footnote. Now we knew we had something, and we took everything else apart even while the management team cut us off from communication. 

As they say… risk happens slowly then all at once. Then d-day happened.

The company reported Q2 earnings, the wheels fell off the bus, the company replaced the auditors, and the stock dropped >40% in a day. (If you haven’t kept up with the PS story, read the last EPS call transcript for the full drama of what management teams should never say or do when they badly miss expectations). 

The silly season in software IPOs will only get worse from here. There are ~300 companies in the private realm worth more than $1b and they are looking at Slack’s kazillion times revenue multiple, or MeDulLA oblongata’s successful heap of dung piled onto IPO investors, as a signal-fire indicating it is time to run every piece of you-know-what up the IPO flagpole.

We, on the other hand, will keep bringing the toothbrush, making sure to keep track of which teeth are clean, and which are ornery. 

Best of luck out there today.

Ami Joseph
Technology Sector Head

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