Smartsheet, Inc. (SMAR) is a Hedgeye Technology Best Idea Short.
Post EPS, we see the outcomes for SMAR on three timelines:
- Timeline 1 – March 18: Smartsheet was sold down with everything else and as it turns out the company is reportedly seeing no impact on its business from the COVID-19 outbreak. In theory, the stock should rebound if investors believe SMAR's management that they are immune from the crisis.
- Timeline 2 – In the next 3-6 months we see the stock going ‘sideways’. The company will likely experience peak NRR (~136%, higher than F4Q, just math) after ~17 straight quarters of rising, and saturation may become slightly more evident as the company delivered 1Q billings expectations slightly below consensus, ditto 1Q revenue, ditto FY21 revenue.
- Timeline 3 – Beyond 3-6 months is painful territory. The math on that is as follows: Smartsheet now has 950k paid seats, up from 800k one year earlier, up from 650k one year before that, which was up from ~500k one year before that. What does that smell like? Not acceleration. The increments of paid seat growth aren’t getting easier despite 1) a bigger sales force, 2) a bigger brand, 3) a larger collaborator pool, 4) very small international presence, 5) increasing market awareness, 6) increasing customer installed base, etc. The main thing that is accelerating is incremental bookings per incremental paid seat which hit ~$1,000 in F4Q up from $660 the year earlier and $400+ the year before that, (in part stimulated by the upsell of Capabilities). The question is: how far can SMAR take upsell if the Land in unit terms is fixed? Management is savvy. They see the end of the upsell road, and will push for more M&A as well as pivot to positive FCF. SMAR will exit FY21 with positive FCF on the way to ~$150MM FCF by FY25. And that is assuming no change in the ability to add 150k new paid seats per year and to continue to increase past $1k incremental billings/seat. But if that is the ‘no interruption’ model (not from saturation or from COVID or from cycle or from competition) and that stock price is already something we have seen if you factor slower organic growth rates and share count dilution…then what is the ‘interruption’ model? Point is: the upside potential from rinse and repeat has already been registered in this stock, and even if perhaps there is a no-COVID rebound, the downside case is more compelling to us for a landlocked company that is good at upselling existing customers but isn't widening out adoption metrics in one of the largest potential markets out there in productivity software and at the best time ever (last few years) for selling into it.
BEARS POINT OUT:
- Uninspiring paid seat growth to ~950k – we don’t really understand why FY20 and FY19 and FY18 all grew paid seats at the exact same 150k increments (especially considering the increments of customer additions at each customer cohort >$5K of ACV continue to expand or even accelerate).
- Best part about the results were from Capabilities upsell, now at 15% of billings, up from 11% last Q. However, the Capabilities will cost a company $8k+ on average, which means that the target upsell spots are with all the $50k+ ACV customers (just under 1k of those customers) plus the upper band of the $5k+ ACV customer category; but only the upper band. Point is: there is an eventual limit to this upsell.
- Incremental total users expanded again, after having been stuck for many quarters at ~300k increments, it expanded by ~400k in F3Q and ~500k in F4Q. However, we wonder how much of this addition came in from M&A considering the timing of this expansion matches directly with the timing of SMAR's push back into the acquisition market. One of the companies they acquired (10,000ft) had at least 1k paying customers.
- And, on that subject of M&A, we estimate the two acquisitions together should generate at least ~$7MM of revenue in FY21 (was $6MM ARR as of October 2019), which means that guidance for FY21 revenue below Street looks even more puzzling.
In sum, we aren’t really opposed to a business model that does a great job circling the wagons and harvesting increasing price against that existing farmstead, but yesterday's report underscores the fact the company isn’t really growing core adoption all that much.
In terms of the COVID-19 comments and lack of factor in guidance, and continuing to press for more hiring and normal day-to-day operations…we are skeptical. Certainly, a Seattle-based company isn’t putting their heads in the sand and ignoring the crisis. We aren’t sure why SMAR has seen no impact from COVID on the business and is continuing to hire sales reps without any pause in growth investment at this time.
WHAT WILL BULLS CELEBRATE:
- Capabilities 15% of billings and growing, and even stripping out Capabilities, core Billings up 48% Y-Y (our estimate) which is pretty darn good and shows the company is continuing to upsell existing customers regardless of the slow pace of incremental paid seat adoption.
- Expansion of the NRR to 135% in F4Q shows near continuous expansion from existing customers since F4Q16 which is impressive and despite guidance for lower NRR in the coming year, the math for F1Q21 indicates a slight step higher to ~136% NRR before it reverses.
- Continued improvement in churn ($ loss rate now below 8%).
- Front and center in COVID-19 related healthcare implementations.
- Acceleration of the largest customer categories.
- FCF guidance, while deeply seasonally negative for F1Q, is bullish on the balance of the year (F2Q-F4Q) and implies a strong positive exit rate, and FY22 FCF of $50-100MM.
Innovation in equity research.
Ami Joseph
Managing Director
Twitter
LinkedIn
