This article was originally published on Forbes on Apr 26, 2020,11:45pm EDT
Product-market fit refers to the degree a product fulfills strong market demand. Rather than look for great management teams, product-market fit investors look for great markets (although both are nice to have; a great market is a must-have).
When a platform successfully fits a market demand with few competitors, while showing potential for profitability, it can and usually does disregard standard valuations that investors use to determine value. Product-market fit is the main reason why I called Slack a buy back in September and guided for a $16 entry on my premium research site. Workplace chat applications are very nascent and are replacing other enterprise and small-to-medium business communications at a rapid pace. Not only does Slack save a company money by not requiring large software suites, but Slack saves company time through seamless collaboration and developer APIs.
The global pandemic is only expediting this process, which is showing up in Slack’s stock price as it trades near the highs prior to the March selloff.
Slack’s Growth Accelerating From Covid-19
Gartner CFO Survey reveals 74% of organizations will shift some employees to remote work permanently post COVID-19. Brad Zelnick of Credit Suisse said in a recent note to clients about Slack, “with what would have otherwise taken three to seven years is being shortened into several weeks.”
Prior to the Coronavirus, Slack reported rare levels of user engagement. The application is reportedly open 9 hours per day and boasts engagement of 90 minutes per day. Compare this to Facebook at 58 minutes, Instagram at 53 minutes and YouTube at 40 minutes.
Slack’s user growth has been parabolic during the pandemic. According to a series of tweets from the CEO, the company was at 1 million “simultaneously connected” users in 2015 and grew to 10 million by March 10th, 2020. From there, the company grew to 11 million one week later and 12.5 million the following week.
Where the market gets uncomfortable with Slack is their current lack of profitability. The company recentlyreleasedits fiscal year fourth quarter 2020 results on March 12, 2020.
Slack’s revenue grew 49% year-over-year to $181.9 million and calculated billings grew 47% year-over-year to $254.7 million.
With no debt as of January 31, 2020, this is the type of top-line growth we want to see. The company’s GAAP operating loss was $91.2 million compared to $43.4 million loss in the fiscal fourth quarter. Their non-GAAP operating loss was at $23.1 million compared to a $37.5 million loss in the previous quarter.
Slack has been increasing its paid users. In the fiscal third quarter and fourth quarter ending in January, Slack added 5,000 paid customers per quarter for a total of 110,000. From Feb 1st to March 18th, Slack accelerated this and added 7,000 new paid customers. The company also reported they have 70 customers spending more than $1 million annually. This is up 79% year-over-year with a net dollar retention rate of 132%.
Business Messaging Duopoly
One of the main arguments against Slack is its competition with Microsoft Teams. Slack is a stand-alone app compared with Microsoft’s legacy enterprise software suite, which is now sold as a subscription in the cloud as Microsoft Office 365, yet was originally launched in 1990. Microsoft Office has an estimated 400 million users primarily enterprise.
To say that Microsoft launched Teams in 2017 and has quickly caught up to Slack is not exactly accurate. Microsoft has owned business communications for nearly 30 years and has spent $35 billion in acquisitions to own the messaging space preemptively with the acquisition of Skype for $8.5 billion and LinkedIN for $26.2 billion. Those acquisitions occurred around the same time Microsoft considered acquiring Slack for $8 billion.
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Microsoft then leveraged its hundreds of millions of enterprise software customers and copied Slack’s approached. Investors should be asking themselves why hundreds of thousands of organizations are downloading a separate app to hold their business discussions with many being Microsoft Outlook users.
The main product differentiation is Slack’s customization. There are over 1,500 standard integrations with Slack, such as with Zoom video-conferencing and Google Drive. However, there are over 450,000 applications developed internally by Slack customers, according to the CEO. Those applications come from developers who want a more advanced alternative to the closed ecosystem that Microsoft provides.
Anecdotally, Slack also owns the verb to “slack someone” whereas this will not be the case for Microsoft Teams. To own the verb is to get the best free marketing available.
Ultimately, there is room for both yet Slack is a pure play stock with the right key metrics, advanced functionality and a loyal following.
Slack: Technical Analysis
There is a head and shoulders pattern forming on Slack’s chart. I’m expecting another pullback to the low $20s; however, as long as it holds $19.50, the bullish pattern off the lows are likely hold.
If the head and shoulders pattern is confirmed by breaking over $30.50 on heavy volume, the target for this break out will be between $45-$60.
The market internals are showing that smart money is buying into the selloff and rally. The Relative Strength Index is range bound in a zone between $50-$35. In the past, the RSI breaking out or down from this zone, signaled the trend in place, at least in the short term. Right now, there are not any divergences on the hourly chart.
