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Slack’s bid to become a public decacorn

By Rohit Kulkarni, SharesPost

Slack recently announced that it has filed confidential documents for an IPO with the Securities and Exchange Commission.

While the company’s prospects look strong, several big questions loom for the messaging and collaboration platform. When will the 10-year-old company reach profitability? Can Slack continue to innovate and thus remain the market leader? How will a Spotify-like IPO impact its chances to become a potential decacorn?

Creating the category: Founded in 2009 by Stewart Butterflied and Cal Henderson, the San Francisco-based company differentiates itself from the other secure-messaging apps by allowing easy integration of existing tools and workflows into its platform. Within a short period of time, Slack saw its popularity soar past strong incumbents, like Microsoft and Cisco Systems, not just at small and medium-sized businesses, but also large enterprises, such as Oracle, Target, Capital One and Airbnb.

In July 2018, the company acquired HipChat, a once popular messaging platform from Atlassian, to become the leading cloud-based collaboration platform. Slack raised over $1.2 billion in 10 funding rounds and was most recently valued at over $7.1 billion at the end of last year. The company will reportedly go public in the next six months.

Rohit Kulkarni, SharesPost.

Can Slack pull off a successful direct listing like Spotify: The success of Spotify’s direct listing has encouraged more companies, including Slack, to bypass traditional stock underwriters like investment banks. While this approach can produce big, one-time savings in underwriter fees and avoid investor dilution, we believe direct listings pose risks of near-term volatility and a potential investor discount on Slack shares.

A direct listing could save Slack $200 million to $300 million, an attractive prospect for a company not yet profitable. In addition, Slack might not worry about alienating potential long-term shareholders because key investors have already backed Slack over many funding rounds throughout the years. However, a direct listing means that the company might need to work harder to convince a broader investor pool of its long-term path to profitability.

Investment Thesis

The Upside Scenario:

  • Huge market opportunity: The enterprise-collaboration market is expected to grow to roughly $50 billion at a compounded average growth rate of over 13 percent by 2021. The growth in mobile and smartphone usage combined with challenges with existing enterprise-messaging options has increased demand for seamless, mobile-collaboration platforms, such as Slack.
  • Leading enterprise messaging platform: Slack is one of the fastest growing messaging platforms. Over the past five years, the company has grown its user base to over 85,000 organizations around the world, despite heavy competition from incumbent enterprise-collaboration vendors, including Microsoft (Teams), Cisco (Spark), Facebook (Workplace) and Google (Hangouts). Furthermore, Slack enjoys geographic diversity, with over half of the clients residing outside the United States.
  • Large and growing number of paid and daily active users: Slack commands over 10 million daily active users, including an estimated 4 million paid customers on its messaging platform. The company offers a freemium model in which people can pay up to $15 per month for enhanced search and integration features. Growing numbers of subscribers helped boost Slack’s revenue per user to $39 last year from $29 in 2016, a 35 percent gain.
  • Revenues growing at 60 percent plus: Slack reportedly generated $389 million in revenues last year and might reach $640 million in 2019 and roughly $1 billion by 2020. Although the company’s growth rate has slowed, Slack is still expected to increase its top line at around 50 percent annually over the next couple of years.
  • Attractive acquisition target: Since Slack’s products could fit very well with large enterprise vendors, the company is an attractive acquisition target. The company’s huge client base and strong brand make it a natural target for big companies seeking to round out their collaboration platforms. Microsoft reportedly planned to acquire Slack for $8 billion in 2016, thus confirming the growing demand for enterprise messaging and collaboration. Slack might see more acquisition offers as it approaches a public offering later this year.
  • Strong investor base: Slack boasts a long list of big investors, both from venture capital and corporations: Accel Partners, Andreessen Horowitz and Social Capital, which own 21 percent, 13 percent and 9 percent of the company respectively. Other key investors include Softbank, Google Ventures and Kleiner Perkins.

Downside risks:

  • Growing competition from tech giants and peers: Slack competes with several big and small vendors in the enterprise collaboration space. Big Tech uses messaging services to complement a broad platform of services to support overall brands. Such a strategy makes it tough for pure-play vendors, such as Slack, to effectively compete for large customers. Several newcomers such as Zinc, Beekeeper and Jive will challenge Slack from the smaller end of the market.
  • Path to profitability: Slack has operated for over a decade but has yet to turn a profit. As the company hits Wall Street, investors will likely examine the company’s bottom line and cash-burn rate as they seek a clear path to profitability. Due to tough competition, Slack will likely continue to burn cash and lose money in order to stay ahead of competitors for at least the next couple of years.
  • Need for continued innovation: Slack will need to continuously innovate to match or beat the emerging competition. One discouraging sign: Slack recently lost its Chief Product Officer right before its IPO. The company needs to quickly find a replacement and restore investor confidence about its long-term plans for innovation.
  • Revenue diversification: Slack is currently the leader in enterprise messaging. However, to better compete with other established software vendors, Slack needs to diversify its products beyond messaging. Furthermore, the company needs to further penetrate the larger enterprise-collaboration market either organically or through acquisitions.

Valuation framework

Enterprise cloud software companies have enjoyed fairly robust multiples over the past few years. For example, Workday went public in 2012 at over 19 times revenue. Last year, public investors valued Smartsheet at over 11 times trailing 12 month revenues. Publicly traded firms comparable to Slack trade at roughly 10 times 2019 revenues.

However, institutional investors give Slack a higher valuation in the secondary markets. In general, investors hold a positive outlook for the company and are willing to pay up to 14 times estimated 2020 revenues.

If Slack goes public in 2019 and maintains a growth rate between 40 percent to 50 percent next year, we expect the company to generate roughly $1 billion in revenues by 2020. Using an EV/Revenue multiple of 9 to 11 times 2020 revenues, we believe Slack could go public with a value ranging from $9 billion to $11 billion.

We expect Slack’s valuation to grow as the company continues to add more large business customers and increasingly converts daily active users into paid subscribers.

Rohit Kulkarni is a managing director and head of research at SharesPost Inc.