Valuentum has an expansive stock research coverage universe. We don’t cover every company on the market, however. We include three new ideas outside of our coverage universe each month in the Exclusive publication—an income idea, a capital appreciation idea, and a short-idea consideration. In this article, let’s cover two companies that aren’t in our coverage universe but should be on your radar. Both are recent IPOs.
By Brian Nelson, CFA
SurveyMonkey’s Shares Are Fairly Valued
SurveyMonkey (SVMK) has been around since the turn of the century, but it has only been a public entity since September 2018. Many members may have already heard of SurveyMonkey. The company has made it easier to engage with customers to get their feedback, and this in turn, helps companies better meet their customers’ needs. Its People Powered Data platform facilitates insights from 16 million active users around the globe, with 20+ million questions answered daily. It has 60+ million registered users to its survey platform. From SurveyMonkey’s S-1:
Organizations have invested heavily in “Big Data” solutions, which are designed to collect and extract information that provides visibility into the observed behavior of key constituents. However, information from Big Data alone is often insufficient to inform decision making as it fails to capture the human voice. The human voice, captured at scale in real time and in a structured manner is what we refer to as People Powered Data. Big Data captures the “what,” People Powered Data captures the “why.” Understanding the “why” enables organizations to make better decisions that can drive optimal outcomes.
With this information, businesses can solve “mission-critical business problems.” Without feedback, a business might die on the vine, and SurveyMonkey enables businesses to stay relevant in the fast-changing consumer landscape. SurveyMonkey estimates that the size of its market opportunity for its People Powered Data platform is ~$25 billion, and the company’s growth rates suggests that it is working to capture a very nice slice of that. For fiscal 2018, the company is targeting revenue in the range of $251.2-$253.2 million, reflecting 17%-18% year-over-year growth. Management’s guidance for fiscal 2018 also calls for non-GAAP operating margin of 6%, with unlevered free cash flow of $43-$45 million (a 17%-18% free cash flow margin).
For such a capital-light, cloud-based SaaS platform, we’d like to see the company’s non-GAAP operating margin much higher, well into the double-digits for being this far into its corporate life (almost 20 years; it was founded in 1999). Free cash flow remains solid, but its balance sheet isn’t all that great, especially for an entity that should be generating more free cash flow that it does at the moment. The company ended the third quarter of 2018 with $257 million in cash and cash equivalents, but total current and non-current debt totaled ~$317 million. SurveyMonkey has a fantastic business model and excellent growth prospects, but its financials aren’t living up to that narrative…yet. We’d much rather see a debt-free balance sheet with free cash flow margins north of 20%+.
We think the future is bright for SurveyMonkey, but the strength of its equity price performance may rest more in the company growing free cash flow more aggressively and de-leveraging the balance sheet. This is something that we’re going to keep a close eye on going forward. Revenue growth has been uneven in years’ past, and while the company has a strong brand, competing against free offerings will continue to weigh on overall levels of profitability (the company has incurred net losses on an annual basis since it was reincorporated). With user data and customer privacy being ever-important and a key theme given news across social media, its cost structure may only become more restrictive in coming years as it faces growing political and regulatory risk.
All things considered, SurveyMonkey has a strong business model with a large market opportunity, but an increasingly competitive market environment, uneven sales growth, lack of profits, and substantial debt obligations leave us on the sidelines. If we assume $100 million in normalized unleveraged free cash flow at a conservative discount rate, assuming 3% expansion into perpetuity, and a net-neutral balance sheet at steady-state, an optimistic fair value estimate would be $1.4 billion divided by shares outstanding, or about $14 per share, which is where shares are currently trading at the time of this writing. Facebook’s (FB) Sheryl Sandberg has an 8.2% stake in the company.
Sonos’ Technology Is Fantastic But It Lacks a Moat
Sonos (SONO) is a relatively undiscovered company. As with SurveyMonkey, it went public in 2018. The company’s mission is “to fill every home with music,” inevitably leading to the creation of the wireless multi-room home audio system. It’s hard not to like Sonos’ market opportunity, but the home sound system market for consumers is one that is overflowing with competitive participants, and various ways to deliver entertainment (i.e. streaming) could impact demand for its products. Here’s more information on where Sonos operates in the home entertainment market. From its S-1:
(Sonos) debuted the world’s first wireless multi-room home sound system in 2005, and (has) since been a leading innovator in wireless home audio. Today, (its) products include wireless speakers, home theater speakers and components to address consumers’ evolving home audio needs. (Sonos) launched (its) first voice-enabled wireless speaker, Sonos One, in October 2017, and (its) first voice-enabled home theater speaker, Sonos Beam, in July 2018. In addition to new product launches, (Sonos) frequently introduce(s) new features through software upgrades, providing (its) customers with enhanced functionality and improved sound in the home. (Sonos is) committed to continuous technological innovation, as evidenced by (its) growing global patent portfolio of over 630 issued patents and 570 applications. (Sonos) believe (its) patents comprise the foundational intellectual property for wireless multi-room audio technology.
Sonos has a fantastic product suite, and we think customers continue to enjoy its products. The problem, however, is that Sonos’ business is not as recurring as one might prefer, given that most sales are driven by products, themselves (i.e. speakers, components, etc.). Though its software may be a differentiated product and existing customers continue to add new products to their Sonos home sound system (existing households account for ~40% of new product registrations), the company will have to continue to innovate to keep revenue moving in the right direction over the long haul. Technology, especially in the music and home entertainment business, changes fast, and those on top of the market today may not be on the top of the market 10 or 20 years from now. Picking long-term winners in emerging-growth equities with nascent products is hit or miss at times.
Sonos’ revenue has advanced at a decent clip in recent years, but our biggest concern is that the company’s revenue model will be lumpy, and revenue from existing customers may not offset the ebbs and flows of a new-product-driven operation. For example, in its first quarter as a public company (its third-quarter fiscal 2018 results, released September 2018), revenue dropped nearly 7% on a year-over-year basis, while its gross margin dropped 2.3 percentage points from the year-ago period. In its second quarter as a public company (its fourth-quarter fiscal 2018), however, revenue leapt 27% on a year-over-year basis, while EBITDA came in at $20 million, representing tremendous growth from the prior-year period.
Sonos’ long-term target for revenue growth is 10%+ per annum, while adjusted EBITDA growth is guided for 20%. For fiscal 2019 (ends September 2019), Sonos is looking for 10-12% sales expansion, and adjusted EBITDA in the range of $83-$88 million. At the end of fiscal 2018 (ends September 2018), cash and cash equivalents stood at $220 million, while short and long-term debt totaled ~$40 million, good for a $180 million net cash position. Free cash flow has been lumpy in the past, too, with the company generating roughly $30 million in fiscal 2017, only to fall to negative territory in the most recently-completed fiscal year.
If we give Sonos an optimistic 8x multiple on 2019 EBITDA of ~$88 million, the high end of the range for fiscal 2019, and add its net cash position of $180, a reasonable fair value would fall in the range of $800 million-$1 billion. With shares outstanding at the end of 2018 of 84 million, we’d value the company at about $12 per share. Though this suggests modest upside following the sell-off related to the news that its CFO will retire later this year (its shares are trading at ~$11 each), we don’t view Sonos as a long-term investment, even if we love its product offerings and the company posts a fantastic fiscal 2019, which is not guaranteed. Bang and Olufsen, Bose, Samsung (Harman Kardon and JBL), Sony (