Slack had a great market debut. Now analysts are wondering if it can live up to investors' sky-high expectations.

Slack had a great market debut. Now analysts are wondering if it can live up to investors' sky-high expectations.

Slack CEO Stewart Butterfield poses for photos outside the New York Stock Exchange before his company's IPO, Thursday, June 20, 2019.

Richard Drew/Associated Press

Investors have heady expectations for Slack CEO Stuart Butterfield and his company.

  • Slack's debut on the public markets Thursday drew in investors who gave the company a valuation of more than $19 billion.
  • The company could find it tough to live up to the expectations implied in that market capitalization, which is around 50 times the sales it posted last year.
  • That price-to-sales ratio is far above that of other recently public companies and other firms in Slack's sector.
  • Meanwhile, Slack is losing money and burning cash, and its revenue growth - while still rapid - is slowing.
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Slack's spectacular market debut on Thursday may be something of a mixed blessing for the company.

Now it has to live up to the exuberant expectations implied in its more than $19 billion valuation.

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That could prove a challenge. The maker of the popular business messaging software is losing money, burning cash, and has already seen its revenue growth slow markedly.

Whether Slack will grow into its valuation is like asking about whether people will ever travel to Mars, said Jerry Braakman, the chief investment officer at First American Trust, an investment firm that has about $1.5 billion under management.


"Can we get to Mars? Sure we can," said Braakman. "But when? And how long do we have to wait, and how bumpy is the road?"

Slack, he added, is "high risk with potential high return."

At least initially, many investors were willing to take that bet. As part of the company's unusual direct listing process, Slack's shares began trading at $38.50 a share. That was 48% higher than the reference price the New York Stock Exchange announced Wednesday night. It also left the company with a market capitalization that was more than double the $7.1 billion valuation it had at the time of its last private round of funding last year.

Read this: Slack's unusual offering isn't designed to have a first-day pop. Here's why most IPOs still factor in a pop, even though they can cost startups billions.

Slack has built a large and passionate following

Founded in 2009, Slack has built a big following, particularly in the tech industry. At many companies, its messaging service has become the primary way workers and managers communicate, replacing email and other messaging services.


"Slack's really revolutionized how many enterprises operate today in terms of communication," said Dan Ives, a financial analyst who covers the tech sector for Wedbush.

The company's business model is a so-called freemium service. It offers a free version of its software to all users, then encourages companies and other organizations to sign up for its paid version to get more advanced features. Slack charges $6.67 a month for the version of its service that's targeted at small and medium-sized businesses and $12.50 a month for the version designed for larger corporations.

At the end of its most recent fiscal year in January, some 600,000 organizations had at least three of their employees using the service, according to financial paperwork Slack filed with the SEC. More than 500,000 of those were on its free tier.

The closest competitor to Slack's service is Microsoft's Teams product, which the software giant offers as part of its Office productivity suite. But Slack is trying to turn its software into much more than just a messaging service. The company has opened it up to outside developers to build applications that can run on top of or inter-operate with it. Slack's even invested in some of these developers, encouraging them to build businesses on top of its service.

The company is trying to turn itself "into more of a platform than a one-trick pony or more of a niche product," said Rishi Jaluria, who covers the company as a financial analyst at DA Davidson.


The company is priced sky high

It's not hard to understand why market observers like Braakman think investors got a little too excited about Slack's offering.

Uber IPO Dara Khosrowshahi

AP Photo/Richard Drew

Uber, which went public last month, has a much lower price-to-sales ratio than Slack.

The company is losing money and is burning through - not generating - cash from its operations. So investors can't value it based on its bottom line, the traditional way of evaluating stocks. Instead, they have to look at other figures, most notably its sales. And by that measure, Slack's stock looks extraordinarily costly.

At the close of trading Thursday, Slack's price-to-sales ratio was nearly 50, based on its revenue from its most recent fiscal year, which ended in January. Even looking forward, using this year's expected revenue, it still looks pricey, with a ratio north of 30.

That kind of valuation is much higher than that of other companies that recently went public, said Daniel Morgan, a senior portfolio manager at Synovus Trust, an investment firm. Pinterest has a price-to-sales ratio of around 15, he said. Lyft's is about 11. And Uber's was between 7 and 8.

That kind of ratio is also much higher than that of other companies in the enterprise software space, Morgan said. SAP trades at about 5 times sales. Salesforce at about 9. Even Workday, still a relatively young company, trades at just 15 times its sales.


"Any way you cut it ... it's pretty expensive," Morgan said.

Growth is still strong, but it's slowing

Investors can often justify paying a premium for a company if it's growing rapidly, and Slack is doing just that.

In its most recent fiscal year, which ended in January, its sales grew at an annual rate of 82% to $401 million. That's far faster than most companies, even in the often fast-based tech sector.

It's also seeing rapid adoption of its services. In the same period, its total number of paying customers jumped 49% to 88,000. Of those, 575 were slated to pay Slack more than $100,000 a year, according to financial filings with the SEC. At the end of its 2018 fiscal year, Slack had just 298 such customers.

The bull case for the company - and why it deserves a price-to-sales ratio of nearly 50, based on last year's revenue - is largely based on the belief that it has plenty of room left to continue such growth. Optimists see the hundreds of thousands of free users of its service as its next paying customers. They see room for it to expand out of its tech industry customer base and into other sectors. And they see a company whose service have the potential to add on new features and functions to become even more central to its customers' operations.


"I think they're still in the first, second inning of this whole thing playing out," Ives said.

But what gives some market watchers pause is that Slack's companies growth rate has slowed markedly over the last year. Its sales grew at 110% annual rate in fiscal 2018. By the first quarter of its current fiscal year, Slack's revenue growth had slowed to a 67% annual clip.

A similar slowing of growth is going on with the number of paying Slack subscribers. That figure grew at an annual rate of 59% in fiscal 2018, fell to about 49% in fiscal 2019, and dropped to 42% in the first quarter this fiscal year.

Company officials are projecting that Slack's growth rate will slow even further. On an earnings call last week, Allen Shim, Slack's chief financial officer, said the company expected to post $590 million to $600 million in sales in its current fiscal year. That would imply about 50% growth for the full year and much slower than that for the three coming quarters.

Shim and Slack are likely being conservative in their forecasts, said Jaluria. Still, one of the big questions for the company is its "growth trajectory from here," he said.


Like other tech startups, it's operating in the red

Slack's red ink is less of a concern for many investors. Many tech companies lose money in their early days. And Slack actually has shown considerable improvement on its bottom line; its annual losses have shrunk both overall and in relation to its revenue.

Two years ago, the company lost $147 million, an amount that was nearly 40% larger than its total sales. In its most recent fiscal year, it lost $139 million, which was equal to about 35% of its sales for the year.

Part of what's helping the company improve its bottom line is that its service costs very little to operate. Slack's direct costs of offering its messaging service were just $51 million in its most recent fiscal year. That means that it had a gross profit margin, which represents the portion of its revenue a company has left over after accounting for the direct costs of offering its services, of 87% last year. That's a remarkably high figure, even among software companies, which tend to have higher than average gross margins.

"They have probably the highest gross margin out of anywhere in software that I can track," Jaluria said.

But the company's generous sales and marketing spending budget offsets some of that efficiency on the operations side. The company spent $233 million on marketing in its last fiscal year, or about 58% of its total sales.


As long as the company continues to grow its sales rapidly, bulls will likely overlook such spending, or even encourage it.

"It's kind of what they need to do right now," said Ives. "They need to go in fifth gear and put the pedal to the metal right now."

It's still early days for Slack

Traders work on the floor during the Slack Technologies Inc. IPO at the New York Stock Exchange (NYSE) in New York, U.S. June 20, 2019.  REUTERS/Brendan McDermid


Traders work on the floor during The Slack Technologies Inc. IPO at the New York Stock Exchange (NYSE) in New York

But the company's ongoing losses leave some investors worried. Shim projected that Slack's cash burn would worsen this year, thanks in part to some one-time factors.

One of the last times that valuations for tech companies got as high as Slack's was at the end of the dot-com boom in the late 1990s and early 2000s, said Morgan. Many of the companies that went public then were similarly losing money. And many of those companies were wiped out in the dot-com bust that followed.


There are signs that a similar downturn or economic slowdown may be coming, he said. Companies such as Slack have basically had it easy, he said. The economy has been growing for a decade, and unemployment is near record lows.

If a company can't make a profit in the current environment, "how are you going to fare when things are really going down the tubes?" Morgan said.

Bulls may say that Slack just has to hit a so-called inflection point in sales before it becomes profitable.

But, Morgan asked, "How much more time is left in this [economic] cycle to reach that inflection point?"

Slack may or may not reach that point. For now, Braakman's taking a wait-and-see approach. If Slack is successful, there will be plenty of time to get into the stock, likely without having to pay such a steep premium as it saw on its first day of trading, he said.


"We're not looking at Slack," he said. "To us, it's too early. We like to wait for the IPO dust to settle."

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