Slack Technologies (NYSE:WORK) seems to have found a bottom. After fading immediately after the company’s direct listing last year, Slack stock roared 28% higher in just six sessions.
In the short term, there’s a case for some caution. As of this writing, Slack stock is declining in trading on Tuesday, and a key recent catalyst may not be exactly what investors thought it was.
From a long-term standpoint, valuation is a worry: WORK stock isn’t cheap, or close to it. With a major competitor hovering, the story echoes that of another growth darling whose shares have faltered.
Still, for growth investors in particular there’s an intriguing case here. Last month, I called Slack stock one of 3 busted initial public offerings to buy (even though the company technically didn’t do an IPO). Even with the recent rally, I see gains ahead — even if investors might want to let the recent dust settle first.
Why Slack Stock Has Spiked
Just two weeks ago, WORK stock looked like it was potentially in trouble. Shares opened their first day of trading in June at $38.50, and from there the trend was negative. Like fellow hyped 2019 IPOs Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT), shares quickly fell below their opening price — and kept falling.
Unlike UBER and LYFT, however, WORK never got much of a bounce. Starting in October, shares simply settled into a tight range between $20 and $24. By late January, as we noted in our Big Stock Charts feature, the technical picture looked worrisome, with support potentially ready to break.
But two catalysts drove the stock back to, and through, the high end of that range. An upgrade from RBC Capital Markets sent shares up over 10% on Feb. 4. (Interestingly, WORK rose less than 5% after an even more bullish note from Wells Fargo the week before).
Why Slack Stock Might Fade
The near-term worry is that both those catalysts may not be strong enough even to keep WORK at current levels. It’s worth noting that RBC’s upgrade only instituted a price target of $25 — below where WORK trades as of this writing (Wells Fargo’s target was $30). Analysts on the whole see upside to $27.32 over the next twelve months, just single-digit percentage upside from current levels. And so Wall Street may not provide another positive catalyst any time soon.
As for the IBM deal, Slack itself threw some cold water on the report. In a Form 8-K filing with the U.S. Securities and Exchange Commission, the company noted that IBM already was Slack’s largest customer – -and had been for several years. IBM “has expanded its usage of Slack over time,” the company wrote in the filing.
As Barron’s noted, Slack in a 2019 blog post said its product was available to 165,000 IBM employees. The expanded agreement covering more than twice as many workers in theory thus could double revenue from Slack’s biggest customer. But in practice, it’s likely that many of the employees not covered last year are unlikely users of the product and not likely to drive much, if any, incremental revenue for Slack.
Meanwhile, Slack’s S-1/A filing with the SEC last year disclosed that no customer, not even IBM, represented 10% of revenue. In addition, the company noted this week that it wasn’t updating guidance for its fiscal fourth quarter or fiscal year 2020 (ending January 31).
And so with time, the takeaway seems to be that the expansion of the IBM deal isn’t as material to revenue as the market initially believed. At best, it provides a boost of maybe a couple of percentage points.
The retreat in Slack stock on Tuesday suggests that some investors are figuring that out. More may do so as the week rolls on.
The Long-Term Case
Looking beyond those near-term factors, WORK is a classic good news/bad news stock. For now, the good news seems to outweigh the bad news, particularly with the stock down so significantly from its initial 2019 trading price.
The good news is that Slack is posting explosive growth. Revenue increased 60% year-over-year in the third quarter and is guided to rise 55-56% for the full fiscal year. Analysts are looking for a 37% increase next week as Slack inches closer toward net profitability.
In a market where growth has been prized, Slack has delivered so far. And there’s a huge runway here. The workplace messaging app has significant room to expand to uses outside of a company, as RBC noted. Slack itself has estimated a total addressable market of $28 billion; RBC suggested the figure could be as high as $86 billion. With Slack’s fiscal 2021 revenue coming in below $1 billion, the company has a long runway for top-line growth.
The bad news comes in the form of Microsoft (NASDAQ:MSFT). The software giant offers formidable competition with its Microsoft Teams, an effort behind which the company has invested in marketing of late. Teams actually has a larger user base than does Slack, though Microsoft’s ability to bundle Teams with its Office 365 suite obviously helps the product’s numbers.
Slack’s product unquestionably has merits, as the company’s revenue growth has been stunningly quick. Revenue quadrupled just between fiscal 2017 and fiscal 2019. But Microsoft represents a real risk. As a result, Slack stock is reminiscent of another growth name that has struggled in recent years.
WORK and BOX
In early 2015, Box (NYSE:BOX) went public. The developer of content management software saw a nice first-day pop in its IPO, but like WORK quickly faded. Shares dropped about 50%, a little further than WORK has. A 150% rally over the next two years followed, but BOX declined for most of last year and now trades below its first-day close.
Box is an instructive example for Slack stock. Early last year, I noted that BOX came down to an argument as to whether the company would be bought out or run out. Like Slack, Box was competing with giants. And as with Slack, investors wondered whether that made Box an intriguing acquisition target for one of those giants. Buyout rumors have moved BOX higher on occasion, but the company remains independent and its stock continues to struggle.
The bear case for Slack is something similar. Teams continues to take share, which makes Slack a less attractive acquisition target. As Slack loses the scale to re-acquire lost share, Teams wins, Slack loses, and WORK stock continues to fade.
Will Slack Be Taken Out?
But from my perspective, the comparison actually highlights the bull case for Slack stock, because of significant differences between the two companies. First, Slack’s competition is direct with Microsoft. Box, in contrast, had potential competitors ranging from Microsoft to Adobe (NASDAQ:ADBE) to Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) and even Amazon.com (NASDAQ:AMZN). David may be able to slay one Goliath, but likely not four or five.
The one-to-one competition also makes a takeout more likely. Amazon and Salesforce.com (NYSE:CRM) already compete with Microsoft, and may see Slack as helpful in that battle. It’s a simpler strategic case for those giants to make to their shareholder and boards of directors.
The second distinction is that Slack’s offering simply is better than most. It’s a hugely useful, well-reviewed tool for workplace productivity. And it will only get better over time. Slack has a much better chance of overcoming the edge Microsoft’s massive existing base provides than do other smaller software companies who lack differentiated offerings.
Valuation admittedly is a concern. But by the standards of this market, Slack stock isn’t terribly expensive at about 15x FY21 revenue estimates. To be sure, “by the standards of this market” is problematic for some investors, and it’s possible high-growth stocks are due for a fall. But analysts and investors can model upside here if Slack keeps delivering the levels of growth that are hard to find anywhere in this market.
And so the long-term case here is attractive. But, again, I’m not sure investors need to rush in. The gains from the IBM reveal, in particular, seem like they could reverse. Fourth quarter earnings are a potential catalyst, but won’t arrive until next month. Slack stock has upside over time — but I don’t think that time necessarily includes the next couple of days or weeks.
As of this writing, Vince Martin has no positions in any securities mentioned.