Thursday, February 21, 2019

Why You Should Stay Away From SurveyMonkey

SurveyMonkey (NASDAQ:SVMK) just reported its first full-year results, and boy, were they discouraging! In this week's episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool contributor Evan Niu take a close look at the report and explain why investors shouldn't get too excited about this company's growth potential.

CEO Zander Lurie's growth projections are at odds with themselves. CFO Tim Maly announced his retirement. The balance sheet is shouldering some hefty debt, and the company isn't profitable. That's not even all of it. Tune in to hear more. The guys also hit on Amazon's (NASDAQ:AMZN) acquisition of router maker Eero. Find out what this mesh Wi-Fi buzz is all about and why this acquisition is so good for Amazon's smart home strategy.

A full transcript follows the video.

This video was recorded on Feb. 15, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Friday, Feb. 15. We're catching up on SurveyMonkey and an acquisition by Amazon. I'm your host, Dylan Lewis, and I've got fool.com tech specialist Evan Niu on Skype. Evan, what's going on?

Evan Niu: It's been a hectic week, like I told you last week, and you've probably seen on the national news at this point, that Denver had a teacher strike. The kids were home three days this week. But I was able to get a good amount of work in, so it wasn't too bad.

Lewis: So you had the kids home. Did you do anything for Valentine's Day? Anything special yesterday?

Niu: No, honestly, because my 10-year anniversary is actually coming up next month, so I'm putting all my energy into planning something for that.

Lewis: That's good! That's nice! That's very thoughtful, Evan! It works out well. You get to be nice and thoughtful, maybe get a little bit of a pass this Feb. 14.

Niu: Yeah, exactly! [laughs]

Lewis: You know who didn't get a pass, Evan?

Niu: You?

Lewis: No. I was fine! [laughs] I did takeout with my girlfriend. We had a lovely time. It's actually the first Valentine's Day that we've spent together. We had a blast! I was actually queuing you up for SurveyMonkey. SurveyMonkey did not have such a sweet February 14th. As a matter of fact, the company reported earnings this week and the stock market, analysts didn't seem too happy with it.

Niu: Yeah, the stock tanked like 15%. It's their second report as a public company. Investors were not very impressed.

Lewis: I think this was a big report for them because their first report came so shortly after they had gone public. A lot of stuff that we were looking at in terms of numbers was more or less related to what we'd seen in the prospectus. This time around, we're getting their full-year results for 2018, and we're getting some news about what's going on with their C-suite with executives.

Niu: Right. They're making some progress in some important areas like user growth. Paying users are up 7%, getting close to 650,000 at this point. 26,000 of those came in during the fourth quarter. But there's still a lot of challenges. This is predominantly a self-serve business, which still comprises almost 90% of revenue, with enterprise sales being just 10%, 13%. I don't like that. It helps them scale, but I don't see a lot of growth there.

Lewis: Yeah. I think ultimately, they want to move to the point where they're working more and more with enterprise clients. There's a lot of value there. In case anyone is not familiar with this company, this is a software-as-a-service play working on research data collection for a lot of big companies. That's the goal. A lot of individual users right now.

Looking at the results, what was interesting to me was on the bottom line, they hit estimates; on the top line, they beat estimates; and we still saw the sell-off. I looked at a lot of these results. We saw for the full year of 2018, the company put up 16% year over year growth, which was actually an acceleration from where they were in 2017; and yet the market wasn't happy.

Niu: They also made progress with average revenue per user. ARPU was up 13% to $425. They're making some progress in certain areas. But at the same time, they're still facing some pretty big challenges, which we can touch on later, in terms of their balance sheet and other areas. But I also think that part of it was the fact that their CFO is leaving.

Lewis: [laughs] Yeah, people generally don't like to see that, huh?

Niu: Yeah. Their CFO, Tim Maly, is retiring. He's been with the company for 10 years. I don't see anything suspicious about the announcement itself. He's been there for quite a long time, it doesn't seem like he's jumping ship or anything like that. But at the same time, with a company that's 20 years old, has this uncertainty, still operating at a loss, having your CFO leave doesn't give you a lot of confidence.

Lewis: Right. He got them to the point where they went public. He was someone that was very instrumental in them building out their finance and accounting departments. I think he started at the company when there were like 15 people there. So he's seen immense growth with them as a company. For him to leave shortly after taking them public, you don't really want to see that. I mean, he said he was retiring so that he could enjoy more time in the outdoors and relax. He's had a long corporate career. I get that. I think most investors, though, would like to see the executives stick around a little bit longer, especially because the company just went public.

Niu: [laughs] Right. It just introduces a lot of uncertainty at this really pivotal point in the company's history. Again, they're 20 years old, so it's kind of crazy that they've only now gone public. But it doesn't really help when you have other challenges going on in the business.

Lewis: One thing I was pretty happy about looking at these results, you hit on the user growth, which is great. You hit on the ARPU growth. We saw dollar-based expansion growth, which is something that this company has really struggled with in the past. For folks unfamiliar with this type of metric, you can think about it the same way that you would for comps for either a store or maybe a restaurant. You're looking at the cohort that you had a year ago and the cohort now and trying to see, OK, how much revenue are we getting from these people? When they went public, they were at 95%, which is to say that they were getting $0.95 on the dollar for all the customers that they were getting $1 from a year prior. Now we're seeing that the expansion growth is over 100%. That's what management said in the call. That's what you want to see with a SaaS company.

Niu: Right. It shows that they're at least keeping their users. There's not a lot of churn within this subscriber base. A lot of these people are using these surveys on a pretty regular basis. That does support their narrative, that they have this user base that's growing and stable and they're not losing a lot of customers.

Lewis: One of the big pushes for all these -- user growth, ARPU, dollar-based expansion rate -- was the fact that they have really focused on the enterprise market and they've rolled out this Teams product. The idea here is, they had all of these customers who were having multiple people use one account, one login, in order to access stuff that several people would be accessing. So, you basically have four people using one login. They have moved to this model that supports four different people having accounts, having them be collaborative accounts that people can work across. If you're trying to target the enterprise market, that's what you need to do, because all of the value comes from having multiple heads and that company paying for each software license.

Niu: Right. At this point, they're up to about 3,500 enterprise customers. Still getting started, but, again, making some progress.

Lewis: Evan, you mentioned the balance sheet. I know you spent some time looking at that. What stuck out to you over there?

Niu: We talked about this when we covered their IPO last year, one thing that stood out to me was the fact that they planned on using $100 million of their IPO proceeds to pay down some of this debt that they've accumulated over the years. They did that in the fourth quarter. They told investors upfront they were going to do that. They announced it when they did it in October. So now, we're seeing what the statements looked like after that. 

The company still has quite a bit of debt. They have $220 million worth of debt, which is actually greater than their cash position. Their net cash is negative $65 million. They refinanced this debt facility and they were able to modestly reduce their interest rates on what they're paying. This is floating rate debt. It's tied to LIBOR. The spread that they have now is about 75 basis points lower, so they will be saving money. It's definitely a good thing incrementally. But at the same time, the broader point is that SurveyMonkey has a lot of debt and they're paying a ton of interest on it. They're operating at a loss. That interest expense doesn't help at all.

Lewis: Yeah, they're not going to be able to do anything to aggressively pay down that debt if that's what they want to do, because they're not profitable.

Niu: Right. It ties into all this talk about them trying to expand their enterprise business. Having an enterprise sales team is super expensive. How are they going to build out this enterprise sales team when they're already operating at a loss, they have this huge debt burden? If that's where the future of this company is in terms of where they want to grow, how are they going to pay for all that?

Lewis: One of the things that I really was interested in with this report is, we got the quarterly guidance, we got the full-year guidance from this company. Looking out to 2019, the company expects growth of about 15%. That's at the midpoint of their guidance. Some of the analysts on the call had looked at this one comment that CEO Zander Lurie made. He said, "I do have confidence that we will reaccelerate growth in 2020." He went on to say, "We aim to double the size of each business in the next two years, and I'd lean toward three more than four." You look at that, and you're like, OK, you're giving guidance saying that you're going to grow 15% next year. If you're doubling your business in a three- or four-year period, that's implying a compound annual growth rate of 26% or 19% respectively. They're forecasting for 15%. What am I missing here, Evan?

Niu: [laughs] Those numbers don't really add up! Yeah, I'd be just as skeptical as you are. How do they double or triple the size of these businesses when this is a 20-year-old business, everyone knows it's around, they have much larger competitors, they can't invest properly in growing the business? I don't see it happening.

Lewis: You mentioned the competitors. One thing that came up repeatedly on the call, it was an allusion to this company but not actually named, was the fact that they have a pretty steep competitor that was recently acquired in the past couple of months.

Niu: Right. SAP bought Qualtrics. Qualtrics is a much bigger company. SAP is enormous, it's a huge player in enterprise software. You have this tiny company like SurveyMonkey trying to compete with this global behemoth, I don't think they have good odds.

Lewis: Particularly when you think about the fact that most of the growth, most of the interesting growth for them, is going to be coming on the enterprise side, where they're going to need to build out a really strong sales force. They're going to be competing against a company that's more established and has deep-pocketed investors in SAP, who's happy to give them a very similar sales force.

Niu: And they have cross-sales opportunities, they have existing relationships, they have all sorts of advantages over little SurveyMonkey.

Lewis: Big picture with this stock, Evan, the way I'm looking at this, I see a lot of things that are going in the right direction. Them moving to this Teams product, them finally getting back on track with dollar-based net expansion, all of those metrics are moving in the right direction. I don't love the fact that the CFO left, but I think the core business looks pretty good. The reality is, it's below its IPO price at $17. That puts them at about a $1.5 billion valuation and 6X sales. Now, I own SaaS stocks that trade for a much richer valuation than that, but they also have a much more compelling growth story ahead of them.

Niu: Right. This is one of those cases where you get what you pay for. If they're trading at a much cheaper valuation compared to other SaaS plays, there's probably a good reason for it. I agree that there are some good signs. They're putting up some good numbers in certain areas of the business. But overall, I'm still not interested in owning this stock at all.

Lewis: Right. Twenty-year-old business, not growing at a compelling rate, not profitable, either. You want one or the other when you've been around for that long.

Niu: Yeah. So, I'm not surprised that they're trading at a discount relative to some of their peers.

Lewis: Evan, one of the other stories that got a lot of headlines this week was Amazon's acquisition of Wi-Fi mesh company Eero. We're going to talk about how this fits into the company's long-term vision. Why don't we do a little rundown on mesh first? I don't think we've talked about this technology all that much.

Niu: For people that aren't as familiar with it, Wi-Fi technology generally doesn't advance super rapidly compared to other areas of tech. Mesh networking is the current big thing in local networking. Mesh networks use multiple network access points, or nodes, to blanket a large area with Wi-Fi coverage. It's different than traditional Wi-Fi extenders because the system is much smarter and the nodes are able to proactively communicate with each other to use algorithms to determine the best way to route traffic within the network, which is called dynamic routing, which is much more efficient than traditional extenders. Those old extenders don't communicate to the same degree, and they tend to send traffic over the same routes. That can cause congestion and other issues with your local performance. Those traditional range extenders usually have weaker signals as you get further and further away from your main router. These mesh systems can keep a strong signal throughout the entire system.

Lewis: Big picture, this is where Wi-Fi is going, right?

Niu: Right. The end result is that they're faster, more reliable, more efficient, particularly when you're trying to cover a large area like a large home, 1,000 square feet, maybe two or three stories or a small office, whatever the case may be. They're also extremely easy to set up. But they're expensive. Most of these cost $300 to $400.

Lewis: We don't know the exact terms of the purchase, Amazon buying this company, but I think it's safe to say that Jeff Bezos and co. were not looking at Eero and saying, "Oh, that's a nice little business. We're going to buy them and just let them do their own thing." This probably plays into some big strategy for them.

Niu: Right. They didn't disclose financial terms. We know that Eero's last valuation in 2016 was about $250 million in a private funding round. Amazon says that they think this acquisition can help them basically improve smart home connections. As we know, Amazon is pretty big in smart home. They have a really strong position. Eero had already been integrating with Alexa, so you could already do things like voice controls, control certain parts of your network. 

I really like how Amazon sees this as an opportunity. At the same time, Alphabet has been getting into this Wi-Fi mesh space a little bit with Google Wifi, which came out in 2016. Google is a pretty big competitor to Amazon in the smart home because they're expanding their smart speaker sales, they have Nest, which has been expanded beyond thermostats and getting into things like home security and cameras. I think this is part of a bigger play to compete better with Google.

Lewis: I think it makes a lot of sense. You look at the way that this technology works, where you have all of these nodes distributed throughout the house or the building or whatever you're looking at, that sounds a lot like the Echo systems that Amazon's currently pushing in hardware. Maybe you have one main hub, and then you have all these Echo Dots sprinkled throughout your house. It doesn't seem like a stretch for that type of Wi-Fi connectivity to then be brought into Amazon devices or vice versa.

Niu: Right. Exactly. I think there's a lot of potential for this deal to accelerate their roadmap. Not only are there benefits with having deep integration between your mesh router system and your smart home devices, but there's a lot of new categories that are coming out that combine a lot of these products. Like you said, Amazon wants you to put an Echo in basically every room in your house. In the past six months, we've seen a couple of companies come out with smart speaker/router combos. An interesting thing, you have the smart speaker with Alexa that also functions as a router. It's easy to imagine a couple of years down the line, maybe Amazon puts out an Echo device that's also a mesh node that improves your network performance. Or, if you look at Echo Plus, which is a smart speaker plus smart home hub, adding it in there, too. Smart speaker plus mesh node plus smart home. There's so many things that they could do with this technology.

Lewis: We can't talk about big tech going into people's living rooms without talking a little bit about some of the privacy concerns that might come with that. I know there's been some blowback related to this announcement. Evan, what's your take on that?

Niu: A lot of privacy advocates are worried that what Amazon is trying to do here is monitor everyone's web activity and traffic and see what you're doing. I think that fear is a little overblown. Eero's privacy policy explicitly says they do not monitor for that type of data, and they're not changing the policy even after this acquisition. Amazon has had, it's not Facebook levels of scandals that we're talking about, but it has had a couple of these privacy snafus in recent years where there's some type of privacy issue related to the Echo, which is a microphone in your house. But they tend to be few and far between, and they're usually a rare technical glitch. 

That being said, I think the data is part of this deal, just not Internet traffic-type data. Eero does collect data on what devices are connected to it. That can give Amazon insights into what kinds of devices people are using in their smart home. That can also be useful for their future roadmap.

Lewis: Is that to say that when these combined devices from Amazon and Eero come out, Evan, you might be a buyer?

Niu: I've actually been looking at one of these for a while, but I've been putting it off because my Wi-Fi is fine and I don't need it. But it's funny, this acquisition actually makes me want to go buy one. A lot of people don't like when these small companies get snapped up by these tech giants, but I actually prefer it that way because I know they'll have more support, they'll be more stable over the long term. I'll probably buy one in the next six months.

Lewis: That's kind of the give-and-take here. Being a part of a larger company gives you access to the ecosystem and everything they've built out, all of the resources that they have available on the technical development side, too. It comes with some concerns, though.

Niu: Right. A lot of these small companies might have hit products, but if they're not financially viable, they go out of business, and then you're stuck with a product that you can't get support on.

Lewis: All right, Evan, I'm going to let you go. I know that you have kids at home and a 10-year anniversary you're planning for. Thanks for hopping on today's show!

Niu: Thanks for having me!

Lewis: Listeners, that does it for this episode of Industry Focus! If you have any questions or you want to reach out and say hey, you can shoot us an email over at industryfocus@fool.com, or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or check out videos from this podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Dan Boyd for all his work behind the glass! For Evan Niu, I'm Dylan Lewis. Thanks for listening and Fool on!

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