Since going public in September Freshworks (NASDAQ: FRSH) didn’t impress Wall Street, and the stock is currently trading 13% below its IPO price. But investors shouldn’t write off this software company just yet. More than 50,000 companies worldwide rely on Freshworks to improve customer and employee experiences, and International Data Corporation (IDC) estimates its market opportunity at a whopping $ 120 billion.
In this Motley Fool Backstage Pass video, recorded and broadcast on October 4, 2021, Asit Sharma, Motley Fool senior analyst, explains why Freshworks is worth putting on your watchlist.
Asit Sharma: That actually went public, I think I won’t say it until a few weeks ago. Is the screen okay guys. FreshWorks is interesting to me because it reminds me of a company that has made a similar journey in the customer-centric world called HubSpot. HubSpot is a hugely successful stock recommendation that the Motley Fool has made for and through many services for several years. We have recommended it in various services and recommend it to others.
Freshworks is basically a customer service organization. This is a software-as-a-service company that provides help desk services for small and medium-sized businesses. Their main product is this product called Freshdesk, and I’ll just flip through here and show you some of their products. But this is basically like a technical support desk that makes it easy to provide customer service when you are a very small business. Let’s say you start this YouTube channel that Jose and I were kidding about, and then you start zooming in a little. You have a couple of employees, you now decide that I am going to sell a service that, having received all this recognition from the YouTube channel, I will use as a marketing transition to selling products. But you don’t have your hands on the table for customer support because you sell worldwide, maybe you use too Global-E Services. [laughs] I don’t know if they hit such small businesses, but you get a picture.
When you start to grow as a business in the current economy, the benefit is that there are so many tools out there to help you grow quickly. The platforms are now very balanced between overnight start-up companies and Fortune 500 companies. My favorite example is halo ice cream. The tools to help you develop a product are now available to everyone. You can take a small product or service out of your house and it can go global overnight. But let’s assume this is h -pening and you want the infrastructure around your business to be able to meet your customers’ needs. They are aimed at small businesses that need these services.
You can see here that they are also branching out into sales. Modules to help you increase your sales if your small or medium business, sales and marketing. Also adjust your IT service management to the right size. As your business starts to grow, this will help you distribute IT across your company in a really efficient way. Also want to show you what the larger -ps for it looked like. They have a few growing companies in their portfolio while focusing on the small and medium business market. they now also serve corporate customers. I think the three of us probably know a number of companies that are both public and private.
Klarna is a very well known company that specializes in Buy Now Pay Later. This above is from Freshworks’ perspective, explaining how their messaging software supports the Klarna service in multiple languages and also automates customer service to find out who needs the most help and how to match that with someone who is relevant information has expertise. Your software is really good at it. It faces a global customer, it is always in the sense that the various suites can be used, again for mom and pop instances through to the company. This will give you a little bit of a rundown of how your product card is starting to flush out. These are the big buckets I talked about, customer experience, IT service management, sales and marketing. You also get into the HR department. It’s a very modular type of company that turns into a platform.
I mentioned HubSpot, it looks and acts a lot like HubSpot. HubSpot started out as a company providing inbound content marketing for small businesses. In other words, instead of trying to go out and throw darts at a dart board and try to market my services over the internet. HubSpot enables small business owners to draw people to their websites with great content. But HubSpot has evolved into building other types of modules over time. They call them hubs. They also have IT modules, they now have a hub dedicated to operations. They are also able to land with customers and expand even in very small companies. I see Freshworks are following this very useful and very effective template because they are attracting the customers and they are gradually adding these different service modules.
Just a few other things I wanted to go over here, some stats at a glance from your S-1 based on your perspective. The S-1 is actually a container document for the prospectus, but they mean the same thing. Basically, the offer documents that a company shows investors before going public.
This is from this document, you can see that it is a growing company. This is revenue for the last 12 months of $ 308 million, revenue growth for the last 12 months, nearly 50% year over year. They have 52,000 customers around the world and 13,000. If we do the math here, 13,000 is roughly a quarter of 52,500. This customer base generates a quarter of its business with annual recurring sales in excess of $ 5,000. There is a very solid recurring revenue component for this company. Great Glassdoor reviews for the CEO. A very large, addressable market. The gross margins are now, I don’t think it’s on the slide, between 79% and 80%. I also like this component a lot.
Now, I’ll take a few minutes here to show you a few things that are of interest to me. Again, this is a stock that I am researching right now. To open a dialogue, I’ll highlight the things that I look at and that I like to have in the Q&A, and I’ll have a chat with my colleagues in just a second here to see what questions they have. But I always like to see gr -hics like this.
This is a cohort chart. It’s a visual way to show customers’ net expansion rate and how spending increases with each cohort. You can see here that at the beginning, i.e. in 2012, they were able to build up these first business cohorts very slowly and gradually. Over time, they sell more and at faster prices to newer customer groups. The youngest cohorts are not only the bands bigger, but they also lean right up which interests me. It means they are getting better at retaining customers. They get better at selling them additional services every year. Since they added these modules that I was referring to, for example a staff module, they have more to sell to h -py customers so these bands are getting bigger. I like to see that in a software-as-a-service company. This struck me visually as well as my investing eye.
Take a quick look at the company’s balance sheet. This is before the IPO. Here you can see how the balance sheet changed from 2019-2020. We’re going to look at this last column here, which is the most recent printout of the balance sheet. You can see that they have -proximately $ 324 million in current assets versus $ 173 million in current liabilities. You basically have very solid working c -ital with no long-term debt, and I like to see that on the books. Just two things here. As we can see, sales grow in a very beautiful clip. These are the year-end views, so revenue grew from $ 172 million to about $ 250 million between 2019 and 2020. This corresponds to a growth rate of around 45%. But if you look at what’s h -pening this year compared to the first six months of 2020. Since this is a business that is completely online and helping businesses grow, they accelerated, not slowed down during COVID, but accelerated after COVID. That growth rate for the first six months of this year equates to a growth rate of around 55%, so growth will accelerate through 2021. The last thing I promise
For key financial figures, this is the cash flow statement. You get into a state of positive cash flow and positive free cash flow. They’re not generating a lot of money from operations right now, but they are reinvesting in business. But I just wanted to make sure everyone knew they weren’t burning money either. You were in a state of negative operating cash flow and you were also buying property, plant and equipment so you had a red free cash flow printout. But here you can see for the first six months of this year that cash flow is positive and it is still positive even after you buy some property, plant and equipment.
Finally here just to sum it up. What is the edge? I always look for an advantage with companies that I research. For me they have several service points in this market for small and medium-sized companies. You can add further modules. They attack many basic functions including IT, sales and marketing, now HR, customer service. But there is a lot more they could do. You could be like HubSpot and even step into operational modules. You have that growing recurring revenue component. As I mentioned earlier, 25% of their customer base gives them an average of $ 5,000 in annual recurring income and the increasing cohort spending I talked about. Really early on in research, but I like what I’ve seen so far.
This article represents the opinion of the author who may disagree with the “official” referral position of a premium advisory service from the Motley Fool. We are colorful! Questioning an investment thesis – even one of our own – helps us all think critically about investing and make decisions that will help us get smarter, h -pier, and richer.
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