Growth Is Strong, But Will It Bounce Back?
Yext helps companies put the right facts in front of potential customers. Yext positions itself as more relevant than third-party aggregators when it comes to reporting relevant and accurate data that customers seek.
Yext declares that customers seek a very specific answer to a very specific question. For example, when customers ask ‘what’s the best menswear store in London that sells dress shirts and is open now?’ customers don’t wish for a generic answer to specific questions. Yext helps businesses to control and publish critical facts about themselves.
Moving on, we can see that up until fiscal 2020, Yext’s revenue growth rates were highly stable:
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Source: author’s calculations; ***high-end company guidance
During fiscal 2018 to fiscal 2020, Yext was growing at plus 30% year-over-year revenue growth rates. However, during Q1 2021, Yext saw a portion of its revenues take a hit.
Specifically, Yext’s exposure to retail and food services got hit hard during April, as one can imagine. The company states that approximately 25% to 30% of its annual recurring revenues came from affected industries.
So as you can see from its guidance for Q2 2021, Yext’s revenue growth rates are now looking at sub 20%. This is a marked decline from its performance during fiscal 2020. Yext consistently noted during its recent earnings call that this setback is temporary, and that customers simply pushed the deals out, but that the pipeline remains strong.
Indeed, Yext’s recent tie-up with Adobe’s (ADBE) Experience segment is promising. Yext contends that Adobe’s site search product got discontinued and Yext is able to fill a hole in Adobe’s Cloud Experience portfolio. The premise being that Adobe will act as a top funnel for Yext bringing customers to Yext, while Adobe gets a referral fee.
Does Profitability Matter?
In 2020, ‘invest for growth’ has taken on new meaning. Companies that are able to deliver reasonable growth are given a wide berth as investors willingly take on losses on the expectations of rosier days tomorrow.
For its part, auditor Ernst & Young is skeptical of how Yext both capitalizes its costs and recognizes its revenues (page 51). Cost capitalization is a pervasive industry tool, and I do not believe it to be a material thesis breaker or maker for either bears or bulls.
However, on the revenue recognition front, this line made me raise a yellow flag:
revenue recognition was especially challenging […] [to] determine if the transaction price expected to be received was fixed or variable.
It could be something, it could be nothing, but clearly the auditor is not totally satisfied with how Yext allocates revenue between its performance obligations and the timing of its revenue recognition.
Valuation – Cheap On A Relative Scale
Yext certainly pushes the ‘right’ narrative as that of a SaaS business. In fact, practically all SaaS businesses trade meaningfully higher, with P/Sales multiples of 15 times to 20 times and even higher; in comparison, Yext trades quite cheaply, at less than 5 times forward sales.
Investors are thereby presented with the thesis that because other SaaS stocks trade higher, this should imply that this SaaS stock should also trade higher, right?
In 2020, that’s certainly a valid thesis. Furthermore, its ability to be supportive of companies in their digital transformation certainly lends itself towards trading at a meaningfully higher multiple.
What’s more, assume that Yext’s operating profit margins should reach 10% at some point in the future, investors are only paying 45x its forward (hypothetical) operating profits, which for a SaaS business is not expensive.
The Bottom Line
For now, investors are unlikely to be overly concerned with Yext’s lack of profitability and are highly likely to give this cloud SaaS the benefit of the doubt that Yext will become highly profitable in the future.
Having said that, investors should still be mindful of its unearned revenues on its balance sheet, and if this figure was to start growing at less than 10% year over year, investors should look to sidestep this investment.
On the other hand, Yext’s exposure to food and retail has plagued its recent results and guidance. Nonetheless, the possibility that Yext bounces back in the later parts of calendar 2020 is not being sufficiently priced in.
In fact, if Yext is able to reignite its revenue growth rate back to low-20 percent to mid-20 percent ranges, one can easily see the company trading for a meaningfully higher multiple.
Put another way, if the recent slow-down was indeed temporary as the economy went into lockdown, and deals got pushed out, Yext should see its revenue growth rates reigniting and investor appetite returning for this stock. This stock is certainly worthwhile watching.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.