How Did Slack’s Public Offering Go?

Slack (WORK) used a direct listing to go public. That's a path that allows investors and insiders to cash out while not actually raising any money for the company. It does, however, benefit the brand in some ways, because the transparency required of a public company should make it easier for larger enterprises to commit to using the workplace productivity app. Shares opened strongly, pushing them to a valuation that may not be justified by the company's revenue.

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This video was recorded on June 21, 2019.

Dylan Lewis: Yeah, Slack listed yesterday. Why don't we talk a little bit about this company? It is probably the most anticipated IPO of 2019 in terms of having a business that people actually want to invest in.

Dan Kline: You know I love Slack. I'm probably on Slack as much as...I'm going to guess I'm top five in a company of heavy Slack users. And I'm on some other Slacks that aren't just The Motley Fool Slack. I love this product! What I don't love so much is their monetization. They don't lose a ton of money. They're sitting on about $900 million in cash. We'll talk about why they went public a little bit later. But I don't see a clear path to increasing revenue. They can add customers, absolutely. But in my opinion, to really become profitable at a significant level to justify the absolutely insane valuation that they're trading at right now, they need to create a suite of business products. I don't think that's an easy thing to do.

Lewis: Yeah, shares had a reference list price of $26. They surged to about $40. You look at what that does in terms of valuation for them, it puts them at about $20 billion, which would be 40 times trailing-12-months sales. I think it's fair to say that's a little rich, Dan.

Kline: I believe they forecast the entire collected workspace market to be about $26 to $28 billion. So, yeah, it's really high. But part of that is, there are some companies that you feel really good about. We're on Skype now, I don't think I've ever felt really good about Skype, even though I like Microsoft very much as a company. But Slack is something that just, it really makes your life better. I know on your end, where you have 1,000 people, you're managing people, so Slack can be overwhelming. For those of us who are part of a remote workspace, Slack is a lifeline. It's something that I feel really positive about. I want to be an investor almost as a thank-you, but I don't see how their business model ever justifies that valuation unless they can figure out a lot more ways. It's interesting to me that you could do the equivalent of a Zoom meeting over Slack, and we use Zoom separately most of the time.

Lewis: I guess it speaks to the quality of the technology that Zoom has and Slack has respectively. Typically, what you see with companies in the software-as-a-service segment is, you get known for doing one thing really well and then you add functionality over time. You look at what they're able to do in terms of billing, right now it's about $6.67 to $15 per month per user, depending on how you bill and the tier they're at in terms of service. The easiest way for them to meaningfully grow revenue, especially as they have these loyal customers, is to add killer functionality onto these other product suites that integrate and allow them to charge more for that. I'm not exactly sure what that is. But there is a profitable business here, Dan. I mean, 87% gross margins over the past 12 months. If they bring that sales and marketing spend down a little bit, I think there's something there.

Kline: Here's the thing. I'm not saying this won't be a profitable business. They don't lose very much money for where they are as a company. But to justify the valuation, they don't just have to be a little profitable, they can't just make $50 million a year; they have to be a company throwing off billions and profit. Again, I think they could get there. They might be able to integrate things that are useful. For example, a lot of the writers and I are talking about a Vegas trip. In theory, could they integrate travel services? They see you're talking about travel, "Hey, look, here's a flight at the time. Here's a hotel deal. Here's a value add for being a Slack user." I'm not sure what it looks like. There are things that could go in. But that's a tightrope to walk, because one of the best things about Slack right now is there's no advertising, there's no clutter. And yes, we can get overwhelmed by the sheer volume of Slack messages, but you can always dig out from that. You don't have to stop like, "Oh, great, Slack saw I was talking about pizza, and now here's an ad for Domino's."

Lewis: There is a part of me, Dan, that looks at this and says OK, I have heard Stewart Butterfield, their CEO, talk quite a bit about how he foresees the obsolescence of email, and that we move away from a very office-oriented, very Outlook-oriented way of doing work, and instead are in something that there's more Slack-like for everything -- for communication, for archiving, for all of the content that we communicate within a company. I wonder what else they might be able to wrap into that service that is currently much more Outlook-like that could allow them to charge some of those higher tiers that they would need to make it a wonderfully profitable business.

Kline: Yeah, I think calendar would be a big one. They do replace email. You and I communicate a lot during the week, and it's almost entirely on Slack, and it's generally only an email when it needs to be something very formal that maybe we want to keep that record of. So I can see them doing it. But you have to do it very slowly. They have to consult their user base. If I was Slack, I would be taking my biggest customers, people like us, we're part of a test that is integrating multiple Slack channels; we have an external channel and an internal channel, and we're allowed to communicate with each other, and there's varying rules on that that Slack has been playing with.

So far, I see this as a very well-managed company that has done everything right. But that doesn't mean they won't make a misstep in the future. They have to go very carefully.

Lewis: As is often the case with newly public companies, I'm looking at this one and saying, there's a lot of good stuff here, I want to see how management handles being publicly traded for a little bit before I decide I'm putting some money into it. Particularly true because of the valuation right now.

Kline: Yeah. One of the things we promised to explain that we missed is that this was not an initial public offering. In a traditional IPO, what happens is, a company sells shares of itself in order to have money to fund operations. This was a direct listing. What that means is, this is an equity event for early investors. Let's say you were a fund or an individual who had shares -- this is a chance to cash out. The company doesn't actually get any money from this listing. But it's important to note, the company doesn't need any money. It actually has some $800 million in the bank. And while it is losing money, it's losing $130 million, about $30 million a quarter. They could go on for four or five years without having to raise even at the current levels of loss. This was a different path to the public market.

Lewis: What I think is really interesting about the direct listing process is the incentives are very different than an IPO. You think about an IPO, and it's a capital-raising event. And then there's also this, "OK, we want to pop a little bit on the first day, so we're going to have our shares be priced at a level where we get the ego boost of having the market want our shares." So, you have this very complex dynamic at play. You're trying to raise money at a good valuation that does service to the people that are existing shareholders and is good for the business, but you're also trying to serve this market euphoria that everyone expects. A direct listing doesn't really have any of that because they're just making their shares available at a price that they think people will want to buy them and exchange them, and then just letting market forces take over.

Kline: Here's the thing. I'm a big believer in ignoring almost the first year of trading on a company. We have a media cycle. "Oh, my god, Uber is terrible! Its stock is down 40%! It's great!" None of this has anything to do with the business metrics of the company. But one of the interesting things I found for Slack is, they'd been asked for financials from some of the bigger organizations that wanted to use their product. If you're a giant company -- let's pretend you're an insurance company that employs 50,000 people across the company -- you're not going to want to move to Slack and have them go out of business in six months. So being public actually gives them a level of transparency that's going to help their business. That's something you don't really hear about when companies go public. But this actually opens new doors for them and might make it easier instead of harder.