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Is Slack a Buy?

By Rick Munarriz - Jul 23, 2019 at 9:15AM

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The fast-growing provider of organizational collaborative tools is slipping since last month's market debut, but it may still not be cheap enough for your portfolio.

One of last month's hottest debutantes is cooling off lately. Shares of Slack Technologies ( WORK ) have fallen for three straight weeks, moving lower in four of the past five trading days. The company behind the popular workplace messaging platform hit the market five weeks ago at $26, peaking at $42 on its first day of trading. It has gone on to shed 21% of its peak value.

Slack stock is still trading above its initial reference price. It's not broken. However, now that the analysts involved in the resale registration have chimed in with their mostly bullish initiations earlier this month, there isn't a lot of institutional ammo to support the investment. Slack is going to sink or swim on its own from here, and with the shares drifting lower, it could be a compelling entry point for investors who believe in the fast-growing company's ability to keep broadening its reach.

Graphics of Slack features available in its collaborative tools.

Image source: Slack Technologies.

Slack of all trades

There are more than 600,000 organizations leaning on Slack to master their internal communications. A whopping 10 million daily active users are taking advantage of Slack's cloud-based team collaboration tools and online services. It's the next step up from interoffice email. It's social networking without the external distractions.

Slack's primary business is selling monthly and annual subscriptions to groups for premium access to its platform. Most of the organizations on Slack are freeloaders, but a growing number of them -- 95,000 by the end of April -- are paying at least $6.67 per person in the organization for enhanced access to Slack.

It all adds up on the premium end, especially since it's often larger businesses on the premium plan. Slack already has 645 major organizations generating more than $100,000 in annual recurring revenue.

The top-line growth has been stellar. Revenue roared 110% in fiscal 2018, following that up with an 82% surge in fiscal 2019 that ended in January. Growth may be slowing -- and Slack's top line rose 67% in its first fiscal quarter of 2020 that ended in April -- but you don't expect triple-digit percentage revenue growth to go on forever. Slack's guidance calls for revenue in the current quarter that ends next week to climb by 51% to 53%, with a 47% to 50% top-line ascent for the entire fiscal year.

Slack is losing money, and profitability is at least two to three years away. Investors won't have a problem with the red ink as long as the cloud-computing speedster keeps delivering strong growth. Decelerating revenue growth is fine, as long as Slack eases up on the accelerator pedal gradually.

There is a lot to like in Slack as both a platform and a growth stock. Now that it's publicly traded, the brand may be exposed to even more businesses and organizations that can benefit from what it can offer. The big concern for investors here is valuation. The stock trades at 35 times trailing revenue, and that's certainly not cheap. The growth is impressive, but how big is the addressable market for organizations willing to pay for a cloud-based interoffice communications platform? There are also fears of competition. At least one software giant that launched its collaborative cloud platform years after Slack is already at 13 million daily active users.

Slack is differentiated enough from the competition to continue to thrive in this climate. Investors will get their first real taste of what Slack can do when the company reports its fiscal second-quarter results at the tail end of this earnings season. Slack's valuation makes this a bit rich to recommend here with so many unknowns in this niche, but it's definitely a growth stock worth watching through the next few quarters as it and the competition play out.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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