In this episode of Industry Focus: Tech, Dylan Lewis and Motley Fool contributor Brian Feroldi discuss the competitive dynamics between Slack (NYSE:WORK) and Microsoft (NASDAQ:MSFT) and the enterprise software segment in general. Learn more about the messaging space and why it's so lucrative for both companies.
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This video was recorded on May 29, 2020.
Dylan Lewis: It's Friday, May, 29th, and we are talking about the ongoing war between Microsoft and Slack. I'm your host Dylan Lewis, and I'm joined by Fool.com's marvelously mediocre Brian Feroldi. I like that alliteration on your title there, Brian; you wrote that, I didn't. [laughs]
Brian Feroldi: [laughs] I figured you would appreciate that, Dylan. I try to mix it up.
Lewis: For the unacquainted, Brian likes to mix up how he has me introduce him [laughs] with every single show, and it always winds up underselling him, which puts him in a position to overdeliver as we do the show and he always does. So, I'm happy to be joined by, again, Brian.
We're going to be talking about Microsoft and Slack, because there's a wonderful interview with Slack CEO Stewart Butterfield that was out recently with The Verge. Very insightful, really good lens into how he looks at the business and really the competitive dynamic between Microsoft and Slack.
But before we get into that, Brian, I mentioned that it's May 29th, a.k.a. 529, a.k.a. National College Savings Day. You know, we're all about financial literature. We've got a little PSA out there on the 529 program, Brian.
Feroldi: Yeah, I don't think everybody knew that it was National College Savings Day. So, if you have kids and you don't have a 529, you have no excuse, go open one up today.
Lewis: Today's the day. And today, and really this week, is a great time to get started, because if you search your local state and 529, it is very possible that they have either a sweepstakes running where they are giving, you know, a couple thousand dollars or $529, because they're leaning into the bit a little bit, to a bunch of people that have applied to the sweepstakes of the contest. There are other states that are doing $50 matches on starting accounts with $50, if you set up recurring payments down the road.
So, just a little PSA, get some free bonus money out there, if you haven't already, set one up for your kids and you're planning on doing it anyways. Great time to start.
With that nice, amicable kind of intro out of the way, Brian, we can get to the feud between Slack and Microsoft. And Slack is probably a business that a lot of people know pretty well, we use it here at Fool all the time. Let's give a quick intro, though, for the folks that are uninitiated.
Feroldi: Yeah. So, Slack is a business communication tool. It was launched in 2013 and it's used to send messages back-and-forth. You can easily use it to collaborate, to build teams, disassemble teams, to share files; when new people come on, it's easy to catch them up with what's been happening on a project. So, it's a wonderful collaboration and creativity tool. We've used it at the Fool for years. We absolutely love it. By using it, it has significantly cut down on email communications. And prior to this company coming public, they came public in June of 2019 or the middle of 2019. We did a deep dive on their S-1; that was on June 19th. But if listeners want that information, IndustryFocus@Fool.com, we'll be happy to send them a link.
Lewis: That's where you can get us, and you can get us there with questions as well. You know, we love hearing from people, getting ideas for shows, all that kind of stuff. And I think for someone who didn't know Slack, and maybe hadn't had hands-on experience, it would be very easy to stare at it and be, it sounds a lot like an instant messaging service, like, how is this a real business? Like, AOL had to sunset it because there wasn't the interest there.
And, really, it at core is messaging, but it's much more structured and organized messaging. It's building project groups, it's building channels around specific topics, and it's making document management and that kind of stuff a lot easier for people that are working on projects together.
Feroldi: Dylan, it just warms my heart that you know what AOL instant messaging is. [laughs] But, yes, as someone that depended on instant messaging throughout basically college, Skype is basically that, but super-useful super-built-out, has tons of integrations, it's very easy to share files with each other, to get comments from multiple people, to build teams, to disassemble team. So, it's basically instant messenger on steroids.
Lewis: On steroids. And they have followed the tried and true tech path of maybe the last decade or so with that freemium approach. You have the free version and the paid version of the product. You know, very often what they do is offer that free version, get enterprise customers in early, maybe people that are more in the start-up world, grow as the business grows, and as their usage grows. And they also have some people that are using it more for personal purposes, but we're generally going to be looking at the enterprise side of this business, because that's where the money is for them. The free side is maybe a hopeful chance to convert people, but really, they're going to be making most of their money inking big deals with big customers in the corporate space.
Feroldi: And that's exactly what we've seen them do, Dylan. And the freemium model totally makes sense here, because having one person in an organization use Slack is useless, you really need everybody using Slack for this tool to be useful. So, whatever they can do to get those network effects going in a business as soon as possible is key to this company's success.
And we've seen some pretty good numbers out of this company so far. And to give listeners a sense of scale, in the last fiscal year, they did $630 million in revenue, that was 57% growth over the prior year. The margins here are just fantastic, 85% gross margin.
They are spending big to kind of build out their offering, Dylan. We saw SG&A was $630 million, the same as revenue, R&D was $400 million. So, they put up a big operating loss but a huge chunk of that, no surprise, stock-based compensation $426 million in stock-based compensation. So, the numbers look pretty ugly, but on a cash basis they're not nearly as bad.
Lewis: I think tech investors, specifically [laughs] folks that are focusing in the software space, have gotten used to this, you got to spend money to make money type approach, with these early, high-growth software companies. The thought is, we'll make the money later, let's really focus on building out our customer base, making sure that we're not too reliant on any one customer, and that they don't become such a critical part of our revenue share that we're really reliant on them.
And then also, you know, kind of, striking while the iron is hot. The reality is, if you create a space -- and I think Slack, kind of, did this -- if you create an enterprise software segment, other people very quickly are going to realize that it's a pretty darn good idea and they're going to hop in. And so, unless you can grab as much land as possible, as early as you can, very quickly, you're going to realize there's not too much to grab.
Feroldi: Yeah. Stewart Butterfield pointed this out in the interview we're going to be covering. He basically said, companies didn't have a budget for Slack ahead of time, so they kind of went in and have to sell their product as a whole new category to go after. And the numbers clearly show they're having success at that. So, this is a company with 110,000 paid customers, that was up 25% last year, almost 900 customers are paying more than $100,000; 70 of them are paying more than $1 million. And, Dylan, the number that we both love to see here, net dollar revenue retention rate, 132%, that means they're getting 32% more revenue from their existing customers each year, a great business model.
Lewis: Yeah. Put another way, without any new customer acquisition, they're still growing that business over 30%, which is pretty incredible. We're not going to spend too, too much time on the financials, just because we've done it before and we want to get into this competitive dynamic with Microsoft.
The thing that a lot of people will look at for something like this, Brian, is the user base, right? That's, kind of, like the lifeblood of all of these platform businesses. Unfortunately, for Slack, we don't really get a great daily active number from them. They've updated it a little bit here-and-there as things have, kind of, gone along with them as a business. We do know that they have about 12.5 million concurrent users, which I have to imagine is less than daily actives, though I'm not 100% sure how they're calculating that number.
One company that does provide us a daily active [laughs] number is Microsoft, which is kind of the chief competitor for Slack. And they reportedly have 75 million daily active users, up from, wait for it, 32 million in early March; that's pretty incredible.
Feroldi: Just crazy to think about. And the even more crazy thing is that Microsoft Teams, again, they're Slack competitor, was launched several years after Slack. So, this was in response to Slack, launched after it. And they have basically gone parabolic with their user growth. So, no surprise to see that investors have some questions about; is this a Slack-killer?
Lewis: Yeah. And that's been the lingering question, as this company has going public, you know, we tend to see a lot of fanfare around the IPOs that are consumer-facing. And you look back at last year and there were a lot of them, right, there [laughs] was a Lyft, there was Uber, there was Slack. And there's so much expectation built into an IPO, period, but then you add the fact that people actually know what the company is and they [laughs] know what they do, and maybe they even use the company. You have this host of retail investors that are possibly interested, and you also have all this additional coverage because news outlets love talking about these highly valued private companies.
The big question throughout the roadshow and I think throughout the first year, really, that this company has been public traded is, as we get a sense of what their books look like with these quarterly updates, are they going to get burned by Microsoft? And are they going to wind up really having their lunch eaten by a much larger company?
Surprisingly, Slack CEO, Stewart Butterfield, said that Microsoft Teams isn't really a competitor to Slack; which seems a little counterintuitive.
Feroldi: Yeah. This was about a month ago on an interview he said, "Microsoft Teams isn't a competitor to Slack," but then, Dylan, just a few days ago, we actually saw an interview that he did with The Verge and he basically said that inside Slack, "Microsoft is unhealthily preoccupied with killing us, and Teams is the vehicle to doing that." So, that's a little bit of doubletalk, if you ask me.
And when we run through this company, when we dug into the details of Slack initially I think, both of us came away pretty impressed with the growth that we were seeing, the stickiness that we were seeing, we both liked the product, but to me, this has always been the big question mark here. So, it is telling that Butterfield has said, Microsoft isn't a competitor and Microsoft is trying to kill us.
Lewis: Yeah. And I think the way to parse that is, in Butterfield's view, it's like the firm view [laughs] for Slack is Microsoft is not a competitor, like, we do different things. I think he's saying here, Microsoft views Slack as a competitor and they want to do everything they can to destroy this company. [laughs]
Feroldi: Yeah, I think that that's fair. And just so we're clear, the reason he doesn't view Teams as a direct competitor is because Slack is primarily a messaging tool. And if you look at Teams, the primary use for Teams, while it does have messaging capabilities, it seems to be more integration with video and voice calls.
So, in Butterfield's mind, Teams is a bigger competitor to a company like Zoom than it is necessarily to Slack. And here at The Fool we use Slack, it's a tool that we use, and we also use Zoom, we're on Zoom right now, Dylan. So, we certainly have used both features. We don't use Teams, but it's interesting to see, if we did use Teams, which one of those would be impacted, usage of which one would be impacted in our company, I don't know.
Lewis: Yeah, you know, I've never used any of the calling features in Slack, to Butterfield's point on this; and I think that it's a good one. What's interesting is, we also pay for the Office Suite, right? [laughs] We have access to all of this other stuff for our full-time employees, including Outlook. And that's, kind of, our main scheduling resource. And so, we are, kind of, a business that is managing to take a little bit of everything and decide what makes the most sense. I think that that's the institutional outlook for Slack.
Now, that doesn't mean that's what Microsoft views. And it sounds like, increasingly, they are focusing on Slack as a major competitor. And the reason for that is, if you think about it, what we're using Slack for is messaging; we're using it for corporate communication. And what we're really doing is moving further and further away from email, which is, kind of, Microsoft's bread-and-butter and really the easiest foundational piece of their enterprise software offerings.
Feroldi: Yeah, Microsoft, obviously has the numbers here. They can probably deduce which customers of theirs are using Slack. And as we said at the top of the show, once we started using Slack here at The Fool, the number of emails that we get in a given day, internally, has just plummeted. So, there's no doubt [laughs] that that is a competitive threat to Microsoft, because Outlook is a major component of their Office 365 bundle. So, it makes total sense that they've seen that trend, they're worried about Slack and they're doing everything they can to, kind of, build themselves up to be a competitor and pushing Teams. It makes complete sense.
Lewis: Yeah. And if you're Microsoft, you like having the leverage of this huge bundle, right? And there's all the strength that comes from being able to say, "Well, we'll be able to give you Outlook, we'll be able to give you access to all the scheduling that comes with that, all the email that comes with that, we can roll in some cloud stuff, you have the Office suite. By the way, we have Teams, which is, we'll just throw that in for free and make it [laughs] really similar to Slack," right?
There are all these ways that they can bundle and offer that strength and leverage. If email is weakened, I think, the cornerstone of that enterprise offering winds up being a lot weaker.
There's also a bit of history here, though, with Microsoft and Slack. And I think it's worth diving into a little bit, because while we have the core strategic elements of this, it seems like there's also a choice that management made a couple of years ago that really solidified how they were going to be viewing Slack in the marketplace.
Feroldi: Yeah. Again, so if you rewind, so Slack was officially launched in 2013. And three years later, Slack had about 2 million users or so. And reports surfaced that Microsoft was interested in purchasing Slack outright for a price of $8 billion. Whoa! I mean, on 2 million users, if that is true, that should tell you about how big of a threat they viewed Slack being in the long-term. Ultimately, the deal didn't get through, but the Microsoft management team, purportedly with Gates and Nadella, really said, OK, this isn't going through, this is a long-term threat, we need to create something that competes with Slack, and fast.
Lewis: Yeah. And I think to your point about how much they valued the competitive threat, I think, Slack's valuation at that time was somewhere around $3 billion to $4 billion. So, that sticker figure thrown out there of about $8 billion, that's a serious premium. And had they bought them at $8 billion in 2016, their current valuation is, like, $18 billion. So, you know, it's possible that that would have actually been money well spent from Microsoft. But Bill Gates and Satya Nadella, I think, were two of the big ones who said, you know what, it doesn't makes sense for us to buy this business, we can go out there with everything that we have already and wind up creating something that operates in this space, and bundle it so well into what we do already, why go out and pay this premium?
And we're at this point now, I think, with Bill Gates, where he's like soft and cuddly Bill Gates, you know, like, [laughs] he's giving money away, he's doing all these nice things, he's charitable, we're a little bit far removed from killer instinct Bill Gates, and that guy still exists, I'm sure he's out there. [laughs]
Feroldi: Bill Gates. The Microsoft Bill Gates is a ruthless competitor. And he became the richest person on earth for a reason. In fact, if you look back to Microsoft's history, this isn't the first time that Microsoft has done something like this. I mean, anybody who's paying attention in the mid-1990s noticed that Microsoft completely ignored the internet and then Netscape, kind of, came to dominate the browser market and then Bill Gates said, hmm... we should make a browser of our own. And they decimated Netscape. They gave their browser away for free, they leveraged their relationships with businesses and just absolutely took that market. It did end up going into a legal action.
And it's not out of the question, Dylan, that we could see a similar fate here. But I do think it's worth pointing out something that Butterfield said as a retort, because he is so used to this question, right? Microsoft is the 8-bazillion pound gorilla in the room, they have relationships with basically every major business on earth, there's no doubt that they've used that scale and those relationships to roll out Teams so rapidly and so aggressively.
And he recently said this, he basically says, Teams has been a threat to us for the last three years and yet our revenue has doubled and then doubled again. The idea that Microsoft could just crush Slack and go away is false, because if they could have, they would have. And I think he has a point there. We've still seen Slack growing, we've still seen the company having success, customers are clearly spending more. So, it's a little bit of a fallacy to automatically assume a big company can instantaneously crush a little one, but that doesn't mean you should ignore the competition either.
Lewis: Yeah. I love this other quote from him, "The small, focused start-up that has real traction with customers sometimes has an advantage versus the large incumbent that has multiple lines of business." And the point there, and I think this also ties back to how he views his business versus Zoom or something like that, is, hey, we're laser-focused on this one thing and we're really good at it; that's a competitive advantage. You know, when you start getting into bundling that means that everything needs to work together, there are probably some trade-offs that come along the lines because you want that interoperability and you want to be able to sell these things together, and you want everything to move cleanly.
So, having that narrow focus can be an edge and it also means that they're a lot more nimble, you know, they don't have to go through these huge corporate bureaucratic [laughs] meetings in order to make things happen, they can, kind of, decide things on-the-fly a little bit faster. And I believe this is still true, and I don't know if it's still true, but it was a couple of months ago, Slack has far more integrations than Microsoft Teams. And so, if you're thinking about usage and being able to bundle other stuff into that product, you're paying for them separately, but if you're thinking about usability and user experience, Slacks seems to be a superior product there.
Feroldi: Yeah. I would 100% agree with you there. And to your point there, how many video operators were there before Zoom existed? I mean, tons, there was plenty of competition, and yet, Zoom was really the first one to come to market with a solution that actually worked. And you've seen how incredibly successful the company has been and we've seen this over-and-over in tech. Again, Facebook was not the first social network, Google [Alphabet] was not the first search engine, but those products ended up winning out because those companies were laser-focused on them. So, there is an argument there.
Lewis: Yeah. And it would have been easy to say, well, you know, there's no way that this search engine business [laughs] in California is going to come out and do anything in the face of Microsoft and this huge internet empire that they were able to build with Internet Explorer. Well, it happened.
You know, it would be easy to say, oh, well, there's no way that Facebook could thrive, look at how many people are already using Google products, they're just going to be able to layer something in, it still happened.
And I don't know that Slack hits the ubiquity of some of these mega-caps that we're talking about now, but I think if you offer a premium product and you offer a better experience, people are going to pay for it. Especially enterprise accounts where you're not just using it as one person, any benefits there are ones that are enjoyed by hundreds or thousands of employees.
Feroldi: Yep. Now, let me ask you a question here, Dylan. We both love Slack, we both like the product, we love founders, we love fast growth, we love high retention rates, etc. What do you think of Slack, the stock?
Lewis: Ooh! Yeah. So, this was on a, like, I want to wait for a while type spot on the bench for me. You know, when they debuted, I think their price-to-sales was somewhere north of 40. It was just a very rich valuation; kind of, going back to what we were talking about before with, you know, there's a lot of hype around this, and a lot of people knew the name already and a lot of people have been waiting for this company to go public. Add to that the fact that it's a wildly profitable business model -- that gross margin number you threw out there before, 85%, the retention rate was really high. That led itself to probably get a little ahead of where it should have been valuation-wise. And I generally like to see businesses trade publicly for a little while before buying-in.
Right now, it's been, kind of, like a lost year for them, they traded below where they were in terms of their IPO price. I think they're a lot more attractive on a valuation basis. I think they are somewhere down in the, kind of, $20 billions now, which makes a lot more sense, it's still rich, but it's a lot more palatable, especially for a software business. I think that they're a pretty attractive business, especially if that dollar net retention number winds up staying around where it is.
Feroldi: Yeah. I think that that's fair. For me, I've always felt that messaging is a hard thing to monetize, maybe that's just a bias that I have against them. I would much rather invest in a video company or an audio company or a company that does something else, I've always just thought that messaging is so much easier to commoditize. When you throw in the competitive threat from Microsoft; I haven't taken Slack seriously as a company, but, hey, this company reports earnings on June 4th, so just a few days from now, I'm sure we're going to learn a lot there. And I could see myself getting more interested if the numbers clearly show, despite Microsoft's best efforts, Slack is still having success.
Lewis: Yeah. And this is, kind of, one of those pivotal moments for this type of company, right? They are one of those businesses that is uniquely positioned to do very well right now because, hey, we're like a highly decentralized business and we are using this product more than ever. You know, we've been able to continue our operations and do everything that we normally would be doing as a company thanks in large part to Slack. You know, you can throw Zoom in there too and Microsoft has helped us out a lot. But this is highlighting the strength of their product and if people don't get it now, it's, kind of, harder to make a more compelling pitch than that.
The only thing I'll add, it seems like I'm slightly more bullish on Slack than you are, Brian, is, I don't at all doubt their ability to keep customers. I think that the product's strength is there, the platform is really great and the lore of the story is that Slack is actually an acronym for Searchable Log of All Communication and Knowledge. And the idea here is, basically, the more you Slack, the more valuable it is, because you have these channels that retain all this institutional knowledge, it's searchable, it's easy for new hires to find and immediately have access to totally a different story than email.
So, I don't think they're going to have a hard time keeping customers, but I do wonder if Teams makes it harder for them to acquire new ones. That's really what I'm watching for this business.
Feroldi: Yeah. I think that's completely fair. And that 20X sales, boy! do they still have to acquire new customers, so whether you own it or not, I think it's going to be a great business story to follow for years to come.
Lewis: Yeah. Before we wrap, I want to take a listener's question. Brian, earlier you mentioned IndustryFocus@Fool.com, that's where we love getting the emails, we like getting love there.
I made a smoked lamb recipe over Memorial Day thanks to one of our listeners, Tom, writing in with a recipe, and I think I posted that on Twitter for folks that wanted to see it. So, not only do we take questions, but we also take recipes, thoughts, ideas and then listener love.
We have one from Manrique who writes in, "Hey, IF team, thanks for the podcasts, I enjoy what you do and learn listening. I'm a regular follower of the podcast and a Rule Breaker subscriber." Thanks, Manrique. "Tech companies report acceleration or slowdown of app downloads per quarter and I was wondering if there is a tool available to the public to track app downloads? Thanks."
And this is kind of a tough one, Brian, because there's a whole cottage industry built around industry analytics, market research. Unfortunately, [laughs] a lot of that stuff is not available for free.
Feroldi: Yeah, that's right, but there are some free resources that you can look at to get information. So, a free and easy one for people to get to know is App Annie. You can make a free account there to learn what apps are being downloaded the most. I also reached out to our tech expert, Tim Beyers, to ask him this question, to see if he had any other sources to pitch. And he gave out Gitstar-Ranking, which is an unofficial GitHub star ranking for users and organizations.
If you're into the database market, then you want to check out a company, like MongoDB or Oracle or Amazon and see which databases are winning. DB-Engines.com is a source, and then there's another one called, Stack Overflow, where you can also get some insights into what's happening behind the scenes.
But if you want links to any of these, again, IndustryFocus@Fool.com, we're happy to share.
Lewis: Yeah. and what's unfortunate is, with a lot of these free accesses; App Annie is one and I think Sensor Tower is another, that are a little bit more consumer-facing. The ones you threw out there were, kind of, a little bit more in the weeds on the tech side. You tend to get rankings, you don't tend to get download figures. And that can be kind of frustrating. But a lot of those places will let you slice by app types. So, if you're looking for gaming, if you're looking for news, if you're looking for maybe video conferencing or, you know, some form of enterprise communication, you can often slice that way and see who's rising the in ranks and who's falling in the ranks and, sort of, by different timelines. Unfortunately, it can be really tough to get actual download figures. Because that's how a lot of these companies that report all this stuff actually make money. They [laughs] have people that pay very expensive subscriptions for access to that information, Brian.
Feroldi: Yeah that's a great point. So, yeah, if you find anything and you think we should know. Please let us know, we would absolutely love to know that.
Lewis: Yeah. And if you have anything else for us, like, we're saying, write into the show IndustryFocus@Fool.com or you can tweet us @MFIndustryFocus.
Brian, thanks so much for hopping on today's show and talking Slack, Microsoft, and apps with me. I always love it.
Feroldi: Always fun, Dylan. Have a great weekend.
Lewis: You, too. Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out, like I said, IndustryFocus@Fool.com. If you want more of our stuff, subscribe on iTunes or wherever you get your podcasts.
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 Austin Morgan for all his work behind the glass today. For Brian Feroldi, I'm Dylan Lewis. Thanks for listening, and Fool on!