Is Slack Stock a Buy?

With the coronavirus driving organizations to adopt work-from-home arrangements, the expectations heading into Slack's (WORK) fiscal second-quarter earnings report on Sept. 8 were high. Adding to the pressure, video chat phenom Zoom Video Communications reported jaw-dropping revenue growth in its earnings announcement just eight days earlier. Even though the team collaboration platform beat its own top-line guidance, the stock pulled back as analysts cut their one-year price targets based on what they viewed as a disappointing quarter.

Data by YCharts.

Given Foolish investors shouldn't pay too much attention to analysts' short-term projections, could this be a good time to buy? Let's find out.

The bull argument

Revenue hit a quarterly record of $216 million, up 49% year over year. The platform attracted 8,000 new paid customers, representing a 30% gain over the previous year and an acceleration from the first quarter's 28% growth. Slack added a net 265 large customers paying over $100,000 in annual recurring revenue to reach 985, an increase of 37% year over year. This was despite 50 clients dropping below the $100,000 mark as their seat count (the number of employees on Slack) was reduced during the period. That cohort now makes up 49% of the top line, up from 43% in the prior-year period. The biggest customers, those paying over $1 million in annual recurring revenue, increased 78% year over year to 87.

Engagement on the platform continues to be high with users connected 10-plus hours per day and logging 100-plus minutes of active usage. Organizations using Slack Connect, the feature that allows teams to create shared channels with other companies, grew to over 52,000 with the number of users in the Connect network growing to 380,000. Both figures were up triple digits, building up a valuable network effect among users. This inter-organization tool has become a marketing funnel to reach potential customers organically without having to expend internal marketing or sales resources. 

Bulls saw an impressive quarter in a difficult economic environment and a platform that users love.

Image source: Getty Images

The bear argument

Even though remote work arrangements are more commonplace now, Slack's growth is slowing on multiple fronts.

Data source: Slack earnings presentation. FY = fiscal year. ARR = annual recurring revenue. All growth percentages year over year.

Revenue growth declined sequentially and year over year. Billings growth was cut in half as customers trended toward shorter contracts, and the company accepted $11 million in coronavirus-related hardship billing concessions in the first half of 2020. The pace of large customer growth is also slowing, as is Slack's net dollar retention rate.

Meanwhile, Microsoft's competing product, Teams, continues to grow unabated and boasts 1,800 customers with more than 10,000 users. Even though Teams was released three years after Slack, Microsoft is investing heavily to improve the service's features, intent on giving the small disrupter a run for its money. 

Bears think that slowing growth and ramped-up competition from a deep-pocketed software giant could relegate Slack to serving a niche market, limiting its long-term potential.

The impacts of the coronavirus

Surprisingly, the coronavirus has been both a tailwind and headwind for Slack. New customer adoption has been the primary tailwind. Over the last two quarters, it added about 20,000 new customers, nearly doubling the additions it experienced in the same period last year. It's also seeing higher conversion rates from its extended 90-day trials than before the coronavirus. Management views this as a sustainable increase in its baseline growth rate that will have benefits down the road.

CFO Allen Shim explained in the latest earnings call: "These [new customer] cohorts take take time to expand over many quarters, if not more like two to three years on a cumulative basis [...] But that will be an ongoing tailwind for us just given the land-and-expand dynamic that we have."

The coronavirus headwinds come in a couple of forms. First, the aforementioned seat loss and slowing spending growth with current customers is a drag on the top line. Secondly, the pandemic caused significant disruption to Slack's prospective customers. CEO Stewart Butterfield shared that chief information officers were in "crisis mode" to support their employees' remote work arrangements. Setting up laptops for secure remote connections and video chat services for business continuity took precedence over implementing a brand-new collaboration tool. But that perspective could change with time.

As remote arrangements become permanent in some form or another, business leaders will be looking for ways to better engage and collaborate with employees virtually. Slack's platform is well positioned to become a critical part of the digital office toolbox for many of the millions of businesses around the globe.

So is Slack a buy today?

In June, I addressed the same question and concluded: "If you don't mind taking a little risk on a scrappy upstart with an exceptional product and a solid management team that isn't scared of its heavyweight competitor, this stock is a buy."

My view hasn't changed since then, but Slack's price-to-sales ratio has declined from 26 times to a more palatable 19. I would still recommend buying in thirds and consider keeping your position small as this tech stock may be more risk than you want in a core portfolio holding.