The software-as-a-service (SaaS) business model worked wonders in 2020. Demand for all things digital spiked during the pandemic and businesses flocked to the low up-front costs of subscription-based services. The model worked well for investors too, as the recurring and predictable revenue from SaaS companies proved resilient during the economic downturn. Many SaaS stocks were up double-digit -- or even triple-digit -- percentages.
The future remains bright for software delivered in this fashion, and Wix.com (WIX -0.14%), Medallia (MDLA), and Bandwidth (BAND -4.44%) look like three promising picks for 2021.
1. Wix: Helping small businesses navigate new e-commerce challenges
Shelter-in-place orders and social distancing sent e-commerce into the stratosphere, and I see no reason for it to go backward in 2021. E-commerce and related services like digital payments and digital marketing are still exceptions rather than the rule in most parts of the world, however, and I think Wix.com and its subscription-based, cloud-based website development business remain a top way to play the global growth of the trend.
Image source: Getty Images.
Unlike other e-commerce stocks, Wix is more a play on businesses and entrepreneurs themselves making the migration online -- an egg rather than a chicken type of investment. I like this positioning. After all, if consumers are to make online spending decisions, they first have to have a place to go to on the web from which to make said decisions. And Wix is helping its business customers do this in a big way. At the end of September 2020, Wix's total user count had increased to 189.4 million (up 19% from 159.5 million a year ago), and premium subscriptions were 5.31 million (up 20% from 4.41 million a year ago). As a result, the company's annualized recurring revenue increased by 24% year over year to $841 million.
Wix stock has done well amid the boom in e-commerce, more than doubling in value in 2020. However, Wix is still a small-ish company with a market cap of just over $15 billion as of this writing. When global consumer purchases are measured in the tens of trillions of dollars every year, suffice to say Wix is barely a blip on the map. Also of note is that this is a profitable growth company. While the bottom line isn't its top priority at the moment (Wix plows the cash it generates from its operations back into expansion efforts), it did generate free cash flow (revenue minus cash operating expenses and capital expenditures) of $106 million through the first nine months of 2020.
Headed into a new year and with the pandemic still wreaking havoc on the world, I say Wix remains a timely buy as businesses look for help navigating the new normal. And with the long-term potential beyond the pandemic still mostly untapped, this e-commerce SaaS stock should have many more good years ahead of it.
2. Medallia: A rare SaaS play on economic recovery
Not all SaaS stocks have been success stories in 2020. Medallia, a little-known name in the "experience management" segment of the software universe, is a case in point. Shares are up "only" 13% this year, but they had lost some 40% of their value during the worst of the economic lockdown during the spring. So much for SaaS being a slam-dunk investment.
However, Medallia's financials have remained very stable this year, so what gives? Revenue was up 20% through the first nine months of the company's 2021 fiscal year (the 12-month period ending Jan. 31, 2021) to $349 million. But the pace of growth slowed early in the year, and many investors were worried that Medallia's customers would take a break from using software to measure the effectiveness of digital communication. In part, this did indeed transpire: Many enterprise software investments were put on hold as organizations took stock of their budgets during the pandemic.
Also of concern to some investors was the total net loss of $100 million Medallia racked up so far in its current fiscal year (although free cash flow, which measures actual cash burn, was a more modest negative $26.0 million). This SaaS play is returning to pre-pandemic growth, but its loss-generating operation is simply not going to sit well with everyone.
However, for investors looking for a growing software play, I like Medallia's positioning. It's a leader in experience management, with an AI-based subscription platform that helps customers automate and predict the best actions to take with their digital applications. And $654 million in cash and short-term marketable securities isn't going to hurt this small firm's chances at staying in growth mode. Trading for just under 11 times trailing 12-month sales and with a market cap of just $5.3 billion, Medallia looks like a buy to me as corporate budgets normalize from the effects of the pandemic.
3. Bandwidth: Betting on the cloudification of communications
Online video conferencing turned into an essential service in 2020. Zoom Video Communications (ZM -1.26%) went from a little-known internet company to a household name. But Zoom Video is an incredibly expensive stock at this juncture, and the jury's still out on how long its epic rise can last. Bandwidth -- which counts Zoom, Microsoft, and other tech giants and digital communications companies as customers -- might be a much more palatable investment option.
Bandwidth offers subscription access to its library of APIs -- software industry parlance for the ability to embed digital capabilities into applications. Specifically, Bandwidth's APIs enable voice, messaging, and 911 access in an app. Given the fast-evolving communication landscape, Bandwidth lies at the heart of a massive movement -- peers like Twilio (TWLO -1.75%) have soared in the last year. But investors have already piled into Twilio, much like they have with Zoom Video. Those two companies trade for a respective 34 and 62 times trailing 12-month sales and have market caps of $60 billion and $117 billion, respectively, as of this writing. Broadband, by comparison, trades for just under 16 times trailing 12-month sales and has a market cap of just $4.6 billion. Talk about a relative value.
That isn't to say Bandwidth is a slouch -- far from it. This SaaS company's revenue is up nearly 35% through the first nine months of the year to $230 million, including a 40% year-over-year increase in Q3 alone. It also operated at nearly breakeven. Free cash flow was only negative $51,000 through the first three quarters of 2020. For a company trying to maximize its growth, that's not a bad figure. It means Broadband is self-funding its expansion at this point.
And as a final positive, Bandwidth had $531 million in cash and short-term investments on its books at the end of September. As cloud-based subscription communication services become an increasingly important function of the business world and everyday life in general, Bandwidth is well-positioned to continue growing for some time. Headed into 2021, this looks like a timely cloud SaaS stock. I plan on making a purchase.
