In this episode of Industry Focus: Tech, we break down Squarespace's (NYSE:SQSP) massive user base, why growth is generally fueled by new users, and how the company stacks up to competitors like Wix, Shopify, and BigCommerce.

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This video was recorded on May 28, 2021.

Dylan Lewis: It's Friday, May 28th, and we're talking about a frequent podcast sponsor gone public. I'm your host Dylan Lewis. I'm joined by longtime Fool and 2015 father of the year, Anand Chokkavelu. Anand, how are you doing?

Anand Chokkavelu: I'm doing great, Dylan. Very happy to be here.

Lewis: Regular listeners, the show might be a little surprised to not have an iterative tongue twister in there, but I like the 2015 father of the year. That's fun. Is that self appointed or do you have a mug to support that?

Chokkavelu: Well, I mean, I think the voting was rigorous. People will keep asking those restaurants 2008, Best Restaurant in DC, wait, what happened since 2008?

Lewis: You're saying you're resting on your laurels?

Chokkavelu: Yeah, I've gotten top five places in a couple of years, but having climbed that mountain again.

Lewis: Well, I'm delighted to have you. For Fools that may not know, you were basically my first boss at The Fool and we spent a long time together in editorial, both understanding the content world of talking about stocks, but also I have learned so much from you in how to look at businesses. You're one of those people that I have cited often in my own investing approach. Really happy to have you on to do a perspective show today, because we're going to be talking about Squarespace and dig into their perspectives.

Chokkavelu: I'm a big-time listener, [laughs] so I'm excited to actually be on one of these S-1 shows. I usually listen to it to crib notes from it.

Lewis: Well, I love that I can provide some value to you. Hopefully some value to all of our Fool listeners out there as well. I think this is one of those fun ones because Squarespace is a business. I think a lot of people already know who they are and what they do. They have for a long time blanketed the Digital Media space with ads and in the same way that a lot of insurance companies really want to be in your brain when it comes time to make that decision. That's what they've chosen to do with their own marketing approach. For folks that don't know, they are really focused on making it dumb simple for people to build a brand and transact online in a beautiful and simple way. Their mission statement, ''We enabled billions to build a brand and transact with their customers in an impactful and beautiful online presence.'' The vision gets at something very similar in, but the idea here, and we've seen a lot of success with these types of businesses, is let's take something that's complicated, it involves a lot of technical knowledge, and make it very easy for the end-user.

Chokkavelu: Absolutely. They provide that all-in-one spot for creators to build that website and also do e-commerce behind it. There are a lot of competitors there, but they really make it simple along with a couple of other folks.

Lewis: Yeah. For people that maybe have heard things, it sounds similar to this, but maybe not Squarespace in particular, Wix is a big competitor and depending on the individual functionality that you're looking at with their website. We're going to be pulling in Shopify, we're going to be pulling in BigCommerce through this conversation as well, because there's a very large commerce component to what they do. At core, I think most people know them for helping them create a digital presence. What does that look like? It's websites, it's domain creation, it's social media assistance creating professional, email tools, and some enterprise solutions. The commerce side, I think, is where this business starts to get interesting. I think there are a little bit more limited in their functionality there than some of the other players I just mentioned. But they are making investments there and they also have some marketing tools. The idea behind, if you're a creator, if you're a small business, you can come here, have a relatively easy drag and drop solution to building a website and getting some of those initial commerce and transactional oriented tools into the mix.

Chokkavelu: Right, Dylan. You look at Shopify and you look at its pricing and it's like we talked about that e-commerce upside. I think the top 10 it's 10 times more from a place subscription with Squarespace. That will definitely be a challenge that we'll talk about.

Lewis: It is, and I think it's unavoidable when you talk about Squarespace to also talk about Shopify because the founding story is going to sound incredibly familiar to a lot of people. I'm just going to pull this quote straight from the founder's letter in the S-1. ''When I tried to build a website for myself, I was immensely frustrated by the lack of polish and integration work required to build even something simple using technologies available at that time, Squarespace was born out of that frustration.'' That's straight from the founder and CEO, Anthony Catalina. I think we've seen a lot of success with executives, specifically founders, identifying a problem, solving it themselves with a product and then bringing that to market.

Chokkavelu: Yeah. Rumors are later in the S-1. He is talking about it. It just sounds generic and then you think about, well, this was like 2003, 2004 when he was founding the company and especially back then this was really pretty pioneering.

Lewis: It was, yeah, and I think we have to take that step back and remember where the Internet was in 2004. This is a business that has the classic valley founding story in that it was built in his college dorm room not far from us at full HQ with University of Maryland. It was a bootstrapped business for a long time. They launched in 2004, hired their first employee in 2006. I know tracing my own Internet history back a little bit around that era, I was a WordPress personal blog guy. I mean, the functionality and really what was out there for building your own stuff from scratch, if you weren't someone who had technical skills, it was pretty limited.

Chokkavelu: I mean, this was before the whole Dylan enterprise took off and you needed those e-commerce solutions before you were in the SCO and all of that stuff.

Lewis: You should see the gross merchandise volume and total payment volume coming through now on it. [laughs] I think with this business, they very smartly saw where the market was going and what people needed because the early on, I think everyone was like, ''I need to be online, I don't really know what I need to be doing online, but I need to be there.'' It was more of a point-of-contact, I think, as we've seen these tools get more and more sophisticated. What we see is, in the Squarespace case, the introduction of commerce functionality. That's key, because I think it's going to be a really big part of what drives their growth going forward. It's also important because I think we've seen a lot of successful businesses tap into that part of this market in particular.

Chokkavelu: Yeah. I mean, you only need to look at the valuation of Shopify to see the potential there, right?

Lewis: Yeah. It's massive and I think the more that you can bring into the fold, we talked about it all the time with Software-as-a-Service providers, but really any platform provider. The hard part is getting people in the mix. Once you start layering things on top of that, that's where you expand your relationship. You hopefully see the value of those customers increasing over time and the value that you're providing to those customers also increasing over time.

Chokkavelu: Yeah. I got to thinking it's pretty sticky once you put a website or a blog or your company's stuff on a platform. Yeah, of course you're going to say, ''Yes, please provide me with that SCL help, provide me with a sharper e-commerce solution, provide me with anything that just puts it online and does it for me.''

Lewis: Yeah. Especially, I think, in the lower end of the market where you have small businesses that are often very leanly run, it could be a sole proprietorship or a very small team. I mean, you think about the upfront investment of learning how to use a web platform to create your digital presence. Do you really want to, if that's not your expertise, have to switch doing that every couple of years, probably not. If you find something that's really adequately fitting, what you need to do as they roll in more things, you're just going to continue to be a customer of that platform.

Chokkavelu: We've all been in those restaurant sites where you're surprised. They even have a website and you realize they haven't updated it in seven years. [...] hasn't been there.

Lewis: It looks like the old school space jam website for anyone that had followed that story online. Recently updated, unfortunately. But a nice, relatively old Internet. No surprise here when you start to look at how a company like this makes money almost entirely from subscription revenue. I think this is great for a variety of reasons. I mean, we're Brian Foley here, frequent contributor to the show, he'd be like, "All right, that's a big check, subscription revenue was saying we often look for, in this case, 94% of revenue coming from that." It makes sense for a business like this, because generally you want that symbiotic relationship. You want the customer using something and having. It makes sense for them only and as much stuff gets value out of it. What we see in Squarespace's case is a monthly subscription and an annual subscription and the pricing is pretty competitive for people coming in and just getting started with their solutions on it.

Chokkavelu: Right. Plans start around $12 a month and they go up to $54 a month depending on the functionality you need. Are you just hosting a blog like Dylan did back in the day, or are you selling stuff online and you need that functionality and whether you pay monthly or annually? You're talking about a few hundred dollars a year, but for millions of customers. We'll be talking about 3 million-4 million ending subscribers in 2020.

Lewis: Yeah.

Chokkavelu: One thing on that 94%, as we go along that upside, we want to see that go lower. Because the other stuff is the revenue sharing with payment processors like Stripe, PayPal and Square, the free-to-pay use. That means that people are actually having high GMV on their sites and then revenue from third-party services offered to their customers. That's only 6% of their business right now, so that's a big potential opportunity.

Lewis: It's an upside for them. I think they're going to have a hard time capturing it because that part of the market is so competitive. One of the things that I loved in our preparation for the show, Anand, was you did a quick breakdown on where they are with their current revenue, where they are with their current subs and just doing a back of the envelope on what that gets you to in terms of a customer per year. It's helpful to gut check some of the numbers that we see from a business.

Chokkavelu: Right. I should have just gone to the ARPU table like you did. But likely, the numbers were pretty close. If you take around $620 million in sales divided by that 3.66 million ending subs, you get around $169 per customer per year or $14 a month, which remember, the low-end of their offering is $12 a month. That makes sense, that jives. Obviously, you have customer churn and acquisitions throughout the year. Some customers haven't been there the whole year. Some maybe only were there at the beginning of the year and turned off.

Lewis: Yeah. It's helpful even if you get numbers in the prospectus to do your own math and just make sure that you're thinking about it the same way. Because even if you're like, yeah, I wound up in the same place, at least you understand the inputs for how you're getting to that end number. In their case, yeah, I think it's worth highlighting a couple of metrics here , you hit it before, 3.6 million unique subscriptions, a very big customer base for them. That's because for the most part, they're focused on the lower end of this market.

Lewis: When you look over, one of the things I've been surprised by with them is we look at the subscription businesses and we talk about the value of being a great provider and that flowing through in what you see in terms of spending increasing from existing customers. Some of that is delighting them, being able to increase the value that you're offering to them. Some of it's being able to exert pricing power and be able to say, we know we're offering a pretty good solution. We can raise our prices every now and then. You see it within Netflix. The content library is undeniable, it gives them that opportunity. In their case, ARPU has trended up, but it hasn't trended up too dramatically, especially for a business that is so reliant on subscription revenue. You go back to 2018, we're seeing it at $178, 2019 $182, and most recently in 2020 $187. I have to be honest, it's a little smaller in terms of growth than I would expect it to be.

Chokkavelu: It is technically a software as a subscription service. It's a SaaS company, but we're used to SaaS companies that go to large enterprises and you do that land and expand and all these things you can upsell folks on. If you are selling a basic subscription that maybe you can get them to a little more functionality as people go to e-commerce and stuff. But if you're running a blog and you have been for five years, what are you going to do? You're just going to pay that $12 a month.

Lewis: I guess that's just the reality of the space that they operate in within this market. There is some upside. There is expansion opportunity with the individuals just running their websites or very small businesses, but perhaps a little bit less than we are used to when you get into mid-market and up-market solutions.

Chokkavelu: They need more people spending other people's money.

Lewis: Generally, that's a pretty good business model, if you can figure that out in terms of how this all comes together for them as a business. I think, Anand, before we even get into the financials, I was about to just start tearing into it, we probably need to add a little caveat here, a little asterisk.

Chokkavelu: Yeah, please don't lose this. This is the hard part of the podcast, the caveat before we get started is as part of the direct listing. There was a conversion of preferred stock that was pretty confusing to us. The pro forma numbers they had, seemed to kick what were preferred dividends. Now the preferred stock was converted into common, and now there's an income statement of facts so there's more expenses there. Here's our best shot at parsing what all this means. Revenue for 2020 was north of $600 million, that was up 28% year-over-year and was 24% the previous year. So, decent growth. Then if we compare, well, the gross margins came in at 82%, which is strong, but they spend a lot in all their categories. So, 50% of sales is on G&A expenses, general administrative, 42% of sales is on marketing and sales, and then 28% is on R&D, research and development. Now, if you're a quick math person, you realize that that adds up to more than 82% and more than 100%. That results in an operating loss of 38%, right, Dylan?

Lewis: Yeah, and for a business that is in this type of land-grab space, I think anyone that is looking at digital footprints, online commerce, moving stuff online, you'd say, yes, the story has been around for a little while, but we're probably an inning three of a game that's going to be played out over certainly the next 10 years, probably well beyond that though. With a lot of these businesses, you're willing to accept those losses because the customer acquisition time is now. But that said, yes, operating losses are coming at you. [laughs] There is a little bit of funkiness to this because if you look at some reports, they seem like a profitable business but because of the caveat that we had to provide up top with the funkiness in the numbers, it doesn't seem that that is an ongoing operating profit that they're capable of posting but more what we're seeing come through the numbers with how all of this direct listing stuff is settling.

Chokkavelu: Yeah, because before the direct listing, you get a net income to common shareholders which we're used to looking at because usually they're aren't that much of a preferred thing. You get a nice decent, low profit, but then you'd have the preference that would take it negative but you are used to just ignoring. You get to net income and you say, yes, positive, awesome. But then that's what's going on there.

Lewis: That's the reality of the situation. There are times where I think it's important for us, even as folks to spend a lot of time looking at things to say, I think I have a grasp on this. I admit I don't totally get it when it comes to the way that these things factor in.

Chokkavelu: This will be very interesting, that first earnings release, because then we can bump up what we think is going on to what it actually is when they report without these pro forma figures that it's just hey, look, this is what happened via gap.

Lewis: One thing that I want to dig into a little bit with that topline is, for 2020, we're seeing about $620 million in revenue for them. They break that out into two different forms. We have the presence revenue that comes through, and just think that it's like the core maintaining online presence for their customers. People that want to stand up a website and are paying a monthly or an annual fee to do that, and interestingly enough, about 70% , I believe, of their customers wind up opting for the annual subscription, which is higher than I thought, the uptake, I assume because the monthly subscription is a little bit less of a commitment. You'd see more people start out there, but only 30%, which I guess means that there's probably legacy customers that start out monthly, switch over to annual at some point because they saw the value there. But by and large, the money is coming in through what they do with digital presence. The commerce side is faster growing, but it's a much smaller piece of the pie. In 2020, $475-ish million coming through for presence, commerce, just under $150 million. The presence growth is only about 18%, whereas commerce is growing over 75%. That's obviously a really exciting part of this business. It's where things are going to get a lot harder and a lot more competitive for them there.

Chokkavelu: Right. If I think through it right, since 94% of the revenues are from subscriptions, I think this is just them parsing out those higher tiers that add e-commerce. If you look at their functionality that will add marketing and e-commerce as modules that you are buying into, they must be parsing it between presence in commerce that way. So it's not that you're also adding on additional features which would be the gold mine if they can start doing that.

Lewis: Yeah, and I think one way to look at this massive "un-monetized" base, they're paying monthly or annual subscriptions, but it's for the more basic level thing. This is an opportunity for them to grow with customers in a way that it feels natural, it feels organic. You're not beating them over the head with upsells and it's a massive cohort of people that you can bring solutions to. You wonder though, if people that are attracted to something like Squarespace may or may not have those same upsell profiles that someone using a Shopify or a BigCommerce might have.

Chokkavelu: Yes. I do wonder about that.

Lewis: It's a hard question to answer, and it's the eternal like when you see a data point like that where it's like so much is comes in through subscription, so much is coming in through one specific part of our business, you've seen stories where that feeds a ton of other parts and you actually wind up accelerating growth over time. You also see a lot of instances of unfulfilled growth stories because it just didn't come together the way that it did for competitors.

Chokkavelu: Another thing, just thinking through it, is say, you have some business and then you start with Squarespace and then even though it's hard to change platforms, if you get to a certain point, you're not getting the functionality you need then do you up-sell to a Shopify and just say, hey, we just need to go there now because this is big.

Lewis: Yeah, and I can see why people would do that. If you're looking in the slightly upmarket e-commerce-based, Shopify is the game. I think even BigCommerce is having a hard time convincing people that for as specifically tailored to that audience as they are, they are worth it over Shopify, just because Shopify has emerged as such a major player in that space. So many big companies choose to use Shopify rather than build something homegrown, which I think is a big selling point for them.

Chokkavelu: You figure once you hit that scale, you probably have either employees who know how to do this stuff or can pay for our consultant versus doing it yourself where that Squarespace or Wix solution just feels really good because you can just do it.

Lewis: Yeah. You want it. You just want to be able to go live with it when you can. Anand, we mentioned the founding story and this really being a business that is driven by management, I pulled that quote before we loved the founder story, we love founders that stick around. In this case, with Anthony Casalena, it is his business. By all appearances, he's the guy and he's staying here. [laughs].

Chokkavelu: He's kept control since 2004. Betting on Squarespace is betting on him. He owns about 36% of the shares outstanding, but does the dual class structure, as we see a lot, 68% of the total voting control. He's got it, which I like that personally.

Lewis: Yeah. I think he's highly motivated. It's his business and he has grown this. It's easy to look at something like a Squarespace and say, like, oh man, that came public. They're at this huge valuation. This is a 16-year overnight success story. Just because we're starting to follow the story now, he has been laying the groundwork for a long time for this business and ran it pretty lean for a long period of time. The folks who have helped him along the way in terms of providing early financing have been handsomely rewarded. The valuation for this business has really swelled overtime. When we look at what we're seeing from employees and just culturally, there are a lot of positive signs with his leadership as well.

Chokkavelu: Right on. Those Glassdoor reviews were great, 3.9 out of 5, 78% approve of the CEO, 74% recommend to a friend, 172 ratings. So it's a decent chunk. I think they're a bit over 1,000 employees. Good percentage of them.

Lewis: That becomes really important when you go from being a private company to a public company. Culturally, it's a big shift. You mentioned that the first earnings report is going to be something we're obviously going to be paying a lot of attention to. Over time, as your company gets talked about publicly and you start to have the scrutiny of being a publicly traded business, that can often affect the way that management makes decisions and also employees tend to feel, particularly when they're equity is being valued on a daily or hourly basis.

Chokkavelu: Right. Hopefully you're happy because going off.

Lewis: I think there won't be any surprises here when we talk about the opportunity in front of this business. The stories that we have seen play out in this space have generally been tremendous. The online space, the e-commerce space, has been exploding over the last 15 years. This is another company that is trying to capitalize on that. In their prospectus, they cite data saying over 800 million small businesses and self-employed ventures worldwide. They estimate a near to medium-term TAM of $150 billion. We're going to discount that a little bit, I think, especially given with their current revenue base. But I think it's easy to look at the space that they're in and say, not only is there a lot of room here to run, there's probably a lot of room for a lot of different players.

Chokkavelu: I believe the total market, the addressable market for them.

Lewis: Yeah. Probably a bit smaller, and depending on what you are going after, whether it's new customers or existing customers from competitors, you're going to have varying degrees of success seizing more land in that market but there's a lot of space there. I think there are also a lot of businesses that still haven't made that jump, even though 2020 we associate a step-change year for companies getting digital, getting online if they weren't already. I think there are a lot of businesses that still haven't made that hop.

Chokkavelu: They cite a firm called Clutch, and they say, approximately, 46% of small and medium-sized businesses are not online today, which you definitely want to dive into at some point. Wait, what are you counting? What's the numerator? What's the denominator? Who are you all counting here, but that's shocking.

Lewis: I would guess that more of those businesses are on the smaller side. I think if you are a medium and certainly, an enterprise business, you're online at this point or you're cycling the drain. I don't know how you've survived, but a lot of the businesses that are going to be, I think factored into those types of numbers are smaller operations, limited staff, and maybe really need something out of the box that just works for them which is to say that's the part of the market that Squarespace really corners and does a good job of addressing.

Chokkavelu: Right.

Lewis: I think there are some interesting opportunities for them in expanding their existing customer base. In particular, it's worth looking at the geography here for where their customers are and where their money is coming from. Because for the most part, it's coming from the U.S. This is a U.S.-driven company and a U.S.-driven story. Looking at 2020, 430 million coming in from the United States, a little bit less than 200 million coming internationally. The international segment, this is going to sound similar to what we talked about with presence versus commerce growing faster but smaller, about 35% year-over-year versus 25% for the U.S. I think there are some interesting expansion opportunities for them. The U.S. is going to be what drives this business for a long time though.

Chokkavelu: Makes sense.

Lewis: I think at this point, Anand, looking at risks and turning over to what can go wrong. We have done a decent job prefacing. There's a pretty substantial amount of competitive risk here with this business.

Chokkavelu: Yeah. I think that's the biggest risk here. Just to recap a bit, on the low end, there are tons of ways to host a basic website, many of them built on WordPress, which is owned by Automattic. On the higher-end, as you get into e-commerce monetization, you have Shopify and BigCommerce as we talked about. In the middle are services like Squarespace, Wix, and Weebly which is owned by Square. They make it super easy but still a nice space. Then in terms of other risks, anything that negatively hurts its brand or product, of course, would be bad. Security of the platform if that were compromised. I feel like that's a risk to just about anyone in today's economy is the risk of an online compromise. Then something you may not think about, which is something like Google dinging it for SEO purposes, but not dinging other platforms for whatever reason. That Google algorithm and ranking highly. If I'm a small business and I find out that you see some headline that Squarespace's sites are getting ding, I'm taking that and I'm moving over even if it costs me some time and money to do anything else.

Lewis: That's a big reputational risk, particularly when you are supposed to be the one that's making things easier for people. If you're simplifying something that's technical and you wind up not being able to deliver on that, you're going to see an exodus of customers, it's just going to happen.

Chokkavelu: On the other side, most of the customers at the low-end are probably not sophisticated enough where they're really tracking SEO performance, but you've got that. Then the third thing is just that it qualifies as an emerging growth company under the JOBS Act so that means less disclosure requirements. That's fairly common but you only get two years of audited financials. I told you that two years ago, it grew at 24%, well that was off of an unaudited figure. Then it doesn't have the Sarbanes-Oxley requirement of an audit of internal controls around financial reporting. Basically, a long way of saying our antenna should be up a little more than normal just because you don't have as robust an auditing procedure here.

Lewis: I think with that, you want as much information as possible and we're always going to gripe about not getting certain details just because we want as full a picture as we think we can possibly get. I'd love financials going as far back as they are willing to give us to be able to see how the growth story changed over time, how their margins played out as they've reached a bigger scale, what upside there is. We're always going to quibble over these things just because it's what we do. We nitpick with this type of stuff. 

One thing that I'm trying to wrap my head around in the vein of numbers Anand is looking at is what we get in terms of a retention figure for this business. Because you would expect, it's subscription-oriented, the value is really going to be in retaining customers over their lifetime. Anytime that's the case, I want some proxy for what's going on with customer spend over time. What's going on with churn? How are they looking at that? We saw ARPU expansion is pretty limited, and so what are we seeing in terms of attrition? I didn't really get a great answer for that looking through their prospectus. They have this cash retention rate number and it's easy to assume that something like this is a comps number the way that a restaurant would provide on a quarterly basis but I don't think that's the case. I'm going to read from their prospectus and to just define this. "It's a percentage of bookings received in the current period from website and domain subscriptions in existence during the same period, the year prior." What I hear there is basically, here's how much our existing customers helped us generate this quarter or this year. It's not how much we're getting from existing customers in a way that you can really show growth within that cohort; is that right?

Chokkavelu: Yeah. I think they spread it over gross merchandise volume, which you would expect the older customers to grow more, but they're still paying that monthly fee. The 80% you hear about it with all these small customers, you'd expect a lot of churn. They do say in the prospectus, a lot of our growth is on the acquisition front. This is a nothing burger for me where it's like 80% sounds good but we know that's not likely the true case of what we would think of 80% of it.

Lewis: For recent years 2018, 2019, 2020, 83%, 83%, almost 86% most recently. I think it's hard to know how to score that number because if I'm thinking about it correctly, that's something that can actually go up if customer acquisition goes down, which you wouldn't want, right?

Chokkavelu: Right.

Lewis: It doesn't actually give you a good look at in a vacuum how existing customers are trending over time. It only gives you a look at how existing customers play into the overall business and there are other inputs that can affect that. I'd like a more complete look at that. Frankly, for the space they're in and the business they run, I would expect that to be a little bit more front and center just because so many SaaS and subscription oriented businesses trumpet that number if it's a strong one.

Chokkavelu: The reason that's important is just those marketing expenses that we were talking about earlier about we have that big gross margin and they're leaking out money everywhere else. They say, pay over time. We expect marketing dollars to go up but smaller as a percentage of sales and you need churn to be as low as possible for that to come to fruition and/or acquisition costs. The cost to acquire those customers either go down or stay steady but it's a competitive space. It's worrisome if you can't retain folks.

Lewis: It is. I think if they were showing pretty solid ARPU growth, I could ignore some of that stuff, but it's in the low single-digits. For as much of a green field as we're looking at here with online presence in e-commerce, that market is going to mature over time. Being able to grow through customer acquisition, they're only going to be so many valuable customers out there to acquire. At a certain point, you're just going to have the stable of people that you're working with. If you can't meaningfully grow the top line with the second lever, it's not as attractive of a business.

Chokkavelu: You started getting consolidation plays and, "Are we going to combine with Wix?" Okay, great.

Lewis: What do I own now, right?

Chokkavelu: Right.

Lewis: What's nice is sometimes we do these prospective shows and we have to wait until we see what the public reception for the company is. In this case, the company's already public, so we can talk a little bit about the way the market reacted, and also we have a firm sense of the valuation so it's helpful.

Chokkavelu: Right on. They came public on May 19th, so it was just a few days ago. Roughly a $7 billion company at 11 times sales. They went through a direct listing, so similar to Coinbase or Spotify, Slack, Palantir, Roblox, they were all direct listings. Pretty [...] as far as IPO's go. The reference price, either the private valuation number was $50. The first day it traded down to $43 a share, right now, the last time I checked, it's back up to $54, but that's all within a fairly tight range, again, as far as IPO's go in this period of time. Just a side note, I do wonder how many people confuse it with Square. The ticker is SQSP not SQ. Square, we were talking about, owns Weebly. They're both in that small to medium size business thing. I was talking to my wife right before the show and she was confusing them. I remember years ago I would confuse them.

Lewis: Could be a potential acquisition down the road, just simplify things on it.

Chokkavelu: There you go.

Lewis: What I think is a little interesting about where they sit now as a $7 billion business is they made their confidential filing, and then they raised, in the interim between listing and making that filing, and I think they raised about $300 million at what was an implied valuation of about $10 billion. We see them now trading a little bit below where some of that capital came in. One thing I realize we didn't mention when we were talking through the financials is, looking over their balance sheet, this is a business that has some cash on the books, and I think a big chunk of it is the fact that they did that recent raise if I have the timing of this right. They have $200 million in cash on the books as of the end of March. That funding round was announced in mid-March, so I'm pretty sure that's included, don't quote me on that, but against that, they have $500 million in long-term debt. They are a levered business, and think it's something that's worth noting because as long as things are going smoothly, it's not an issue. But if they hit any hiccups along the road, the growth story changes or they have a much harder time bringing in customers. That is something that's going to rear its head.

Chokkavelu: Absolutely.

Lewis: Anand, one of the things that I always enjoyed doing with the show is bringing investors on, who have their own approach to looking at businesses. I think Brian is such a staple of the show, we've basically walked through his S-1 approach in preparing our notes, so we just shamelessly cribbed it from him. But what I'm excited about is you have your own way of looking at businesses, and I think it's a really helpful shorthand for people to just understand philosophically what you're buying, why you're buying it, or why you're even interested in a business. I wanted to wrap up our discussion of Squarespace here, just talking through your stoplight framework, walking our listeners through it, and then putting Squarespace through that framework.

Chokkavelu: Great. It's basically five questions, just because I know I won't go through an entire checklist like Brian can for every stock. The five questions, I can usually do that and it's red to green. Red is bad, green is good, yellow's in the middle, and then you got light green, orange, those things. The first question is the upside. What is my potential upside? Could it 10x in 10 years? To give you an idea, the market as a whole, if you get 10% for 10 years, that's 2.6x in 10 years, so you'd be in the orange area for that, which is fine. It's just that's what it is. I put Squarespace in the yellow range and I'm being nice a little. I think I personally put it at the orange range, but I was like, "No, there's potential upside." What about you, Dylan?

Lewis: I think for where they are, I would like to see a little bit higher growth with the top line. I can't help when I look at a business like this to also stack it against companies like Wix and Shopify. Squarespace is at a higher margin business than either of those companies. Those companies were at a similar revenue base, so Squarespace's 84% gross margins versus 65 and 53% for Wix and Shopify. But Shopify was a much faster growing business at the same stage of revenue than Squarespace currently is. When they were doing $600 million in revenue, they were posting 70% year-over-year growth, and so I think that's where the comps between some of these businesses start to fall apart.

Chokkavelu: Yeah, and Wix, I think you'd noted earlier before we talked about it, being a 10x from 2015, but that was from a market cap well below $1 billion, and Squarespace is at $7 billion now, so past performance doesn't mean future performance.

Lewis: I think we're both looking at this and scoring it in a way where it's like, there is the possibility of a 10x in five to 10 years, but I wouldn't necessarily put a lot of money on it. Is that the right way to characterize that?

Chokkavelu: Yeah. I'm highly skeptical of 10x. The yellow zone usually for me it's like, 3x-5x is a possibility.

Lewis: Yes. Which by the way, great return.

Chokkavelu: Which would be amazing.

Lewis: Yeah.

Chokkavelu: Right.

Lewis: But if you're truly looking for maximum upside, I think they have a harder path there than some other businesses currently out there on the market.

Chokkavelu: I'd be shocked if we were looking at a 10x in 10 years from Squarespace, but I'm shocked all the time. The other side of the ceiling is the downside, the floor. How high is that floor? For them, they are losing money after we adjust for the preferred shares conversion stuff, and have some debt on its balance sheet. Not positive on the cash flows, because I don't think I saw the proforma of the cash flows, so I don't know fully how the preferred factors are. But a long way of saying, "Yeah, you have debt, you have losses." I'm putting it in the orange category, which is, "Yeah, there's existential risk here potentially."

Lewis: One way I would take this question is the classic David Garner snap test. If this company disappears over time or overnight, what happens? How do people feel about that?

Chokkavelu: Wix feels pretty good.

Lewis: Yeah. Wix is really excited at Squarespace, they have to shut up our doors. But I think with Squarespace, 3.6 million customers is nothing to sneeze at. They've a very large customer base. I think they're probably a pretty loyal customer base, so I think this business sticks around. I can't picture it disappearing, but I would like to see a little bit cleaner financials, especially with that net debt position they have.

Chokkavelu: Then the next one is the wild factor of, what's the most important thing? If someone says, "Hey, why are you buying Squarespace?" What's the one thing you tell them? I had a simple leading way people in businesses make a web presence, so that simplicity and that scale that Dylan was talking about, that's a yellow reason. A green reason would be Intuitive Surgical, first mover in robotic surgery or Shopify, Amazon stopped competing with them. That's green.

Lewis: Yeah, and that's good context because I think this is much more of a subjective category, if we're looking at businesses and something has to leap off the page to you. I know personally, for me, it's a lot easier to put money behind an idea where the financials look great, the management team looks great. There is something, maybe it's born out of the financials, but then you start looking culturally and you see more and more of it, that just gets you excited about the business. I think this is a wonderful tool for a lot of people. I haven't had that aha moment with them as a business. I do think the margins that they're able to post are interesting given where the rest of their competitors are. That's probably the closest thing I have in addition to the more user-facing simplicity. Looking at their books, that's a little bit of a wow for me, but it's a muted wow in the current scheme of wows. 

Chokkavelu: Fair enough. Firstly, those are the stock specific criteria, the upside downside, and wow. The next two are to the stock picker. I call it on specific criteria, you probably want to use your own name. The next one, how excited I am to own it for ten years? I just wrote down, meh, that's all I have.

Lewis: Yeah, I think with a business like this, you have the tailwinds behind you. I think my specific criteria with a lot of stuff is like, is there an undeniable macro trend that's going to push this thing forward? In their case, it's there. There's been a lot of customer acquisition that's already happened in this space. My concern though is, I think there are people that are better monetizing those audiences and maybe even providing better tools for those audiences. It almost just seems like they're easier ideas to invest in the markets that they're in.

Chokkavelu: Yeah. I didn't even realize Square owned Weebly until we were doing the research. Square, they have a big ecosystem to feed you into. Then you've got the Shopify and Wix. Wix is a little bigger than Squarespace in terms of revenues, so you've got some major competitors. The last one is my confidence level in my assessment. This is another warrant for me because I'm early in my understanding of both the company and then I have some work to do. I want to go over Wix and Shopify and anything I can see from other public companies, look at that and get under that gross margin, things like that. Then being confused by some of the preferred stock stuff. Definitely that will solidify a little more with the first earnings release.

Lewis: I'm curious about that, Anand. My general arc as an investor is I go from, OK, I think I understand this thing and then I do a lot more research, I'm like, I have more questions than answers. The more I learn, the less I feel like I actually know about something. For your confidence level, in an assessment, is there something recently that you've looked at and said, this is green, I get it. I know the story and I have a really good handle on what this is.

Chokkavelu: Yeah, something like, to give you an idea, Etsy was light green across the board for me, and some of it's like, hey, I followed it longer. I'm not just looking at it this week because it just had an S-1. You've seen it perform and you've dealt with it, I've been a customer of it, I know how other people use it. I can see their track record of over a 100% growth in this last year and things like that. Also just the valuation, things like that where you like, oh, I can easily see how this could grow and how it can really make something bigger than it is today.

Lewis: It's interesting that you mentioned Etsy there because that is a category of competitor that we didn't even really get into.

Chokkavelu: Yeah.

Lewis: For these businesses. I think there's enough there that separates them because what you're talking about when you're looking at the Wixes, Squarespaces, Shopifys of the world, is ownership over the customer experience. Whereas with Etsy, it's fragmented. You're playing in a marketplace, but also your upfront stand up costs are way lower.

Chokkavelu: You're going to want both, right?

Lewis: Yeah.

Chokkavelu: You are probably going to want an Amazon thing, whatever, all of that. But then you think about, well, if you grow and it's on the Etsy platform, does that help you that much with your organic traffic into Squarespace and you really going to buy a lot more, you just keep paying out subscription fees to keep your web presence.

Lewis: Yeah, I'm a believer that generally we're going to see more businesses, entrepreneurs take ownership of their digital presence. There are dozens, maybe a hundreds of businesses that investors could hop into with that thesis and probably make some pretty good money. But I think that in the era of the platform and marketplace, they are doing well and they're going to continue to thrive. But I think a lot of businesses are feeling pinched by meal delivery companies, they subject these businesses owners and proprietors to the algorithm. Losing that control and having someone in between you and the customer just means that you're taking less of every single thing you're selling home. I think we're going to see more and more money go in this direction. Unfortunately, there's just a lot of businesses in Squarespace's case that are putting money there and they already have some [...] customers.

Chokkavelu: Ride on. Yeah, always on attention within the platforms and the folks and even social media platforms, all of that, as a business you want to be everywhere, right?

Lewis: Yeah. Omnichannel is the name of the game.

Chokkavelu: Yes.

Lewis: Anand, thank you so much for coming on, talking Squarespace and walking our listeners through the Stoplight framework.

Chokkavelu: Thanks Dylan, I had a great time.

Lewis: Awesome. Listeners, that is going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say "Hey," shoot us an email at industryfocus@fool.com or you can tweet us @MFIndustryFocus. If you are looking for more of our stuff, subscribe on iTunes, Spotify 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 Tim Sparks for all his work behind glass today, and thank you for listening. Until next time, Fool on!

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.