Growing Fast, but Burning Cash. Is This Stock a Buy?

Technology companies that generate revenue from software subscriptions have many attractive attributes that make them compelling investments. These businesses typically have high gross margins and can benefit from economies of scale. However, these same companies tend to spend many years unprofitable as they pour their revenue back into growing the business.

At some point, investors will want to see strong revenue growth and an increasing customer base start to translate into cash generation and profitability. How long to wait for that transition is the million-dollar question when evaluating these businesses within a stock portfolio. Asana (ASAN 5.90%) is one company that has been producing strong growth but burning a lot of cash, and its results from the first quarter of its fiscal 2023, which ended April 30, featured more of the same. So should investors buy now?

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Investments in large customers are paying off

Asana is a leading work management platform. It aims to increase productivity in the workforce by streamlining project management. For example, Asana could make it so multiple employees could keep track of a project they're collaborating on without long email threads and in-person meetings. In the company's words, Asana tries to eliminate "work about work."

Asana employs a trial model in which customers can try the product for free and then subscribe for additional features and functionality. While anyone can use Asana products, the company has been focusing on enterprise customers with great success.

In Q1, Asana reported over 126,000 paying customers, an increase of 26% year over year and 6% sequentially. More importantly, customers spending larger amounts grew even more.

Data source: Asana. YOY = year over year.

This growth shows that Asana's focus on enterprise customers is paying off. Management stated that Q1 also saw a new record, with a customer paying for over 100,000 seats. It's clear that Asana's products are being seen as a valuable asset to these larger customers.

Not only does Asana bring in new customers at an impressive rate, but it's also monetizing them successfully. Asana's overall dollar-based net retention rate (DBNRR) was over 120% in Q1. This means that existing customers spent 20% more this year than last year. More impressively, the DBNRR for customers spending $5,000 or more, and $50,000 or more, was over 130% and over 145%, respectively. When existing customers are spending more, it increases their lifetime value and decreases the need to spend more to acquire new customers.

Can Asana sustain its cash burn rate?

One concern about Asana as an investment is its increasingly large cash burn and trend away from profitability. Considering that Asana has a gross margin of 90%, it's rather surprising that Q1 saw an operating loss of $96 million. Put another way, while revenue was up 57%, operating expenses increased 72%. Net loss for the quarter was $99 million, compared to $61 million in Q1 2022. 

Asana's cash flow from operations was negative $41 million and free cash flow was negative $42 million in Q1 2023, compared to cash from operations of negative $7.4 million and free cash flow of negative $7.7 million in Q1 2022. That's a big step in the wrong direction for a company that needs to be heading toward positive territory as it scales.

Something that may put shareholders at ease would be management laying out a path to profitability. Unfortunately, in the Q1 earnings conference call, there were only vague commitments to progress toward positive free cash flow in the coming year. 

Is Asana a buy?

Before the market sell-off began, Asana was a hot stock and its price-to-sales ratio (P/S) reached a high of 72. Accounting for its lack of positive cash flow and profitability, that valuation looks absurd. Currently, Asana's P/S is 9.7, which is near its all-time low. Asana is putting up similar results to when its valuation was at its all-time high, but at this lower sales multiple, shares look much more attractive.

For investors who are patient and believe that Asana's strong sales growth will eventually translate into positive cash flow and an improving bottom line, now may be a good time to pick up shares. For those who prefer to wait, there should still be opportunities later to buy this stock at reasonable valuations that could still result in positive shareholder returns.