Websites are one of the two core ways we access the internet, along with mobile applications. Building websites is a cornerstone of having a presence on the internet, and is vital for any small business that wants to interact with customers. The website-building market has grown through a monumental transition as customers switch from open-source platforms like WordPress to vertically integrated providers, which are called software-as-a-service (SaaS) content management systems (CMS).
From 2011-2021, SaaS CMS websites have gone from 18% to 37% of CMS websites. All indications are that this trend will continue over the next ten years, presenting a multibillion-dollar opportunity for website software providers. There are two companies I think will benefit the most from this transition to SaaS CMS: Wix.com (WIX -2.00%) and Squarespace (SQSP -1.71%).
Here's why these two companies are poised for breakouts in 2023.
1. Wix.com: A website builder anyone can use
Wix.com is one of the leading SaaS CMS companies in the world. Headquartered in Israel, the software company has grown from 100,000 paying subscribers in 2010 to 6 million at the end of 2021, a 60x increase in just over 10 years. Individuals and businesses have transitioned to Wix over legacy solutions like WordPress due to its easy-to-use interface that doesn't require a computer science degree, which makes it a time- and cost-effective solution. Last quarter annual recurring revenue (ARR) from its core website-building subscriptions hit $1.07 billion, up 8% year-over-year.
Outside of website-building software, Wix has expanded into new tools for its customers, which mainly help with e-commerce and online payments. These segments were a blessing during the heart of the COVID-19 pandemic as revenue growth accelerated to new heights, but have since been a burden on Wix's fundamentals as the world has returned to a more normal cadence. The big problem is that Wix hired new employees expecting the growth from 2020 and 2021 to continue over the next few years. When that didn't materialize, profitability took a hit. Free cash flow -- a key profitability metric for a software business like Wix -- has started moving in the wrong direction over the last year or so.
These headwinds have caused Wix's stock to go down in 2022, with shares down 50% year to date as of this writing. While this is a concern for investors, Wix's management has easy solutions to solve this problem. First, it just did a layoff/restructuring program to save $150 million in expenses a year. Second, it will be able to gain operating leverage as it grows its top-line revenue with high gross margins north of 60%. By 2025, Wix thinks it can generate $500 million in annual free cash flow as it rightsizes its expenses and continues to ride the SaaS CMS tailwind. At today's market cap of $4.6 billion, Wix's stock looks cheap if it can hit this free cash flow target.
WIX Free Cash Flow data by YCharts
2. Squarespace: Nipping on Wix's heels
There's not just one SaaS CMS provider out there. Another company with a very similar product offering is Squarespace. It also offers an easy-to-use website-building product for individuals and small businesses that continues to win market share each and every year. Squarespace is slightly smaller than Wix, with 4.2 million paying subscribers and $861 million in ARR, but it has shown consistent growth over the last few years.
The only difference between Squarespace and Wix is that Squarespace has fewer tools for payments and e-commerce for its customers. This can be thought of as a good and bad thing, as Squarespace has not faced as bad of a profitability headwind in 2022 (free cash flow was $127 million over the past 12 months). However, it also might be at a disadvantage in acquiring new customers vs. Wix if it doesn't have as robust of a product offering for people looking to sell things online.
At a market cap of $2.78 billion, Squarespace trades at a similar valuation to Wix when considering the size of the respective businesses. With even stronger gross margins than Wix (82% last quarter), I think Squarespace could perform better over the long term if it keeps growing revenue at a consistent rate and expands its profit margins.
Investors might be worried about the downsides to competition between Wix and Squarespace, but there is plenty of room for both to grow subscribers (and therefore revenue) over the next decade. Third-party analysts estimate that Wix has a 3.5% market share of the CMS industry, while Squarespace has a 2.9% market share. Both are up from virtually 0% a decade ago. If their respective market shares keep moving in the right direction and the companies start producing solid earnings for shareholders each year, I think both stocks can do well in 2023 and for the rest of this decade.
