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A Broken Record

My past two articles on Smartsheet (NYSE:SMAR) make me sound like a broken record. Each time, I’ve offered investors a general refrain along the lines of:

The company posted another strong quarter, but…[INSERT BEAR ARGUMENTS HERE].

Well, despite the firm…wait for it…posting another strong quarter, I will continue my bearish tirade a bit longer in this analysis.

A Striking Contrast

The work management leader just announced their Q3 FY ‘23 results on Thursday, December 1 and the stock took off like a rocket on the following trading day, gaining nearly ~17% to close at $37.90. By contrast, SMAR competitor Asana, Inc. (ASAN), who released their own Q3 FY ‘23 earnings results also on December 1, saw their stock nosedive more than 10% on the day.

Exhibit 1: SMAR and ASAN 5-Day Stock Price Performance

Exhibit 1: SMAR and ASAN 5-Day Stock Price Performance (Seeking Alpha)

SMAR beat on both lines, with that performance coming despite challenging macroeconomic conditions.

Exhibit 2: SMAR Q3 FY ‘23 Sales and Earnings Results vs. Estimates

Exhibit 2: SMAR Q3 FY ‘23 Sales and Earnings Results vs. Estimates (Yves Sukhu/Seeking Alpha)

Notes:

Interestingly, ASAN also beat estimates; but investors were particularly impressed with SMAR’s bullish Q4 FY ‘23 and full-year guidance, which was raised against management’s more cautious outlook provided at the end of Q2. As per SMAR’s Earnings Release Q3 FY ‘23:

For the fourth quarter of fiscal year 2023, [management] currently expects:

For the full fiscal year 2023, [management] currently expects:

Notably, SMAR’s expectation of positive free cash flow (“FCF”) for the full-year exceeds their previous break-even guidance.

Credit Where Credit Is Due

Irrespective of how I feel about SMAR as an investment, I think it is important to heap appropriate praise on SMAR as a company. It could be fairly argued, I think, that the nearly 20-year-old company was at the vanguard of those software providers who recognized limitations in spreadsheet technologies and sought to revolutionize project management and collaboration in the modern digital age. Today, they find themselves recognized as a work management software leader.

Exhibit 3: Forrester Wave Collaborative Work Management Tools Q4 2022

Exhibit 3: Forrester Wave Collaborative Work Management Tools Q4 2022 (Forrester)

Further, they have a strong, comprehensive offering as supported by Forrester’s grading of SMAR’s general capabilities versus key competitors, including ASAN. Their more recent move into the digital asset management (“DAM”) space with their acquisitions of Brandfolder and Outfit is also bullish in my opinion, albeit not without risks. As with the work management space, there is no clear-cut definition of the DAM market and therefore its size. But analysts who attempt to model the market seem to agree that it is growing at a healthy double-digit CAGR, with one particularly bullish assessment offering a nearly 25% growth rate. SMAR’s DAM push is quite logical as organizations of all sizes have to manage the development process of all kinds of content – digital, print, social media, etc. SMAR, and larger competitors like Adobe (ADBE), have a growing market opportunity to help customers store and organize their brand/digital assets, and to manage the creative processes themselves that deliver finished content.

So, I get why SMAR bulls are excited. You have a company that is a leader in their space, they have fertile ground with their (newer) push into digital asset management, and they continue to improve with respect to several key performance indicators:

But, repeating my general thrust from my earlier articles, I think SMAR presents certain risks from an investment standpoint such that I continue to recommend that long investors avoid the stock.

Still Not Convinced

In my prior Seeking Alpha articles on SMAR, I (broadly) argued:

1. SMAR may be more of a tactical rather than strategic solution for many companies.

2. The company’s competitive moat might not be all that wide.

3. The overall economics of the business are weak.

4. Current macroeconomic conditions are not favorable heading into FY ‘24.

5. Sales execution challenges may hint at deeper problems.

I’d like to elaborate on a few of these points using some additional context from SMAR’s latest Earnings Call Q3 FY ‘23.

Expectedly, I am still in the bear camp when it comes to SMAR as an investment even though, as I laid out in the prior section, I think SMAR as a company deserves a lot of credit for what they’ve accomplished.

Takeover Speculation

The rally in SMAR shares come as a respite for long SMAR investors who have taken a beating over the last few months.

Exhibit 4: Smartsheet and Selected Competitor Performance

Exhibit 4: Smartsheet and Selected Competitor Performance (Yves Sukhu)

Notes:

Notably, a number of analysts raised their price targets for SMAR following Q3 results with a moderate “buy” consensus among them.

Exhibit 5: Selected Smartsheet Analyst Ratings

Exhibit 5: Selected Smartsheet Analyst Ratings (MarketBeat)

The average price target of the analysts I selected for Exhibit 5 above is $43.80, implying shares have more room to run.

Unsurprisingly, I wouldn’t touch shares where they are trading now based on the areas of concern that I outlined. But, SMAR has value; and some analysts have identified the firm as a takeover target. I tend to be skeptical of a takeover at current levels, with SMAR sporting a market cap ~$5B. So, what valuation makes sense? Of course, I don’t exactly know what someone would be willing to pay. But, assume that a 4x sales multiple is reasonable in this market and SMAR will hit $760M in sales exiting FY ‘23. That would give the firm a “fair” valuation of ~$3B right now. If we divide that figure by 130M shares, we would get a price of about $23.40/share. So, personally, I’d be willing to make a speculative bet below $20/share. Granted, this is just a quick back-of-the-envelope calculation, and I won’t hold my breath that SMAR shares are going to be in that neighborhood anytime soon with the stock finding support at ~$25 over the last few months.

Exhibit 6: Smartsheet Stock Price Performance

Exhibit 6: Smartsheet Stock Price Performance (Yves Sukhu)

Notes:

Still, as discussed earlier, many forecasts for 2023 are less-than-rosy and, while SMAR looks poised to close out their FY ‘23 with a good performance, FY ‘24 is anybody’s guess even by management’s own admission. Speculators looking for an entry point might indeed find one with SMAR’s new fiscal year approaching.

I maintain a “sell” recommendation for SMAR; but, as explained, would be willing to speculate on shares at the “right” price on the bet of a future takeover. While SMAR, and just about every tech company, talk about building enduring enterprises, the grim reality is that many tech firms do not have business models that will lead to sustainable, profitable growth. I suspect management may be increasingly eager to find a suitor for the business given its inherent economics (see my earlier point) and as the business nears 20 years in age.