Indicator of less Moat?

Investment Analysis Clubs Saul’s Investing Discussions
1

I came across the following statement in a monday.com article that I read, and it attempted to make the case that the company is in a highly competitive market (cannot deny that) and that monday.com may be “juicing” its sales buy discounting price, and sending the difference to S&M.

It read:

“Growth companies need to show revenue growth, or people may be loath to buy their stock. One way of doing this is luring in large customers with steep price reductions off the listed price. The retail price gets sent to revenues, and the cost of the rebate goes into cost-of-goods, but usually sales and marketing.”

It went on to say, using the formula (Sales/Marketing + COGS) ÷ Revenue that "if a digital services company spends more than 80% of revenue on COGS and sales/marketing, they are likely engaged in some revenue juicing.

I want to understand this and know if it is a real issue. I ran the test on the last two Q’s of my holdings and only monday.com + SentinelOne were above the 80% threshold.

This tells me that at a minimum, they are having to fight for market share, but we also know they are being successful at it. Cause of concern, or just…interesting?

-Chad

Detail below:

[monday.com](http://monday.com)		
	                        21-Q2	21-Q3
REV	                        70.6	83.0
Adj COGS	                 7.3	 8.1
Adj S&M	                        55.5	61.0
Sum (Adj COGS, Adj S&M)	        62.8	69.1
REV/Sum (Adj COGS, Adj S&M)	89%	83%
		
Datadog		
	                        21-Q2	21-Q3
REV	                        233.5	270.5
Adj COGS	                 55.3	 60.5
Adj S&M	                         60.9	 64.6
Sum (Adj COGS, Adj S&M)	        116.1	125.1
REV/Sum (Adj COGS, Adj S&M)	50%	46%
		
Snowflake		
	                         22-Q2	22-Q3
REV	                        254.6	312.5
Adj COGS	                 66.2	 78.1
Adj S&M	                        125.3	136.9
Sum (Adj COGS, Adj S&M)	        191.5	215.0
REV/Sum (Adj COGS, Adj S&M)	75%	69%
		
SentinelOne		
	                         22-Q2	22-Q3
REV	                         45.8	56.0
Adj COGS	                 17.4	18.6
Adj S&M	                         36.9	36.0
Sum (Adj COGS, Adj S&M)	         54.3	54.6
REV/Sum (Adj COGS, Adj S&M)	119%	97%
		
Zscaler		
	                        21-Q4	 22-Q1
REV	                        197.1	230.5
Adj COGS	                 39.4	 43.8
Adj S&M	                         93.4	110.3
Sum (Adj COGS, Adj S&M)	        132.8	154.1
REV/Sum (Adj COGS, Adj S&M)	67%	67%
		
ZoomInfo		
	                        21-Q2	21-Q3
REV	                        174.0	197.6
Adj COGS	                 27.1	 35.1
Adj S&M	                         42.7	 55.8
Sum (Adj COGS, Adj S&M)	         69.8	 90.9
REV/Sum (Adj COGS, Adj S&M)	40%	46%
		
Cloudflare		
	                        21-Q2	21-Q3
REV	                        152.4	172.3
Adj COGS	                 33.5	 35.8
Adj S&M	                         68.4	 77.6
Sum (Adj COGS, Adj S&M)	        101.9	113.4
REV/Sum (Adj COGS, Adj S&M)	67%	66%
		
Amplitude		
	                        21-Q2	21-Q3
REV	                        39.3	45.5
Adj COGS	                11.5	13.1
Adj S&M	                        19.2	19.4
Sum (Adj COGS, Adj S&M)	        30.6	32.4
REV/Sum (Adj COGS, Adj S&M)	78%	71%
		
[Bill.com](http://Bill.com)		
	                        21-Q2	21-Q3
REV	                        78.3	116.4
Adj COGS	                15.9	 19.4
Adj S&M	                        22.3	 45.3
Sum (Adj COGS, Adj S&M)	        38.1	 64.7
REV/Sum (Adj COGS, Adj S&M)	49%	56%
44 Likes
2

Well I don’t think it’s fair to use a 80% cut-off like that. Smaller companies like Monday.com and Sentinelone have to spend a larger % of rev on sales & marketing; and you want to watch the trend on whether and how fast it’s falling as a % of rev as rev scales.

Monday.com’s S&M % of rev is falling quite rapidly (to 73% of revenue from 100% of revenue just two quarters ago).

More importantly, you should look at the “magic number” (which is what crowdstrike focuses on) or the LTC/CAC ratio. The above metrics measure how efficient the sales and marketing spend is, in generating revenue. These two metrics are commonly used in the VC community in assessing whether the company should be spending more (or less) on sales and marketing.

6 Likes
3

typo: I meant LTV/CAC ratio (though most companies don’t disclose that). You can calculate the Magic Number instead which can be calculated from publicly disclosed information.

https://www.smartkarrot.com/resources/blog/saas-magic-number…

3 Likes
4

Please be careful interpreting or believing the “article” you are quoting here. SAB 101 & 104 and ASC 606 are very clear and do not allow accounting for discounts to revenue as a S&M expense. If this is happening at either MNDY or S, there is a much bigger problem than merely spending too much on Sales & Marketing, there is outright fraud. Furthermore, any respectable auditing and accounting firm (PWC, Deloitte) will red flag such “creative” accounting immediately and issue a dissenting opinion or simply disengage from the company (usually a very bad sign), which we have NOT seen…and furthermore, the SEC will come down extremely hard on public companies in violation of rev rec standards. I do not believe or have any indication that this is happening at either company and both high growth companies are in my portfolio of 10 companies. If you have some sort of indication with some proof they are recording revenues at retail and sticking the expense into S&M, please do share as that would be a huge red flag we should all be careful to avoid. That said, I certainly do not believe and would be extremely surprised if this turned out to be the case.
Cheers! -Poleeko

51 Likes
5

Poleeko, the article gave absolutely no proof. It inferred, but did not claim.

What really peaked my interest was the calculation itself.

When I put my companies through it, I really came away with who is in a dogfight, which made me think of Moat.

As for Monday, of which I hold a high position, EVERY single comparison I’ve seen on people who have used the product in the market space say it’s the best. I also think the space is crowded. Luckily, there is a lot of market space.

I appreciate the accounting rules explanation for sure! It helped me temper concerns.

PS: Big on SentinelOne, too.

Chad

5 Likes
6

The seeking alpha article you referred to was brought up way back in August, 2021.
There’s lots of disinformation/misinformation on the internet. Don’t believe everything you read. We don’t have time to answer the same question thousands times or answer questions about all the disinformatoin misinformation out there.

Let me quote Saul:

Saul: “This is still early innings. All companies out there need what you are selling but most of them don’t have what you are selling yet. You want to go all out and sign up as many of these companies as possible before credible competitors emerge on the scene. This means increasing S&M expense now. You know that while a dollar of S&M expense spent today is mostly expensed against your current earnings, it will bring in (expanding) revenue almost forever in the future. This incredible opportunity also means spending on R&D so you continue to have the best products to sell. But this is all new and greenfield, and the imperative is to sign up as many customers as you can, as rapidly as you reasonably can while still providing good service, and not worry about current profits.”

https://discussion.fool.com/why-my-investing-criteria-have-chang…

4 Likes
7

I forgot to comment on the S&M issue.

Increasing sales and marketing only works IF the company has compelling products that customers love! If the high sales & marketing is all it takes to grow revenue , all companies will increase S&M and take over the world. It doesn’t work like that. The product itself is the moat. Without a good product, the customers will cancel the subscriptions shortly after signing up no matter how much a company spend on S&M and the result is low NRR or even less than 100%. Monday.com’s NRR is increasing! NRR from last 4 quarters from new to old: 130%,125%,121%,119%

7 Likes
8

To answer the subject line question, no, I don’t see any of this as an indicator of less moat. In fact, once imbedded into a company, Monday.com, and their main competitors, have very large moats. Monday is used for no-code or very low code creating applications to facilitate tasks at a company. Once an application is in, it takes MAJOR effort to change from using that to another one.

I’ve seen companies still using Lotus Notes because of the integration “apps” that have been built in and around it. For those that aren’t very familiar, this is a very old type of technology. There are companies still using mainframes etc. To change from an app that works (even if it sucks), to another app is usually a sunk cost. Companies are too busy thinking about the future of their product etc… Changing the software your company relies upon is a MAJOR risk. Look at all the failed SAP implementations (they’re well documented; some to the point where it drove the company out of business).

The trick is getting into a company. If it takes a deep discount to start, its highly likely that is still well worth it because once imbedded, its not going anywhere and will simply drive future dollars and usage.

1 Like
9

As for the article on MNDY regarding “juicing the revenue”, this same author on Seeking Alpha posted a similar accusation on ZS in Mid December. This post from XMFSandman was a response to me bringing up the issue and he completely put this to bed using 10-k reporting:

https://discussion.fool.com/they-currently-are-spending-88-of-th…

So I decided to challenge the author of this “revenue juicing” claim on Seeking Alpha, and they eventually stated “they are either revenue juicing or they have a wildly unproductive sales force. Take your pick.”

So they in fact have no idea or proof, they just see a big marketing spend. So I concluded that ZS is definitely NOT revenue juicing. So let’s look at their “Wildly Unproductive Sales Force”:

There are various metrics to actually assess the usefulness of S&M spend as pointed out above by Catunited (magic number etc). I use a ratio that measures how long the payback window is for Customer Acquisition in terms of added Gross Margin $'s. I get this data from Jamin Ball, a good Twitter follow and data provider - so shout out to him here.

Both Zscalar (16 months) and Monday (17 months) are able to cover their high S&M costs currently in short periods of time (compared to average SaaS companies), and so, as stated by many above - they need to keep juicing S&M spend so they can keep bringing in solid life-time customers.

The author of the reports making claims that they cannot back, are akin to the Short Reports we see. I prefer to deal in the facts. YMMV

20 Likes
10

https://www.scalevp.com/blog/a-quick-primer-on-the-rule-of-4…
https://www.smartkarrot.com/resources/blog/saas-magic-number…
https://corporatefinanceinstitute.com/resources/knowledge/va…

I was reading up on this question last night, and had forgotten Mike Sandrick’s post from the past on this very topic, so I was reading on various implementations of Rule of 40 because it seemed to me that anything other than GM% was going to capture any place they tried to bury a rebate. (Mike’s statement makes it clear that the rebates belong in the Revenues, to begin with.)

So, I was on a wrong track.

The 2nd and 3rd links, though, discuss metrics to evaluate the effectiveness of S&M.

11

Interesting thread, but to be clear and somewhat repeating poleeko above, there are two topics here.

One is juicing revenues. It is clearly illegal to call a rebate or discounted price, revenue. They never collected the money so it is not revenue. To take it to the extreme, I could give my product away and just make up a price as the sale price and then call the difference the rebate. It would make “revenues” a worthless data point.

So I hope none of our (or any) SAAS companies are doing that, if they are that is very bad news and I would sell anyone who was doing that immediately (and I tend to hold onto stocks much longer than most on this board.)

The second topic is a good one and probably the most critical to follow for SAAS type companies. But in my mind, it is interesting to see what the ratio between revenues and expenses are, and even more important, how are they trending? Because I believe that the costs to acquire customers will pay off in the long run for a SAAS company, it is okay for that ratio to be high but it is very important to see that ratio coming down, the quicker the better. That is where the real profits will eventually be made.

If I believe the revenue growth is both large and will continue for at least a few years, then the key to profits is whether the relevant expenses are growing slower than revenues. That should show up as the ratio dropping.

So the table at the top becomes interesting to me, but watching these numbers change in the future becomes even more interesting.

Something for me to watch more closely in the future.

Randy

2 Likes