Question for Saul, Bear, Wise re: Monday

Hi All especially the wise long-term members of the board

I posted a question about Monday (#79466) that went unanswered but now has quite a number of recs so I feel it would be really helpful to the board, especially newcomers, to have your thoughts on this. (I did email GolfCaddy about it and he pointed me to an article that said, yes, it’s a negative that may be an issue one day, but you need to make your own conclusions.)

I have combed the knowledge base and it is not there.

Both Monday and Asana have SG&A ABOVE 100% of revenues. (Actual numbers are in the post mentioned above)

To me this is a red flag but to some of you clearly it’s not and I would love to understand WHY so I can get over my reluctance to jump into Monday.

What this means to me is: For every $ Monday or Asana makes, they have to spend MORE than one $ in SG&A to get it. That’s NOT including R&D, which would be understandable, that’s SG&A alone.

And this for a product that has low switching costs. You can go with new PM software at the beginning of any project and although yes, there is a learning curve, it’s not too tough to change compared to cyber security.

When I did the numbers for all the other stocks we talk about for the last 5 quarters, the highest SG&A expense was at about 80% of revenues for Zscaler and there was one quarter of UPST that was higher than 100 but that was pre IPO.

So: Do any of you think this matters and if not why not, and when does it start to matter? Is it ok as long as its trending down…?

Thanks so much.
Monika

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So: Do any of you think this matters and if not why not, and when does it start to matter? Is it ok as long as its trending down…?

I’m just one man/bear here; also I don’t own any MNDY. But I think these things absolutely matter. But they aren’t necessarily decisive. These are pieces to the puzzle – no individual piece can tell you whether to buy or sell.

Another piece: MDNY is also sporting a PS ratio over 80.
Another piece: MNDY is also growing incredibly fast.

There are many things we must weigh. To your point: perhaps they can grow revenue faster than expenses in the near future? I don’t know this.

Bear

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This is a hotly debated topic in the VC world.

Here is a quote from probably the most widely circulated research from Tomasz Tunguz a Venture Capitalist at Redpoint on this topic.

“In the first 3 years, these public SaaS companies spend between 80 to 120% of their revenue in sales and marketing (using venture dollars or other forms of capital to finance the business). By year 5, that ratio has fallen to about 50% where it remains for the life of the business.”

https://tomtunguz.com/saas-marketing-spend/

If you believe this survey, Asana and Monday are in line with the data. What should happen is sales and marketing ramp up, but revenue ramps up more over five years and that is why that line item becomes a smaller percentage overall.

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What this means to me is: For every $ Monday or Asana makes, they have to spend MORE than one $ in SG&A to get it. That’s NOT including R&D, which would be understandable, that’s SG&A alone.

Monika, SG&A includes both Fixed Costs and Variable Costs. Generally, fixed costs do not increase as the company sells more. The term, operational leverage means to grow out of the fixed costs. I dont know what % of SG&A costs are variable… but those would be the costs that scale up at a certain percentage with revenue you would need to look at.

Typical SG&A items include rent, salaries, advertising and marketing expenses and distribution costs. Items that are usually considered fixed costs are rent, utilities, salaries, and benefits.

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@MizzMonika, I don’t claim to be as wise as Saul or Bear, but perhaps I can explain a bit as a new shareholder of MNDY (it’s only a starter position). Their spending is a concern, but what makes it ok by me is the fact that they are demonstrating scalability of the business and progress towards profitability. Two metrics that point to this are their non GAAP net loss and their non GAAP operating margin. Non GAAP net loss came in at -11mm in the most recent quarter vs -15mm in the comparable quarter last year, and Non GAAP Operating margin went from -41% last year to -14% this year!

Clearly it’s moving in the right direction, and its spending is under control.

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My personal take. In general and in many businesses it wouldn’t make any sense to spend more in marketing than in revenue. Why would a company pay $12 in marketing to sell a $10 t-shirt, it wouldn’t make sense. But these aren’t t-shirt companies. The obvious difference is the “land and expand” and recurring revenue aspect gained by spending these marketing dollars for these SaaS companies. One could also look at it as, what is my payback period on every new $1 spent in marketing for my SaaS company? To spend $1.20 in marketing to land only 1 year revenue of $1 is not a great deal, but if that $1.20 marketing lands the customer into $1 revenue year 1, $1.25 revenue year 2, $1.56 revenue year 3 and so on… that becomes an excellent investment. What is the sweet spot on payback, well that would depend on each individual company and how well they land and expand - the metrics we already look at such as ARR, Gross Margins etc.

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A few additional points …

I was also about to point out the link GolfCaddy referenced - but with a slightly different take. The timeline referenced by Tomasz is for the life of the company (not since they went public). Based on that:

  • Monday (I do not own) was founded/incorporated in 2012 (9 years ago) and, in my opinion, they should be below the 100% level already. If you choose to use the timeframe from when product was first released, that is 5 years and borderline for when they should be below 100%.
  • Asana (now 7% of portfolio and up 212% since 1st purchase) is even older - founded in 2008. So again, beyond the expected curve.

Interesting side note: both companies changed names at some point:

  • Asana began as “Smiley Abstractions, Inc” - changing in 2009
  • Monday began as “DaPulse Labs Ltd.” - changing in 2017

A Paul stated, this is one of the many data points. That SG&A as % of rev is declining is good, but you also should try to understand why they are declining at a slower rate than the revenue growth.

More thoughts on SG&A:

While salaries are often defined as a fixed cost as part of SG&A (as Titan pointed out), a portion of them related to cost of sales (in the Selling part of SG&A) tends to be variable in high growth companies. They are generally hiring more sales & marketing people and often they compensating the same number of sales people more as they do better (incentivized to go over quotas and targets in search of revenue growth).

As they begin to transition from high growth to more of a profitability focus they will need to keep cost of sales in line with revenue and you will see a slowdown in hiring and less upside in the sales compensation plans. That is when the cost of sales part of Selling become a fixed cost (for example, that is where my company is at today).

Asana has stated in past earnings calls that they have been increasing the size of the enterprise sales organization which contributes to the increasing SG&A $'s. You see this as part of the Sales & Marketing report out (vs the General & Administration portions of SG&A).

Qtr    S&M  G&A  EC Notes
Q2-21  20    8
Q3-20  36   20
Q4-20  31   11
Q1-21  36   12
Q2-21  39   14
Q3-21  48   15   doubled sales force
Q4-21  54   18   increased sales team
Q1-22  57   22   increased enterprise sales
Q2-22  64   27

I have not followed Monday so can’t speak to them, but assume they are similar.

Another factor that is hard to determine is the detailed breakdown of the high SG&A costs. Are they spending too much on fixed costs (and thus burdened by costs they can’t easily reduce) such as rent, equipment leases, and the like? Are they spending a lot on employee perks like free lunches, large parties, and other “optional” expenses? Some early Silicon Valley companies were known for this (and still are), but it’s much easier to bury these costs when you have $55B in revenues than when you are at $250M.

So in summary, Asana’s high SG&A is concerning, but I am willing to accept it (not overlook it) while revenues continue to grow. But at the same time I am starting to try to better understand why they are so high and when they will come more in line with the other companies on our list.

Best,
BornGiantsFan

  • Giants took an early lead today - let’s hope they can keep it
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Tunsfool,

You just needed to keep reading. Toward the bottom of the press release in the section called:

Reconciliation of basic and diluted weighted average number of shares outstanding
https://ir.monday.com/news-releases/news-release-details/mon…

It gives the total as 43,993,679 shares.

44m * $396/share = $17.4b market cap

17,400m / 223m TTM revenue = PS of 78

Bear

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Tunsfool -

This is from the bottom of MNDY’s press release:

Weighted average number of ordinary shares outstanding used in computing basic and diluted net loss per share (Non-GAAP) 43,993,679

$396.10 * 43,993,679 / 222.6M = 78.3 P/S

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I hesitated to post this, because many of the salient points have already been made. But I feel like some of my own personal experiences might add some insight.

I think the critical thing to think about is that you aren’t paying $12 in sales/marketing to acquire $10 in revenue.

  • As MoneyTree pointed out, you are actually paying $12 in revenue to acquire a $10 a year revenue stream in perpetuity.
  • In fact, many of these SaaS companies have retention greater than 100%. i.e. even though you will churn an occasional customer, the customers you renew spend so much more every year that you end up with each cohort actually growing in revenue. As MoneyTree said, you are paying $12 now, for $10 this year, $12.50 next year, $13.62 the year after that, and so on.
  • But one critical point that I don’t think has been made yet is that many of these SaaS companies have network effects such that there will be only one eventual winner. Every $1 of revenue you earn is not only many $$$ later, but it’s money that you are depriving you competitors. Every $ that Monday gets in a revenue is not only a $1 earned, it’s $1 that a competitor can’t claim.
  • Taking the above points one step further, if I can raise $80 in capital for each $1 in revenue, for every $1 in revenue I earn I simultaneous gain $80 I can plow into my company AND I steal $80 from the potential capital of my competitors.

Trust me, I’ve worked for early stage startups. How much would I spend to win a good customer? Anything. Everything. I remember landing Nike as our first F500 customer at one of those startups. We easily spent $10 in SG&A for every $1 we earned in that contract. It didn’t matter. I would have done it a thousand times. I try to stay anonymous on this board so I don’t want to give too many details. But that I think that every $1 in that contract meant $250 in our next VC round.

This isn’t to say that I endorse Monday. It’s on my list to research. But I just haven’t done the work yet. And I’ll admit to being skeptical, as there’s too much good competition. For the “Saul stocks” in my portfolio I want them to be “slam dunks” on everything except valuation.* But big SG&A doesn’t concern me anymore than big R&D. They are both investments in the future, that if all other elements are in place, will reward investors hansomely.

–CH

*As an aside, I feel like that Saul’s success basically boils down to that premise. That in SaaS markets, and other markets with similar network effects, the rewards of success are so huge that the market inherently does a bad job of valuation. That if you look for companies that will define a category or crush a category, the price you pay is almost irrelevant. Not because valuations are unimportant, but because the upside potential means that the market still struggles to valuate them fairly.

I remember looking at AWS in 2008 or so, and saying to myself, this is a great product but the business model is terrible. Amazon is clearly playing balance sheet shenanigans just to amortize all of the server and network costs. As you say, they were clearly paying $12 to gain $10. But even worse, their effective margins were terrible. (They looked decent on paper as long as you didn’t look carefully, but to a wise investor it was clear that were hemorrhaging money on each customer.) I knew there was upside, but I felt that $80 per share was absurd, I felt that it had priced in perfection!

But, history has proven me terribly wrong. AWS has come to define an entire category. All that money they lost in sales, and in R&D, has now basically given them a duopoly for the next few decades. And that $80 share price that I found mind boggling absurd, would be worth $3200 today. All essentially because I failed to recognize that how absurd the payoffs would be that would come from defining that category. The share price hadn’t priced in perfection, SaaS had changed the rules, and perfection was a lot more worthwhile than the market (or I) could envision.

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Just a quick (anecdotal) observation on this comment by Monika: “And this for a product that has low switching costs. You can go with new PM software at the beginning of any project and although yes, there is a learning curve, it’s not too tough to change compared to cyber security.”

About 5 years ago, I was working with a Project Manager at a small tech start-up, where we used JIRA for all the tech and product related activity. The Project Manager tried to introduce Asana for coordination between Sales and Marketing, Product development, and Tech. (The Sales/Marketing people did not like JIRA, and basically didn’t use it, relying on email instead to communicate with the tech people.) The CTO (chief technology officer) refused to use Asana and that was the end of the story. This was a pretty dysfunctional organization, but I think these project management tools (like JIRA or Asana) are very sticky. I think you would need a good reason to switch to a new tool, once one tool has been established within a group.

I watched the video for Monday that someone referenced in another post. It seemed like a good tool, with a good deal of overlap with some features of JIRA. But I don’t see them taking over the world. Asana is also a good product in the same space. And JIRA is very good for tech teams. I think Asana and Monday might be Covid stocks on some level, in that the demand for these tools has increased due to Covid. But I haven’t looked deeply into these companies.

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I don’t think that using the weighted average shares outstanding is the correct way to calculate the company’s CURRENT market capitalization. These are used to calculate earnings per share because earnings are by definition a “flow” over a periodo of time and must be divided by a weighted average amount of shares over the same period of time to make sure it’s “apples to apples”.
Current market cap should be calculated multiplying the CURRENT market price per share by the CURRENT diluted number of shares outstanding, otherwise for these type of companies that keep issuing shares one risks to understate current market capitalization.
Now, the problem here seems to be that the company hasn’t issued the equivalent of a 10-Q yet (at least I couldn’t find one under SEC filings on their website), so we just have numbers from the press release, where ONLY the weighted average number of shares is provided.
However, based on their IPO registration statement (equivalent of an S-1) the total number of diluted shares outstanding as of March 31st, 2021 is 46,161,974 (page F-25), and probably the CURRENT one is even higher than that.
So, with that number: 396.1 * 46,2m = 18.3b.
It doesn’t change substantially the picture, but I think it’s more accurate.
Silvio

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“*As an aside, I feel like that Saul’s success basically boils down to that premise. That in SaaS markets, and other markets with similar network effects, the rewards of success are so huge that the market inherently does a bad job of valuation . That if you look for companies that will define a category or crush a category, the price you pay is almost irrelevant. Not because valuations are unimportant, but because the upside potential means that the market still struggles to valuate them fairly.”

Many thanks for sharing your first-hand experience, great post!

I wonder, however, why you put it this way when you seem to mean the exact opposite: for all the temporary overshoots and undershoots, the broad market fluctuations, and the post-IPO craziness, the market on the whole “gets it” while individual investors, funds, or talking heads struggle and refuse to buy a pricey stock until it is mainstream enough to do so (or for good). The Gardner brothers coined this as Rule Breaker key trait (perceived as overvalued by traditional metrics) and turned it into a requirement.

Traditional financial research admits that you can beat the market if you have information most don’t know or simply don’t understand (not insider info, but a deep grasp of product and competitive landscape, company efficiencies etc). In addition, what TMF and Saul have been doing, in different ways, is to pay the market price a top race car commands. Who wins in Formula 1 or the Baja 1000 by being cheap? So the high valuations of SaaS are reflection of the market understanding its value, rather than being “wrong.” That does not mean we cannot “crash and burn” with the next crisis, but as we know from the past, this “overpriced” space is also likely to rebound first and best, just as the best of race teams after a crash.

I would love to see valuations mapped against performance but don’t have the time for that.

What the above means is that the interesting questions become not “why is this stock so pricey!” but “why is this SaaS that I like so much cheaper than other SaaS, what am I missing?” or “Why has this SaaS been sustainably expensive even if I don’t like it, am I missing something?”

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Thank you to everybody who has engaged in this conversation and enlightened me. This board is such an amazing resource.

I appreciate everybody’s opinions on not being dogmatic about SGA, so thank you for that.

Certainly for a company like Crowdstrike I would let it go now. I did go look at the post-IPO numbers for CRWD and they weren’t above 100 by the way. They were about 70.

So to me that number represents the efficiency of the company in selling its product, and as Bear says, it matters but it’s not the only thing that matters.

So to Monday:

  • The final points about stickiness may be true per team, but as Brooklyn’s example shows (CTO refused to leave Atlassian for Asana, which marketing didn’t want to use), landing into one zone of an enterprise does not mean you will take over. PM software really is group by group, and the decisions of one don’t affect the other. So very different than cyber security, in which it is a whole-organization decision.

  • I think it all comes down to superiority of product. If Monday is really that much better, they will get more efficient in selling because it will start to spread into the organization organically.

I will likely regret this decision as I watch all of you Monday holders make big $$ but I am going to sit on the sidelines for another quarter and watch for it to reach that level of efficiency.

I’m a little conservative but that’s ok with me.

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One concern that I have for companies that have no net margin is, how do you know the business model works? What if SGA always exceeds revenue? This is a highly competitive space, Monday, Asana, smart sheets, atlassian, one of my teams started using a new package I hadn’t even heard of before (not saying all these are identical). Just that the market is hyper competitive and fragmented.

This board has identified many companies where the business model is proven and operating leverage is observable in the results. I wouldn’t rule out investing in a company whose model is unproven, but for sure it wouldn’t represent the bulk of my holdings. Some of my worst investments have been companies where it remained unclear whether the company can generate significant positive cash flow over time.

Rob

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how do you know the business model works?

This is a good question in my opinion with respect to companies who are spending heavily in S&M.

Payback period is one way to gain insight into how the model is working. It has several definitions/calculations, but one way to define it is as follows:

1 - Note the previous quarter S&M spend
2 - Calc the difference in Gross Profit from the current quarter compared to the prior quarter
3 - Annualize #3 by multiplying by 4
4 - Take #1 divided by #3
5 - Multiply #4 by 12 to get the payback period in months

Generally speaking, a payback period in the upper teens to low 20s is considered quite good.
If you have any questions on this, feel free to email me personally as I’m not sure this is of great interest to the entire board.

The above was one reason why I became excited about Asana early on. While the S&M spend was quite high, the payback period was very attractive. It appeared the heavy spend was bringing in clients. Coupled with a super high gross margin and a sticky platform especially with the big spenders, this suggested a strong business model and suggested that growth would accelerate.

FWIW the payback period for Asana this past quarter was 14.4 months which is the lowest it has been in quite some time.

A.J.

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1 - Note the previous quarter S&M spend
2 - Calc the difference in Gross Profit from the current quarter compared to the prior quarter
3 - Annualize #3 by multiplying by 4
4 - Take #1 divided by #3
5 - Multiply #4 by 12 to get the payback period in months

Ughhh…
That should say “Annualize #2 by multiplying by 4”

Just wanted to correct that so it didn’t confound anyone who is interested and apologies for the mistake and additional post.

A.J.

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I wonder, however, why you put it this way when you seem to mean the exact opposite: for all the temporary overshoots and undershoots, the broad market fluctuations, and the post-IPO craziness, the market on the whole “gets it” while individual investors, funds, or talking heads struggle and refuse to buy a pricey stock until it is mainstream enough to do so (or for good).

That’s definitely not what I mean. If the market “got it” then we wouldn’t have Saul getting “ridiculous” returns. It’s not just undershoots and overshoots, or volatility, or even rewarding extra risk, these stocks are vastly exceeding market returns. If the market was efficient, these SaaS stocks would “hockey stick” during the period where they gain viability, but then achieve an extremely high valuation that reflects their future market dominance. Instead, the hockey stick is much more gradual than it should be, as the market takes much more “convincing” than it should. Thus providing a (fairly long) window where these stocks are vastly undervalued. But more on this later.

I feel like the “talking heads” don’t get it because it’s not in their interest to get it. They will, almost by definition, take both sides and talk “the controversy”. You can’t have stocks at these relative valuations without talking heads getting into a lather about it. They have no interest in getting people to buy stocks or sell stocks, they have an interest in having people watch them because they feel scared, or greedy, or intrigued.

But let me address Rob’s question first.

One concern that I have for companies that have no net margin is, how do you know the business model works? What if SGA always exceeds revenue?

Well there is the trillion dollar question. If it were obvious then everyone would do it and there wouldn’t be this evaluation discrepancy.

Because this, arguably, is the other half of the question above. Why aren’t there more funds that also take advantage of this? Because it can be hard to tell the Cloudflares from Nutanixes. Even this board, with its track record of success, has had some “swings and misses”.

I do think that a big part of the reason this evaluation discrepancy exists is fear. We can look at a Cloudflare and see that the business model works. We can see the future fairly easily. But it still isn’t making any money. There are still articles on SeekingAlpha that insist that it is “priced perfection”. It is very hard to have the discipline to hold in the face of dips. It is very hard to have the discipline to hold even in the face of gains!

And on the flip side, it’s also all to easy to get greedy and see these discrepancies where they don’t exist. (Thus the swings and misses.)

But, nonetheless, as evidenced by Saul’s returns, on average, I still think there is a gap between where the market is currently evaluating these companies at, and where they deserve to be. It may not be easy, but it can be done.

And, so, after much rambling, my only real answer to “how do you evaluate these companies” is to read the Knowledge Base and to read the analysis here.

The Gardner brothers coined this as Rule Breaker key trait (perceived as overvalued by traditional metrics) and turned it into a requirement.

I do think there are some strong similarities between Rule Breakers and Saul Stocks but also some minor differences. (I have been reading the Fool for an absurdly long time but do not subscribe to Rule Breakers.)

I probably shouldn’t express my opinions since my knowledge of Rule Breakers is so out of date, but I feel like Saul’s criteria are much higher in multiple dimensions.

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It’s important to keep an eye on the cash balance during these high spend periods to ensure the company has adequate cash to sustain operations and fuel the research and investment in product development. In the last quarterly report the company disclosed: Cash, cash equivalents, short-term deposits and restricted cash was $878.0 million as of June 30, 2021, including $21 million from borrowings under our revolving credit facility, and net proceeds from our IPO and concurrent private placement of $736.2 million. Their current ratio and quick ratio are both 4.9, so they have plenty of cash on hand.

Having worked in multiple tech startups, I am not surprised SGA spend is higher than revenue during hyper growth stages at tech companies. To gain momentum and establish a moat, companies often have to make some tough decisions to win certain milestone business opportunities. Sometimes that means accepting losing deals just to keep those accounts from going to your competition. It could mean expensive commitments to meet certain contractual or compliance obligations to gain eligibility to compete in certain markets. It could mean making some big bets to position your business for exponential growth, even before that growth materializes.

Obviously it’s not sustainable for a long time to continually spend more than you take in, but it can be a calculated, strategic, risk for a limited time to facilitate growth and momentum to get to the next level. With the cash Monday has, I can tolerate it for a while.

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