Slack’s Q2 Earnings, Outlook: What’s Working for WORK?

Yesterday, Slack (WORK) released its first earnings results since it went public in June in an unusual manner. For the second quarter of fiscal 2020 (quarter ended July 31), the company reported a net loss of $359.6 million ($0.98 per share).

However, excluding the $285.8 million stock-based compensation, the company’s adjusted EPS came in at -$0.14. That’s an improvement over its EPS of -$0.26 reported in the second quarter in fiscal 2019. However, the number of outstanding shares almost tripled.

The company reported 58% growth in revenues as the number of paying customers jumped 35% to over 100,000. In April, Slack had 88,000 paying customers. In our view, Slack’s revenue growth is modest because it went public at an eye-popping valuation on the promise of growth.

WORK stock gained 8% yesterday in anticipation of better-than-expected earnings. However, its stock dropped 14% in premarket trading after its earnings were released after market hours. Although its shares recovered once the market opened, they were still down 5% at 12:16 PM EDT, as Wall Street seemed disappointed with the outlook.

Slack’s Q3 and fiscal 2020 outlook

Slack expects revenues of $155 million at the midpoint of the current quarter, which ends on October 31. Its revenues are expected to reach $606.5 million for fiscal 2020. The adjusted losses for the current quarter and the full year are expected to be 9.5 cents and 41 cents, respectively, at the midpoint.

Analysts seemed more concerned about the company’s fiscal 2020 operating cash burn forecast of $105 million at the midpoint. Excluding $51 million of operating cash burn related to its public debut, the company’s forecast for cash burn is higher than $32.5 million, which the Reuters-surveyed analysts expected. 

Revenue per customer on the rise

Notably, Slack’s revenue growth topped its growth in the number of paying customers. This could mean that Slack is generating more from each paying customer. That could also mean Slack is targeting larger companies.

In January, Slack reported that 65 of the Fortune 100 companies used its product. However, Microsoft Teams (MSFT)—Slack’s primary competitor—was used by 91 of the Fortune 100 companies in July. In July, Microsoft reported that Team had 13 million daily active users (or DAUs), potentially surpassing Slack, which crossed 10 million DAUs in January. Slack didn’t disclose the latest DAUs numbers in its presentation.

In July, Slack launched a new update to make its desktop and web versions load faster and consume less memory. We believe that the update was targeted at enterprise customers.

Cross-selling and upselling concerns

While the number of paying customers and revenue per customer is on the rise, the average revenue per user (or ARPU) is a hard-to-move metric. After William Power of Robert W. Baird & Co. asked a question regarding ARPU growth, CEO Stewart Butterfield sounded cautious. Butterfield noted that the company was laying the “groundwork for incremental ARPU opportunities down the road. So not charging for shared channels themselves but establishing those secure connections.”

To generate higher ARPU, the company will either have to raise pricing, come up with new products, or both. The first is not really an option, as the battle for enterprise messaging supremacy is just starting among Slack, Microsoft Teams, and Facebook Workplace (FB).

Like Slack, Microsoft Teams is also a “freemium” product. However, Microsoft Team’s free version offers more perks than Slack’s free version. Moreover, Microsoft Teams comes bundled with other Office 365 benefits in its paid avatar.

Facebook Workplace is also priced aggressively with higher perks for the free version and the premium version starting at $4. Slack’s premium pricing starts at $6.67 per user per month.

In addition, Slack doesn’t have comparable products to cross-sell to generate higher ARPU. On the other hand, Microsoft can sell its family products to users of Teams. Facebook can also sell advertisements and other products to Workplace users.

Can Slack compete with Microsoft Teams?

While enterprise messaging products have mushroomed since Slack was launched, the real competition today seems to be between Microsoft Teams and Slack. Butterfield, who ruled out competition from Microsoft Teams, mentioned Office 365 several times during the earnings conference call.

He mentioned that several enterprise customers who use Office 365 (Team comes bundled with Office 365) also use Slack. Slack currently has an advantage over Microsoft Teams and Facebook Workplace when it comes to third-party integration.

However, most enterprise customers use Microsoft products heavily, and Teams provides seamless integration with other Microsoft products. The fact that Microsoft Teams is growing significantly faster than Slack says a lot about its adoption. Microsoft Teams also has an edge, with 91 of Fortune 100 companies using it.

Is Slack going the Uber way?

WORK stock is down from its public debut highs. With the pre-market fall, it even flirted with the public debut reference price of $26 set by the NYSE. That’s equivalent to the $45 price set by Uber (UBER) in IPO parlance. Most days since its IPO, Uber stock has failed to reach that milestone.

At around 12:00 EDT today, Uber was trading at $32.40. Interestingly, Masayoshi Son’s SoftBank Vision Fund has invested in both Uber and Slack. So far, UBER and WORK haven’t turned out to be a strong bet for those who invested in its debut. In our view, Slack would have to grow faster and burn less cash to grow more sustainably.