Tech IPO season has well and truly kicked off — Uber, Lyft, Pinterest, Zoom, and now, Slack.
It’s an area that I’ve been talking about a lot recently; they’re huge events in the tech scene:
- Lyft hit the market at a $24bn valuation despite losses of almost $1bn.
- Uber is chasing a valuation of $90bn, reporting that it ‘may never make a profit’.
- Zoom (ticker ‘ZM’) caused confusion when it went public as the share price of a similarly named company (ticker ‘ZOOM’) soared 80%.
- Slack just filed to go public.
And it’s that last one that I want to talk about because they’re doing things a bit differently.
What is Slack?
Ask anyone working in tech and they’ll know exactly what Slack is, but outside of this, you’ll probably be met with a slightly puzzled face.
Slack explain their product as:
A collaboration hub where you and your team can work together to get things done.
In other words, it’s an instant messaging platform where you can share ideas, progress and updates with your team, with each topic held in a separate channel. It was designed to be a replacement to traditional emails. This is how it looks:
They’ve just filed for an IPO
At the time of writing, Slack has filed the paperwork to prepare itself for life as a public company (meaning the public can buy and sell shares on the stock market). The official Form S-1 is here, if you’re interested.
This is what you need to know 👇
1️⃣ The Key Metrics
Slack is free to use, but they have a paid plan which is where they get most of their revenue. It’s called a ‘freemium’ business model — the practice of allowing people to use your product for free (forever, not just a trial) in the hope that some of them convert into paying customers (to access extra features).
Revenue growth of Slack is typical of that of a tech company; $105m, $221m and $401m in 2017, 2018 and 2019 respectively. This is driven mainly by an increase in paid customers, which were 37,000, 59,000 and 88,000 for each year.
The average customer pays around $2.7k per year for using Slack once you adjust for customers that were paying in excess of $100k per year (135, 298 and 575 for each year). Slack count 65 of the Fortune 100 companies as customers, although it’s not clear whether all of these pay over $100k.
Profit (well, loss)
Like most tech companies, Slack doesn’t make a profit. Its loss from operations was $154m in 2019. If you’re wondering why tech companies make a loss, check my article here.
From a gross profit level (revenue less cost of sales) the company is profitable which is a good sign. In 2019 its gross profit margin was 87%, which simply means they make a profit of 87% from each customer (before you deduct costs that aren’t directly attributable to customers). These costs are primarily made up of hosting and customer support costs.
Slack has two kinds of users — those on the free plan and those on the paid plan.
Over 600,000 organisations use Slack across both plans with over 10m daily active users(‘DAU’) which is defined as “users who either created or consumed content in a given 24-hour period on either a free or paid subscription plan”. Monitoring DAU is important because it excludes people who sign up but never use the platform.
Paid customer growth was 59% from 2017–2018, and 49% from 2018–2019.
Of the 600,000 organisations that use Slack, 88,000 are on the paid plan. Here’s a quick note on the freemium business model:
With 88k paying users, Slack has an overall conversion rate of roughly 14.7%. Under the freemium business model, if you can maintain that % then you’d need to gain 7 customers to, on average, get 1 new paying customer. Knowing that can help you price the service for the paying customer, as it needs to cover the acquisition cost of 6 other free users…
Slack state that they believe the main reason people upgrade from Free to Premium is that the free package restricts the number of searchable messages to 10,000. Pay, and you can access more.
2️⃣ The Winners
There are a lot of people and organisations who own shares in Slack. Prior to an IPO, it’s very difficult to sell those shares because there isn’t an open market. Once the company goes through the IPO, these shareholders may finally be able to sell their shares often at a huge return (subject to any lock-up period).
One of the biggest shareholders is Accel, which holds 24% of the shares. They know a thing or two about investing in tech companies, having previously backed Facebook, Dropbox, Deliveroo, Spotify and more household names.
VC firm, Andreessen Horowitz, holds a 13% stake. Marc Andreessen tweeted a graph of Slacks growth back in 2014, captioning it with:
I have never seen a viral enterprise app take off like this before — all word of mouth.
3️⃣ The Risks
With every S-1 filing, there is an interesting section where the company must disclose the key risks that it faces. Here are some of the risks disclosed:
👉 Limited operating history so it’s difficult to forecast the future
This is pretty standard for a tech company. There’s not a long history to look at when calculating the forecasts that need to be reported as a public company. This means the actual results could differ materially from those forecasts, which could cause the share price to take a hit. A lot of the risks disclosed revolve around this concept.
👉 They may never make a profit
The media love this one, but again, it’s pretty standard. You can’t predict profitability for a tech company scaling at such a fast rate. They need to make a loss to drive rapid growth.
👉 They know a lot about you, and might accidentally do a Facebook
Slack appreciates that it holds a lot of files, data and information for organisations that use their platform, much of which concerns individuals. They also note the ‘numerous lawsuits and regulatory proceedings in progress against various technology companies’ currently in progress.
Failure to comply “could harm our business and reputation”. That’s putting it lightly.
👉 Customers on the free plan may never convert to paid customers
This is exactly why the freemium business model can be risky. There needs to be sufficient benefits in the premium package to encourage users to convert, but if you don’t make the free package attractive enough, you won’t get the users in the first place.
If free users don’t convert, they’re costing the company money.
So we (the UK) get a special mention, albeit under the ‘risks’ section.
But it’s not pretty. They’re talking about the uncertain relationship with the EU, coming at it from a data protection and compliance angle here. Basically saying “we haven’t got a clue what’s going to happen”.
👉 The management team has limited experience managing a public company
This is actually very common for tech companies. Take Mark Zuckerberg, as Chairman and CEO of Facebook. He launched Facebook from his dorm room, now he’s heading up a multi-billion dollar organisation.
The risk details are fairly standard, essentially saying the complications of running a public company could distract senior management from the day-to-day and strategic position of the company. Let’s hope they don’t do an Elon…
4️⃣ They’re not doing a normal IPO
I refer to Slack doing an ‘IPO’ because most people know what it means, but that’s not strictly correct as they’re actually pursuing a DPO (or a ‘direct listing’).
A DPO is the process of going public without raising more money. Check out this article for an overview of Direct and Initial Public Offerings.
It’s significant because it’s pretty rare. Probably the most well know DPO was Spotify in 2018. Other than that, there are very few major tech companies that have gone public via a DPO.
Why are they doing a DPO? Because they don’t need to raise more money right now.
What will the future hold?
The S-1 also includes a bit about the growth strategy, but they’re fairly vague. The focus is certainly around growing the user base by continuously improving the product. This should drive more organisations to sign up, which should, in turn, increase the number of paid customers.
There’s a little bit of focus on getting larger organisations on Slack, because that’s where the big bucks come from.
The final one is a little more interesting as the company looks to leverage AI, ML and advanced search to streamline people’s working lives, although that’s all they’re telling us for now.
All in all, it’s difficult to know how a tech company will perform as a public company, but its certainly going to be a ride that I’ll be watching closely.
Please note this is not personal advice and you should carry out your own research before choosing whether to invest!
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