Just because you use a company's product, it does not mean you should buy its stock. For example, chances are that you've heard of Lyft, but if you had invested in its shares when it went public on March 29, your holdings would be down 9%.
As I wrote on April 11, Lyft and its bigger rival, Uber, are in a terrible industry -- the low barriers to entry and huge private capital flows into the industry mean that competitors cut price to gain market share even as payments to drivers keep rising.
I think you're better off investing in companies that have figured out how to earn a profit before they go public and are still growing very rapidly. As I wrote in April, a case in point is Zoom Video Communications which provides an excellent example of how to build a scalable business model. Since its April 18 IPO, Zoom shares are up 65%.
Now San Francisco-based Slack Technologies -- a business communications service that gives workers wide access to messages -- is going public in a so-called direct listing. I use Slack's product -- but do not love it. (Slack claims in its April 2019 prospectus that many do).
However, my feelings about its product are not among the four reasons why I would avoid its stock.
(I have no financial interest in the securities mentioned).
Before betting into the reasons, let's look at Slack's method of going public. Like Spotify -- whose shares are trading at $139, the price at which they went public; Slack is doing a direct listing.
A direct listing is quite different from the more common Initial Public Offering (IPO). In an IPO, a company pays banks that run the process a fee of 7% of the amount raised.
For that, the bank does a road show which introduces the company to investors, it lines up buyers before the shares go public, it helps set the price for the first trade, and it stands ready to buy shares in order to create a big first-day pop that it hopes will strike the right balance between creating a Fear of Missing Out among the general public without leaving too much money on the table for the company.
That last point hints at one of the key differences with a direct listing. Slack will not be selling new shares, therefore the proceeds of the direct listing will go to employees and investors who sell their stock. Moreover, there is no road show for the direct listing and the pressure for a first-day pop is more muted.
And the fees Slack is paying are lower as well. As Bloombergreported, "three banks— Goldman Sachs, Morgan Stanley, and Allen & Co. —are splitting about 90% of the $22 million in fees earmarked for all 10 advisers."
Instead, Citadel Securities and Morgan Stanley will talk with buyers and sellers and shares will begin trading once the difference in the prices at which they are willing to buy and sell narrows to $1.
Unlike an IPO which limits the number of shares being sold initially, there is no limit to how many shares can be sold. This creates the risk that there will not be enough buyers -- creating what the Wall Street Journal called a "death knell."
Meanwhile, the reference price -- a guidepost for where the shares might begin trading -- is $26. This price would value Slack at $15.7 billion, 120% above the $7.1 billion at which Slack was valued in 2018 the last time it raised private capital, according to the Journal.
To put this in perspective, the April 2018 direct listing of Spotify had a reference price of $132 and 14 months later its stock trades about where it closed on its first day, around $149, according to the Journal.
This brings us to the four reasons you should resist your urge to buy Slack stock today.
1. Its revenue growth is slowing down
While Slack's top line grew 82% to $400.5 million in 2018, it is slowing down. In the first quarter of 2019, its revenue rose 67% to $134.8 million, according to its prospectus. And Slack is guiding investors to expect 2019 growth in the range of 47% to 50%, according to Barron's.
Slack has a so-called freemium business model in which only a small number of users pay. Indeed, according to the prospectus, more than 600,000 organizations had at least three users-- but in the quarter ending April 30, only 95,000 paid for the service -- 645 of whom accounted for over $100,000 in recurring annual revenue.
2. It's hugely unprofitable
There is little chance Slack can earn a profit. Slack lost a whopping $139 million in 2018 and in the first quarter of 2019, its net loss of $38.4 million was 28% of revenue. Slack noted "We have a history of net losses, we anticipate increasing operating expenses in the future, and we may not be able to achieve and, if achieved, maintain profitability."
As I wrote in my latest book, Scaling Your Startup, there are four stages of scaling and many companies going public these days skip the second stage of scaling -- Building a Scalable Business Model. They go from the first stage -- Winning the First Customers -- to the third -- Sprinting to Liquidity.
Slack is clearly one of the second-step-skippers. By contract, as I wrote in April, Zoom did not skip building a scalable business model -- instead as it got bigger, it figured out how to get more efficient at key processes like selling, marketing, service, and product development while selling more to its existing customers.
It could be challenging for Slack to build a scalable business model while spending heavily to keep its revenue growth rate from slowing down further.
3. It's burning through cash at a rapid rate
In 2018, Slack burned through $97 million in cash and $34.2 million in the first quarter of 2019.
To be fair, Slack does have $792 million in cash on its balance sheet, but given its high rate of cash burn, it seems to me that doing a direct listing instead of an IPO -- which would have enabled it to raise more capital -- was not the smartest choice.
4. Its corporate governance is not shareholder friendly
If you buy into Slack and you don't like how the CEO is managing the company, you are out of luck.
That's because the dual class structure of its common stock will concentrate 65.6% of the voting control in the hands of executive officers and directors, according to its prospectus.
To be fair, that concentration may have dropped since the April prospectus. "To sell stock, existing stockholders converted shares from Class B shares with 10 votes per share into Class A shares with one vote per share. Roughly 194 million shares were converted ahead of the direct listing, or around 38% of about 504 million shares," according to the Journal.
Nevertheless, Slack CEO Stewart Butterfield has "[concentrated] voting power," according to the prospectus. This will give him -- and not investors in the stock being listed today -- in electing directors, selling the company, and merging with other companies.
Butterfield -- a former philosophy student with a Masters in Philosophy from University of Cambridge -- has no prior experience running a public company. He was previously General Manager of the photo-sharing website Flickr at Yahoo! Inc., following Yahoo!’s acquisition of Flickr's developer, Ludicorp Research and Development, of which he was CEO.
If Slack can exceed investors' quarterly growth expectations and become profitable, it could be a good investment.
The first could happen but I don't see it becoming profitable. Don't buy stock in Slack.
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