The Stock Of The Day Is Monday... Dot Com

There are clearly a set of industries that seem to screen consistently well in the Green Screens.

Scanning the lists, there are always plenty of e-commerce names, commercial-stage biotech firms, medical device companies, and even a handful of semiconductor firms.

But no business model meets the tenants of the Green Screens like enterprise software. Almost half of the total stocks in the screens fall into this category!

And why not? Enterprise software is a fantastic business. It has been a perpetual growth market since its genesis in the 1980's, as companies constantly vie for competitive advantages and efficiencies. With the basically ubiquitous software-as-a-service (SaaS) model, subscription sales create steady streams of reliable recurring revenue. Most enterprise software offerings also boast high switching costs, as they are used to manage critical business functions like customer management, employee benefits, payroll, project management, customer service - almost anything!

Investors have to be careful in this space, though. There are a lot of very rapidly growing SaaS firms that spend prolifically, leading to meager or even negative free cash flows. We've also seen several firms spend obscene amounts of money to make acquisitions they were in no position to make, leading to dwindling business results (Okta's acquisition of Auth0, or Twilio's numerous big purchases come to mind).

Today, though, we're going to take a look at one of the better profiles of a SaaS stock on the Green Screen. The company is called Monday.com. Let's have a look!

The Business

Monday.com makes cloud-based workplace management software. Its core offering is called "Work OS". Like it sounds, this is a platform for combining various "widget" or "app" functionalities, such as document and data management, visual dashboards, automated workflows, reports and graphs, and even integrations into hundreds of 3rd party apps like Slack, Excel, Zendesk, and others.

The promise of Work OS and its apps/widgets is the ability to build just about whatever business functionality you need, without requiring professional software developers. For example, Monday's software could be used to develop project management systems at both a high-level (an entire corporate website) and low-level (one page on that website). Or, you could use it to build, manage, and monitor a marketing funnel. Or, it could be utilized to build a software development workflow from story planning, through development, QA, and deployment.

With close to a dozen built-in widgets, hundreds of apps on its App Store, and native integrations with nearly all of the big SaaS platform providers, Monday.com offers a lot of flexibility and bang-for-the-buck. The company has over 186,000 total customers across 200 industries in nearly every country on the planet. Its enterprise-level customer base (over $50,000 in annual recurring revenue) has ballooned to over 1,600 customers.

As mentioned, the Work OS platform is a subscription service. Currently, the company has several pricing tiers, ranging from free for very small shops (2 users), up to $19 per seat/month for the "Pro" tier, to customized pricing for large enterprises.

Growth Opportunity

This has been a rapidly growing firm, with a 3 year compound annual revenue growth rate over 50%. Even in its most recent quarter, Monday.com was still delivering year-over-year sales growth at that pace. Paid customers over $50k annually, easily the firm's most valuable clients, have been nearly doubling annually.

Clearly, maintaining a 50% growth rate isn't sustainable for an extended period of time. But I still think Monday.com has quite a bit of growth runway left here. This kind of software offering lends itself well to a "land-and-expand" model, where a client will start by using Work OS for a single use case, like software development, then quickly expand its usage into other departments where it can provide value. We can see this in its net revenue retention, which sits right around 130%. This means that not only is Monday.com retaining its existing clients, but it is expanding sales with them at a 30% annual clip! That's fantastic.

This company also has a very strong R&D track record. It launched with just a handful of native "building blocks" in 2018, and now has over a dozen native types, 92 3rd party integrations, 246 apps on the App Store, and dozens of widgets. The platform has become ever-more-valuable year-by-year, and I expect this will continue.

In the big picture, business process software is an enormous market. By 2024 (next year), it is expected to exceed $90 billion worldwide. With that kind of massive market, there is room for many very successful competitors. Monday's trailing 12 month revenue is $575 million, or just 0.6% of that pie. It doesn't take a whole lot of market share for this firm to double, triple, or quadruple its sales.

Finally, this is a subscription business, meaning virtually 100% of revenues are reliably recurring. That's what we want to see!

The Moat

We've touched on Monday.com's net revenue retention rate as a testament to the success of its "land-and-expand" growth strategy.

It is also a statistic that backs up the notion that this company has a strong switching cost moat. Once customers build a lot of their business processes on Work OS, migrating them off that platform is extremely expensive, time consuming, and error prone. Clients are unlikely to switch unless there are substantial advantages.

Virtually all enterprise SaaS offerings have some level of switching costs, but some are higher than others. For example, migrating to a new operations monitoring tool is not as costly as changing a core CRM platform, because monitoring tools deal primarily with machine-generated real-time data that has limited long-term usefulness. A CRM, on the other hand, contains human-generated client data that is useful to a company for a very long time.

Monday.com clearly falls into the latter category. It takes time for a client to develop workflows using Work OS, and once they are in place and relied upon, switching away from them would be quite disruptive. These switching costs grow exponentially once Monday is deployed across the enterprise and used to create workflows within and between departments. This is why the firm is keen on developing its largest clients - they are far more sticky than a small business with just a handful of employees.

We've touched on the huge market size and "sticky" nature of the product, but be aware this is a very competitive space. The workflows touted for Work OS form the basis of many huge software firms, including Atlassian (TEAM) (software development), ServiceNow (NOW) (IT and customer service), Asana (ASAN) (project management), and many others. Giants like Microsoft (MSFT) and Adobe (ADBE) also have competing offerings. Monday.com will always have to fight to win new business.

Management and Finances

I'm always on the lookout for Green Screen stocks that are founder-run, and in Monday.com we've got a double shot!

Co-founders Roy Mann and Eran Zinman still sit as co-CEOs of the company today. In general, I'm not a fan of "co" leaders, but in some cases - such as two founders - I don't have a huge problem with it. In fact, it reminds me of the setup at Atlassian, where founders Mike Cannon-Brookes and Scott Farquhar have successfully pulled off the arrangement for over 2 decades.

In Mann and Zinman's track record, we have the hallmarks of excellent leadership. Monday has not only grown rapidly, it has done so with phenomenal capital efficiency. The company has no debt and no goodwill, meaning all of Monday's growth has come from good, old-fashioned organic product development and marketing. As a result, free cash flow returns on capital are over 60%, and there is plenty of room for this to grow as the cash flow model matures.

Both men also maintain sizable stakes in the company they founded. Mann owns over 12%, while Zinman holds a 5% stake. This aligns their interests in the long-term success of the business, not in bonuses derived from short-term quarterly earnings beats.

Finally, these are two pretty young guys. Mann is 44 years old and Zinman 39. That puts them many years from retirement and, hopefully, they remain at the helm for decades to come.

I couldn't be more pleased with Monday.com's leadership team. Investors should be in good hands.

Risks

The biggest risk I see is in Monday.com not meeting our revenue growth and/or cash flow profitability expectations due to intense competitive pressures. Currently the firm does about a 13% free cash flow margin - I expect it to eventually mature into a more industry-norm 27-30%. Additionally, expectations are for Monday.com to continue its rapid growth trajectory, delivering 25-30% annual sales growth over the next 5 years, and significant growth rates out from that.

Considering the litany of competition, that could prove aggressive. It is a big market to be sure, but the barriers to entry are not especially high. Any competitive slip-ups and the company could easily miss our expectations, leading to a losing investment.

We should also consider the fact that Monday.com is domiciled in Israel. While I would certainly consider Israel one of the "safer" foreign countries as far as political stability goes (it's certainly no China or Russia), it has also historically been involved in many geopolitical disputes. It's conceivable that these could flare up again (or worse) and lead to under-valuation of Israeli stocks.

Conclusion

As a business, Monday.com meets all of the criteria we are looking for in a "green dot" stock. It is growing rapidly and organically in a massive industry. It has almost 100% recurring revenues. The switching costs around its solutions are high, particularly for enterprise businesses. It is led by two co-founders with a track record of efficient operations. There's really not much else we can ask for. It makes the cut for the Watch List.

Now the question is, when do we buy? My model has some pretty aggressive expectations: 29% average revenue growth, 30% FCF margin at maturity. This is moderated by the expectation of 5% annual share dilution and a high discount rate of 12%. Given these expectations, the stock's fair value is $182. MNDY trades slightly under that at present, so more aggressive investors might be interested in a small starting position. By our rules though, we will keep an eye on it and buy in if it reaches a 25% margin of safety.