Smartsheet and the Citizen Developer

Date of Recommendation:       December 26, 2019 
Closing Stock Price:          $43.93

Smartsheet (SMAR) is a leading provider of collaborative work management tools for enterprises. Their flexible, no-code platform allows users to automate common business workflows like project tracking, request approval processing, customer onboarding, event registration and sales pipeline management. This automation is accomplished without writing custom code, allowing developers to focus on building higher-value customer-facing software.

Due to Smartsheet’s rapidly growing product offering, the huge addressable market, its strong leadership team and consistent expansion within large enterprise customers, it should be considered as a long term investment. I expect the stock price to at least triple and reach a target of $140 in the next 5 years.

Financial Overview

I won’t spend a lot of analysis on the past and current financial picture, as I think long term growth will be driven by product and market forces. With that said, Smartsheet is appealing from a financial point of view, assuming rapid growth can continue from what is now a relatively small base. Here are some high level metrics from the most recent quarterly report (Q3 FY 2020):

• Total revenue grew 53% year over year. Subscription revenue grew 55%. Raised annual guidance to total revenue of about $270M, representing growth of at least 52%.
• Q4 FY 2020 revenue estimate calls for year over year growth of 48% to 50%. While this might seem like a slight deceleration from Q3 FY 2020 growth of 52%, keep in mind that the Q3 beat was $1.7M or about 3.6%. So, assuming a similar marginal beat for Q4 revenue, we would be back in line with 52% y/y growth.
• Ended the quarter with 83,139 domain-based customers
• The number of all customers with annualized contract values (“ACV”) of $5,000 or more grew to 8,421, an increase of 51% year over year
• The number of all customers with ACV of $50,000 or more grew to 770, an increase of 114% year over year
• The number of all customers with ACV of $100,000 or more grew to 279, an increase of 120% year over year. This spend represents the threshold that most SaaS companies define as enterprise spend.
• Average ACV per domain-based customer increased to $3,286, representing growth of 48% year over year
• Dollar-based net retention rate was 134%, which has remained the same for the last 4 quarters.
• $563M of cash and equivalents on the balance sheet, with no debt. They are judiciously applying cash towards acquisitions.

SMAR stock is valued at the higher end of software companies, but near peers with similar growth rates. Current EV / Revenue ratio (as of publishing date) is 18.6. Forward EV / Revenue ratio to end of FY is 16.8 and forward 12 month EV / Revenue ratio is 12.1. Peers with similar revenue growth rates include COUP, MDB, OKTA, SHOP.

Profitability is not immediately favorable for SMAR stock. Non-GAAP operating loss this quarter was $20.7 million, or 29% of total revenue, compared to non-GAAP operating loss of $10.2 million, or 22% of total revenue, in the third quarter of fiscal 2019. However, they do intend to improve on this with a net even FCF target for next year (FY 2021).

At their Analyst Day in October 2019, SMAR leadership provided a long term financial model that projects a 20% operating and FCF margin at scale, which improves the profitability picture significantly. Additionally, they are targeting $1B in revenue within 3-5 years. SMAR originally established this goal at last year’s analyst day, and reported in the Q3 FY 2020 conference call (Dec 4, 2019) that they are still on track.

In my opinion, these two charts provide probably the most compelling justification for an investment in SMAR. A company with $1B in revenue and a 20% operating margin growing at about 30% a year would justify a P/S ratio in the range of 12 – 18 (PAYC has a P/S ratio of 22, albeit with a 30% op margin). SMAR’s current market cap is $5.11B. Therefore, by these measures, we could see a market cap of $12B – $18B in 3-5 years, representing growth of 2-3x in market cap over the same timeframe. Granted, this assumes consistent execution over this time period, but with the relatively small revenue base (avoiding law of large numbers) and demonstrated past performance, I think these goals are achievable.

Product Overview

From the Smartsheet web site, “over 83,000 brands and millions of information workers trust Smartsheet to help them accelerate business execution and address the volume and velocity of today’s collaborative work. Smartsheet is used by over 75% of the Fortune 500 and maintains rich data integrations with mission-critical applications from Microsoft, Google, Salesforce, Atlassian, and many others.”

Smartsheet provides a set of online, SaaS tools that enable information workers to re-create many of their common work management functions in an intuitive interface. Data collected and steps in the workflow can be customized for each user. Users can generate reports and dashboards to share the status of the work effort with other users within the enterprise. Collaboration is enabled by supporting commenting within Smartsheet, and through integrations with other popular collaboration tools, like Slack or MS Teams.

Smartsheet has been described as “Excel on steroids”, and in some investor circles pejoratively as just a slightly better spreadsheet application. I think this understates the utility of Smartsheet and the power of its flexible data and workflow model. Smartsheet occupies a layer above two-dimensional spreadsheets, project tracking applications and other information capture/display tools.

Smartsheet’s flexibility is encompassed along several dimensions:

• Data Collection. Through forms and custom fields, the user can capture and store any data type. This is akin to creating a data model on the fly.
• Conditionals. The user can associate basic logic with data collection, status changes and workflow steps. These conditionals allow Smartsheet to mirror workflows that consist of several steps, like approvals. This is not easily achieved in a spreadsheet.
• Views. Data can be displayed to the user through different visualizations – easily customized to the preferences of that user group. This can range from a grid, card, project or calendar view. Data can be updated directly in these views.
• Reporting. Users can create custom dashboards and status reports that can be shared with multiple users.
• Access Controls. Administrators can control access to Smartsheet content at a very granular level.
• Collaboration. Users can make comments within the application views to share conversations, decisions, and rationale in one place. This allows new employees or team members to get up to speed quickly, or existing team members can revisit decisions that were made previously to gather context around the work.

Interestingly, when applied to reproduce a standard workflow within an organization, the Smartsheet application resembles a custom developed internal software application. This “no code” solution provides the real power behind Smartsheet and other low code solutions like it. Instead of going to the internal IT organization for a developer resource to custom build a business application for a team, those team members can “assemble” the application through the tools provided by Smartsheet. This gives rise to the term “citizen developer“, in which a technically-minded employee can create a basic productivity application without writing code. I covered a similar trend in another post about Zapier.

Smartsheet makes money by charging a license fee for each user who creates content. Sharing with other users is free – they can view the output without a license. But, if they want to start creating their own workflows, they must be licensed. This is a common model for software distribution, first popularized with Adobe Acrobat (you can read a PDF for free, but need a license to create/edit one). Of course, allowing free sharing of Smartsheet content enables a strong virality motion through an enterprise. This is part of the “land and expand” strategy, which I will discuss further below.

After building the core platform with the capabilities discussed above, Smartsheet invested in a set of pre-made “solutions”, which span templates, integrations with other tools, data importers (connectors) and their newest offering called accelerators. The goal of these solutions is to help users get to a working, value-generating application faster by re-using pre-built components.

• Templates provide pre-built forms, sheets, reports and dashboards which users can modify. Examples include expense tracking, sales pipeline management, new employee onboarding and event registration.
• Integrations and Connectors allow for the import or export of information from or to other popular enterprise applications. These include Slack, Teams, ServiceNow, Power BI, G Suite and Zapier.
• Accelerators focus on a specific business context and provide a fully packaged solution to solve that particular problem. Examples include M&A, GDPR compliance, marketing campaign management and sales forecasting.

Accelerators represent a big financial opportunity for Smartsheet, as they sell these separately. Approximately 10% of revenue comes from these currently. There are 13 accelerators available now. On a recent quarterly conference call, the leadership team covered their product development strategy with accelerators. Their intent is to continue to develop new ones, but not at a rapid rate (likely several a year). They view accelerators as an opportunity to go very deep within a particular problem space, and then sell that solution broadly.

Smartsheet has been strategic in their approach to acquisitions, using them to further their depth in specific customer use cases. They have made two acquisitions in the last year.

In May of 2019, Smartsheet acquired 10,000ft. The 10,000ft acquisition allows Smartsheet customers to conduct resource planning, optimize resource allocation by skill set, track resource time against forecast and gain more visibility into the status of budgets and deliverables.

Founded in 2012, 10,000ft provides an intuitive, dynamic way for organizations to plan and manage resources across a portfolio of projects, track time by initiative, and build accurate forecasts using real-time insights. 10,000ft has more than 1,000 customers, including some of the world’s most innovative brands across consulting, advertising and creative agencies, consumer products, and technology.

Smartsheet press release

Also, 10,000ft focused on customers in the marketing and professional services segments. This, in turn, provides Smartsheet with a cross-sell opportunity to existing 10,000ft customers in that industry segment.

In January 2019, Smartsheet acquired Slope. Slope is an application focused on the creative content space. It provides capabilities to enable creative teams to automate workflows around content review, proofing and client approvals.

Launched in 2016, Slope combines robust project management with capabilities like proofing, version control, and real-time collaboration, enabling people and organizations to increase efficiency, improve communication, and produce higher quality content. Slope has over 100 customers across marketing, finance, retail and other industries.

Smartsheet Press release

Smartsheet will harness Slope’s technology in two ways. First, they will incorporate Slope’s content review and proofing functionality into existing workflows to drive feedback on images, videos, articles and other creative content. Second, Smartsheet will create one or more Accelerators built specifically for marketing and creative development workflows. Accelerators are sold as an add-on, which will represent a new revenue driver going forward.

Smartsheet leadership intends to continue making acquisitions. With over $500 million on the balance sheet, they are well-positioned to execute on a number of smaller, tuck-in acquisitions. These will be evaluated opportunistically – there isn’t a set target or formula according to the CEO (per recent conference call). The market does offer a number of smaller start-ups that focus on a discrete product niche, which would benefit from a larger scale go-to-market capability.

Product Landscape

In October 2018, Forrester Wave published their report on Collaborative Work Management (CWM) Tools for the Enterprise. In the report, they reviewed the 10 most significant providers along a set of 34 criteria. Smartsheet scored highest across all measurements, which encompassed product offering, distribution strategy and market presence.

Commentary specific to Smartsheet, it is described as “leading the pack” with a strong combination of product features and market support.

Data management, artificial intelligence, and business-oriented workflow design are Smartsheet’s most important differentiators. These capabilities enable teams to design tools that support project and process management that fits their needs with little formal technology support. Integrations and partnerships with vendors such as Google and Microsoft position the vendor well to address collaborative work management at the enterprise level.

Forrester Wave Collaborative Work Management Report 2018

The research for Forrester’s report revealed that Collaborative Work Management (CWM) is just getting started as a software category and has plenty of room to grow. As knowledge workers are pressured to increase productivity, they are increasingly turning to automation of information sharing and repeatable workflows. This goes beyond the first generation Google Docs and Office 365 tool suite, with which most information workers are now comfortable. CWM tools facilitate this automation of work the next level up. This is particularly impactful where the knowledge worker can enable the automation themselves, without writing code, through self-describing data fields and drop-and-drop workflow builders.

Forrester even elevates the CWM category to equal footing with CRM and ERP systems.

Unfortunately, unlike customer relationship management (CRM) solutions that become the customer system of record, or enterprise resource management (ERP) that is the financial system of record, firms lack an operational system of record, relying instead on a menagerie of tools to actually manage the way they work. Companies don’t have a single vendor solution to support an operational system of record. However, CWM’s flexible use cases and consumer-grade usability create common workspaces that act as an execution- level system of record.

FORRESTER WAVE COLLABORATIVE WORK MANAGEMENT REPORT 2018

Some analysts and investors group CWM tools with Microsoft Project and other Teams products, worrying that the Microsoft behemoth will keep a cap on the enterprise advancement of stand-alone CWM offerings. Digging into this, I found evidence that advanced use cases enabled by Smartsheet go far beyond what is possible with these first generation tools. I think this distinction will become more acute as CWM tools evolve and address more sophisticated workflows at a deep level. This is certainly Smartsheet’s strategy with Accelerators.

Forrester emphasizes this distinction in their report, highlighting the ability for CWM tools to be applied to a growing set of business workflow use cases.

Adaptability for a broad set of use cases. The notion that everything ultimately is a project still holds some water for many teams, but linear task management does not fit everyone’s needs. Today, most CWM vendors offer several options for organizing and tracking activities; the most innovative vendors offer end users greater flexibility to design different workspaces, workflows, and collaboration interactions. To gain enterprise adoption, vendors need to expand accelerators that automate repeatable processes such as onboarding new hires, pre-deal and deal execution merger and acquisition activities, or Scrum workflows.

Forrester Wave Collaborative Work management Report 2018

As another example, Smartsheet features a customer case study with Sunoco on their web site. Sunoco had embarked on a strategic M&A initiative in order to remain competitive. With all the deals being considered, they needed a way to ensure a standard set of information was being collected on each deal and to track the deal through a consistent set of review gates.

They initially tried to use a shared Excel document for this and quickly ran into issues with overloaded cells, consistency and state transitions. By moving to the Smartsheet M&A Accelerator, Sunoco was able to customize the workflow and data collection for deal evaluation. The net gains were better visibility into the due diligence process, easy evaluation of the overall deal pipeline for the program manager and a savings of about $800k in employee time, due to automation and information sharing. I assume that Sunoco similarly had access to other Microsoft tools, like Project or Sharepoint, but did not try to utilize these to address this workflow.

I captured some screenshots from Sunoco’s case study webinar that are relevant.

Total Addressable Market

Smartsheet defines their TAM in two ways. First, they estimate the size of their current “Base”, representing the knowledge workers who could be immediately impacted by utilizing Smartsheet’s current product offerings. They then define a broader TAM, which includes the full spectrum of Collaborative Work Management tasks that could be automated through Smartsheet’s growing toolset. This includes the impact of a broad set of accelerators, which handle many specialized, but repeatable, workflows at depth.

With FY 2020 revenues projected to be about $270M, Smartsheet has plenty of room to grow. Even at a $1B run rate in 3-5 years, they would occupy 4% of the larger projected TAM.

Customer Mindshare

Smartsheet is the leader in a large and growing market. While they have 83,000 “domain based” customers (measured by unique internet URLs), their penetration in the enterprise Fortune 500 companies is significant.

The initial sale into an enterprise is often to a single team. Smartsheet can be downloaded and installed in a self-service motion from the web site. The trigger might be a new employee joining the team from another company that is a Smartsheet user, or as a result of the brand marketing campaign that Smartsheet started in 2019.

Regardless, once the single team embraces the product, they can easily share output to other employees. This first wave typically starts as consumers and eventually become publishers, requiring additional license themselves. As the use cases within the enterprise expand, more Smartsheet product offerings are consumed across increasingly larger departmental circles. This life cycle is depicted in the diagram below.

Financially, this increased usage within an enterprise manifests as Smartsheet’s land and expand sales motion.

The dollar-based net expansion rate (DBNER) of 134% overall is in the top ranks of software companies. Further, to experience 159% DBNER in the Fortune 100 is even more impressive. These rates have remained fairly consistent over the last couple of quarters as well. It is this kind of expansion rates that make a CAGR of 56% over the next several years realistic, as Smartsheet advances towards its $1B revenue goal.

Over longer periods, customer expansion continues. As you can see in the chart above, customers landed 6 years ago have experienced a 426% expansion rate. This reminds me of the extraordinary customer expansion rates experienced by Alteryx (AYX), highlighted in my prior recommendation of that stock.

Leadership

Mark Mader is Smartsheet’s CEO. According to his LinkedIn profile, he joined the company in 2006. Smartsheet was founded in 2005. Mark is not listed as a co-founder, but has been with the company long enough to be considered one. Having a founder still at the company is an important criteria that I use in evaluating software stack companies. I think this elongated tenure suffices.

Mark also has a number of personal accolades listed including past awards as Ernst & Young’s Entrepreneur of the Year in Technology for the Pacific Northwest and GeekWire’s CEO of the Year. I enjoy hearing Mark speak at Analyst Day Events and on Quarterly Conference Calls. He exhibits a deep understanding of the space and an incisive perspective on various challenges and opportunities for the company.

Jennifer Ceran is the CFO. She has extensive experience in CFO and VP Finance roles at a number of companies before Smartsheet. These include Quotient Technology, Box, eBay and Cisco. Clearly, she understands financial drivers for growing software-oriented technology companies.

Mike Arntz is the CRO and EVP of worldwide field operations, responsible for the company’s sales, service, and support operations. Before joining Smartsheet, Mike led sales teams at NetSuite and Oracle. He built and led the sales process for Oracle’s Software as a Service (SaaS) applications.

A final highlight worth calling out is the recent hire of Anna Griffin as CMO. Smartsheet is investing in an awareness marketing campaign targeted at leaders of enterprise companies. The goal is to facilitate adoption and expansion of the Smartsheet solution within large companies, by removing the obstacle of familiarity. This investment makes sense to me from personal experience. As a CTO, I felt more comfortable green-lighting an IT investment if I had heard of the vendor previously.

Going Forward

Smartsheet is experiencing rapid revenue growth that has been consistently over 50% annually. Their land and expand model within Fortune 500 companies is driving an impressive DBNER of 134% overall and over 150% within their largest customers. They are a recognized leader in a large addressable market. They have a rapidly expanding product line, driven by their own development and thoughtful acquisitions. While not profitable now, they have a long term model calling for 20% operating and FCF margins.

For these reasons, I recommend an investment in Smartsheet (SMAR) stock. I expect significant growth over the next 3-5 years, in line with leadership’s target to achieve $1B in revenue within the same time period. At favorable P/S multiples, this should drive the market cap up by 3x. I expect a stock price of at least $140 within 5 years.

Risks represent SMAR’s ability to execute against its long term model. Additionally, the product landscape continues to be in flux and competitive offerings could emerge that disrupt growth.