Monday.com: A Binary Bet With a High Risk
An Israeli company that specialises in workforce management, Monday.com (NASDAQ: MNDY), has submitted its F-1 registration form in preparation for an initial public offering (IPO). Following the most recent funding round, the company had a valuation of $2.7 billion at the time. The company, which develops software to assist employees in working remotely, has received funding from a number of investors, including Sapphire Ventures and Hamilton Lane, amongst others. In the following paragraphs, we will go over the most important aspects of the investment prospectus and analyse what those aspects mean for potential investors.
The global health crisis is the most disruptive crisis that the majority of companies have faced in the past several decades. However, for a certain group of software companies, the pandemic served as a source of rocket fuel for their business models. These software companies help distributed teams work more effectively and become more critical as a result of the trend toward remote work. Monday.com is one of the companies in this category. Ahead of the pandemic, the tech unicorn had already broken through the threshold of $100 million in annual recurring revenue (ARR), earning $130 million in ARR in February 2020. The pandemic led to an increase in usage, which in turn led to an increase in revenues (Monday.com does not offer a free tier). The revenue increased by 106 percent from the previous year, reaching $161 million in 2020, up from $78.1 million in 2019. The rate of expansion has remained at an astronomically rapid level. The amount of money brought in during the first quarter of 2021 increased by 85 percent when compared to the same period the year before, going from $31.9 million to $59 million.
Monday.com is a software as a service (SaaS) provider, and it derives the majority of its revenue from the subscription fees paid by more than 128,000 customers located in more than 190 countries. Monday.com has been very successful in expanding its client portfolio to include more prominent organisations, which is a significant contributor to the company’s revenue. In 2019, it had 76 customers from whom it obtained an annual recurring revenue (ARR) of more than $50,000. By the end of the year 2020, it had grown that segment by 247 percent, bringing the total number of clients in that category to 264.
Investors who have been paying attention to the startup scene will be aware that the majority of unicorns are not profitable in their early stages. Only six of the 73 unicorns that had completed their initial public offerings by November 2020 were profitable, and no unicorn has been profitable since Zoom completed its IPO in August 2019. According to the available evidence, those unicorns that are still privately held do not generate profits, and the absence of profits is becoming an even more ingrained issue.
Monday.com does not deviate from the standard format. It is a loss-making unicorn that, like many other unicorns, compensates for its lack of profitability with blisteringly fast growth in customer base. The company’s annual net loss ballooned to $39 million in 2020, up from $19.9 million in 2019. During that time period, operating expenses increased to $289 million, an increase of 82.3 percent from the previous level of $159 million. The company’s operating expenses that are related to sales and marketing are, by a significant margin, the most important ones. In the year 2019, they were worth $119 million, while in the year 2020, they were worth $191 million. When we compare this year’s first-quarter operating expenses (($89 million) with those of the previous year’s first-quarter operating expenses (($47 million), we see that the pattern has continued into 2021, with operating expenses growing by nearly 88 percent.
Because the costs associated with the company’s sales and marketing are so high, Monday.com would not be profitable even if it cut all of its other expenses and reduced its workforce to zero. Since 2019, every single quarterly reporting period, they have exceeded quarterly revenue totals. For example, during the first three months of 2021, the business brought in a total of $59 million in revenue while incurring expenses related to sales and marketing totaling $63 million.
Monday.com is placing a straightforward wager, which is that it will be able to realise economies of scale, construct formidable barriers to entry, and turn a profit as a result of driving revenues to ever-higher levels. It’s a straightforward wager, and a lot of companies make exactly the same wager.
As a consequence of this, the costs of sales and marketing can be seen as an investment in the future profitability of the company, much in the same way that sending a child to an after-school programme is an investment in the child’s future. Once a customer has been won over by a company, it is difficult for that customer to switch to one of the company’s competitors. These switching costs are competitive advantages, and once the business reaches a certain minimum viable scale, it will be able to raise prices to a point where they are profitable. Despite this, the reality is that many businesses make this wager, but the vast majority of those businesses do not experience any positive outcomes as a result of it. An investment in the company becomes a gamble with only two possible outcomes: either the company will reach the point where it can achieve minimal viable economies of scale, or it will fail completely. There is no room for compromise. Without scale, there is no possibility of making a profit. An investor who has faith in the company may be rewarded with substantial gains, but the investor also runs the risk of suffering financial losses. This type of binary bet results in manic-depressive stock price movements, which are marked by high levels of volatility. Every single earnings result and every single operating announcement is interpreted and overinterpreted, which can lead to either euphoric or depressive pricing.
In addition to the inherent volatility of binary bets, there is also the question of how significant the switching costs can be. Because there are so many opportunities in the SaaS market, competition is extremely fierce in this industry. This indicates that new competitors are appearing, prices are being kept at extremely low levels, and competition is just a click away at all times. It is possible that the competitive environment is such that the prices offered by competitors are so low that the costs of switching are less than the economic savings that can be gained from switching.