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$S: The $S Problem and Opportunity
Quick and dirty post-earnings thoughts on $S
$S is down big after earnings. They revised prior revenues down $27mm. Obviously it's never good when a company revises past numbers downward. Apparently, their sales reps were using Salesforce in such a way that when a customer wanted to renew a contract and also buy a new upsell item, the sales reps were creating entirely new contracts that included the base product as well as the upsell item. The problem was the old contracts still existed, so they were essentially double counting some of their sales. How an auditor didn't catch this, I have no idea.
Another issue, and one I suspect had less of an impact on the downward revision, was they were annualizing consumption based revenue. Consumption revenue is not as predictable as subscription revenue. It probably wasn't a big deal when that line item was a small portion of revenue, but became an issue as revenues grew over time.
Altogether, these were a a $27mm problem. On top of this, they missed and guided revenue down. Once the street can't trust a company's numbers, it's very tough to recover.
These are the current problems, and they present what I would consider to be a glaring opportunity… which is that $S is beginning to take the shape of a company that fits the profile of a perfect acquisition target. You can read a previous article on my substack that details my criteria for what makes a good acquisition target, but to summarize:
It Fits the Bill
Management has to want to sell
The acquisition price needs to clear 52 week highs
How well does $S fit the criteria? A heck of a lot better after that call last night. I’ll touch on each point. To start, it’s now misunderstood by the street because it misunderstood it’s own numbers to the point it had to go back and revise them. Not a good look. It’s already on it’s way to being hated. It’s getting cheap too, it just took $2B off its market cap after earnings. It fits the bill because it has an excellent endpoint solution being used by many enterprise customers and MSSP partners, and any cybersecurity platform provider without a competitive endpoint solution could benefit from adding a solid endpoint to their platform. If management doesn’t want to sell yet, just wait until the pain of a lack of faith and recovery in the stock price wears them down over time. This could take 6+ months to happen. The acquisition price needs to clear 52 week highs, and it’s currently sitting around $30 from Q2 2022, instead of the closer to $50 level it was at in Q1 2022.
$11.50 is where I plan to start buying heavily, as that's about 3x EV/ARR (Fy24), which is what $SUMO got sold for, and $S is a much better company that $SUMO. I think investors are going to do the math and expect a sale at some point. If I’m going to hold something for 6 months or more, I want to make sure I have an entry price that can sustain broader market moves without sweating it too much. I do believe we’re headed for a recession and we will see multiples come in as a result.
A question I now have is how many other companies have been annualizing consumption-based revenue? A recession could spell trouble for them in more than one way.