- Integer Investments
Companies we are buying: WIX
Updated: Aug 9, 2020
Companies we are buying: WIX
While the Coronavirus crisis continues, we have been searching for companies that can not only survive a prolonged shutdown, but can thrive for years to come.
One of the first companies we have bought is Wix.com.
WIX is an online platform that helps businesses create websites with little investment but beautiful results.
Although the current crisis might have a short-term negative effect on WIX business, the long-term move to online activities will only accelerate.
What does WIX do?
In short, WIX helps small businesses create a stylish website in a few hours, without the need for coding skills. Over the years, it has added products catered to different skill levels from novice to expert.
Clearly, e-commerce is on the rise, and more and more businesses will need a website. The current crisis will increase the need for websites. Every offline business should have an online storefront. However, WIX offers more than a tool to create a fancy website.
In just five years, the company has added many features to its original service. For example, WIX Mobile made it much easier to build mobile websites. WIX Restaurants, an all-in-one, easy-to-use restaurant system, allows restaurateurs to create a stunning menu, take online orders and reservations and receive payments. This feature is an example of how restaurants could move their operations online and better navigate social distancing periods. WIX not only targets restaurants; but also many other verticals (e.g. hotels) as well as functions (e.g. CRM). The company is currently investing 32% of its revenues on R&D, improving its platform consistently.
Why we like WIX
In our letter to shareholders (read it here) we mentioned that we were looking for companies with:
(a) long-term sustainable businesses, meaning with long-term trends supporting their industry and with solid competitive advantage;
(b) low leverage;
(c) good management;
(d) positive free cash flow;
(e) And of course, a fair share price.
Long-term sustainable businesses and competitive advantage
First, as mentioned above, WIX has a long-term sustainable business. The company has structural tailwinds benefiting from the move online and more people deciding to be entrepreneurs (think about all the WeWork entrepreneurs). The company applies a ‘freemium’ business model, so customers can try its services and then subscribe to paying versions.
The figure above shows that the company has 165M users, but only 4.5M are paying subscribers. Two things come to mind. First, the company has an untapped market of potentially paying subscribers that is 40 times those paying. Second, the company has been growing at compounding rates of 13-16%. We do not expect those rates to decline in the next few years (apart from short-term issues).
The first point is further clarified by the following graph. As you can see above, WIX is not only adding subscribers, but it is monetizing existing subscribers more efficiently due to more services and higher prices.
In just two years, the average revenue per user has increased from $143 to $179. Despite this growth, the current cost equals to $0.50 a day. Imagineyou are a restaurant owner: would you cut this cost? If the company decides to charge 10% more a year, would you consider shifting to another provider or maybe pay $5,000 to a web developer for a one time job? The bill also comes once a year, so by the time you get the bill, is probably too late to change.
The following graph shows the incredible consistency of revenue collection. It is hard to see the previous years, but you can see that customers from any cohort (year) are incredibly consistent. This means that they are staying on WIX for 10 years. In fact, the amount collected from customers entering the platform from 2018 to 2019 has increased by $38M or 5.9% in one year.
Overall, revenues have been growing at outstanding compunded rates. From 2017 to the end 2019, revenues grew by around 26% a year. The figure below provides more clarity. The consistency of revenue collections is incredible. Extrapolating these numbers, the company expects to collect $6.8B from existing subscribers. On top of this, the company is growing its subscriber’ base by 13% a year. Assuming the same growth rate, WIX would move from 4.5M subscribers to 12M subscribers by 2027, almost triple. To be conservative, we have modelled a growth significantly smaller (5M a year, so a declining growth rate, see valuation below).
So, on the first point, we believe that WIX has a sustainable advantage. High R&D spending will strenghten its products and customers have low incentive to change provider and generally face high switching costs. The company also has long-term tailwinds and this makes it an attractive play, especially considering its stable revenue generation.
The company does not have debt in its balance sheet. In fact, WIX has more than $300M in cash. Considering that, over the next few years, it should invest approximately $25M/year in capital expenditures (but last year collected $127M in free cash flow), even if there is a significant slowdown due to the current crisis, WIX should not have any financial problem.
Management is crucially important in any firm. The CEO Avishai Abrahami is the cofounder of WIX and has been with the company for almost 10 years. The CEO compensation package includes $443,000 in salary that is very reasonable. Almost all other executives have been with the company for many years. The average tenure of the management team is 8.3 years.
Positive free cash flow
The company is currently generating positive free cash flow. Furthermore, it is doing so at increasing rates. Free cash flow has increased at 26% compounded from 2017 to 2019. The current Coronavirus crisis might have a short-term negative effect, but unless companies go bankrupt, they won’t be cancelling their website subscriptions as this might be their only source of revenue.
Before the crisis, WIX touched a maximum of $156 a share. We entered our position just around $115, added around $90 and now have an average price of $97.17. This gives us a paper profit of 6.6% at today’s closing price of $103.58. Our valuation of WIX was conducted in two ways. First, we extrapolated future cash flows and costs for the next 16 years (including terminal value), then discounted our cash flow for the entire period. Second, we tried to value the company in 5 years based on potential market multiples.
We expect revenues to climb from approximately $1B today to $2B in 2025, and $3B in 2030. Discounting future cash flows gives us a $5.5B EV. Today’s EV is $4.5B. Thus, starting our position at today’s prices not only provides us with a 14% compounded return for the next 16 years (hypothetically), but also adds some remaining value. The other valuation tool assumes that we sell our position in 2025. In that case we assume we could sell at 6X revenues for a total of $11B EV, for a total profit of 144% in 5 years. In comparison, Salesforce (CRM) currently trades at 5.38X EV/Sales expected in 2021. Salesforce is a more mature company compared to WIX since it has more than $20B in sales, 10X what we expect WIX to achieve in 2025. It is admittedly very hard to put a precise valuation on growth companies, but we believe WIX provides compelling value at these prices.
We entered this market correction with a conservative portfolio, but we are now adding positions that we think provide long-term value. One of the companies we have invested in is WIX. The company is managed by the founders that have been with the company for many years. It has a long-term sustainable business, a focus on R&D, long term industry tailwinds that should only be strengthened by the current crisis. It has no leverage, a large cash position and generates increasing amounts of free cash flow. We also believe we are buying it a fair price that ensures long term value appreciation.
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