Monday.com (NASDAQ: MNDY), an Israeli work management firm, filed its F-1 registration form in preparation for an initial public offering (IPO). The company was last valued at $2.7 billion after its previous funding round. The startup, which makes software to help employees work remotely, is backed by Sapphire Ventures and Hamilton Lane, among other backers. This article will discuss the highlights of its investment prospectus and what they mean for investors.
The global health crisis is the single most disruptive crisis that most firms have faced in decades. Yet, the pandemic has been rocket fuel to their business models for a particular cohort of software companies; These companies help distributed teams work better and become more critical as work has gone remote. Monday.com is one of those businesses. Before the pandemic, the tech unicorn had already crossed the $100 million annual recurring revenue (ARR) threshold, earning $130 million in ARR in February 2020. The pandemic boosted usage, and consequently, revenues -Monday.com does not have a free tier-. Revenues grew 106% year-over-year, from $78.1 million in 2019 to $161 million in 2020. Growth has continued to grow at an exponential pace. First-quarter revenues in 2021 increased 85% over the previous year’s first-quarter revenues, going from $31.9 million to $59 million.
As a SaaS company, Monday.com generates revenues from subscription fees paid by more than 128,000 customers across more than 190 countries. Large companies are responsible for a big chunk of the firm’s revenues, and Monday.com has been skilled in growing its portfolio of big clients. In 2019, it had 76 clients from whom it obtained more than $50,000 in ARR. By the end of 2020, it had grown that segment by 247% for a tally of 264 such clients.
Investors who have paid attention to the startup scene will know that unprofitability is the mark of most unicorns. Of the 73 unicorns that had done IPOs by November 2020, only six were profitable, and no unicorn since Zoom’s IPO in August 2019 has been profitable. The evidence suggests that those unicorns that are still privately held are unprofitable and that unprofitability is becoming an even more entrenched problem.
Monday.com does not break the mold. It is an unprofitable unicorn that, like many unicorns, matches its unprofitability with scorching hot revenue growth. Net loss widened from $19.9 million in 2019 to $39 million in 2020. Operating expenses grew by 82.3% in that period, rising from $159 million to $289 million. Sales and marketing expenses are by far the most significant operating expenses the company has. In 2019, they were $119 million, and in 2020, they were $191 million. The pattern has continued into 2021, with operating expenses growing by nearly 88% when we compare first-quarter operating expenses (($89 million) with last year’s first-quarter operating expenses (($47 million).
The company’s sales and marketing costs are so big that even if it eliminated all its other costs, Monday.com would still be unprofitable. They have been bigger than quarterly revenues in every quarter since 2019. In the first quarter of 2021, for instance, the company earned $59 million in revenue and spent $63 million on its sales and marketing costs.
Monday.com is placing a simple bet: by driving revenues ever higher, it can achieve economies of scale, build formidable barriers to entry and thereby attain profitability. It’s a simple bet, and many firms place this same bet.
Consequently, the sales and marketing costs can be interpreted as an investment in the company’s future profitability, like an after-school program is an investment in a child’s future. Once the company has won a customer, it’s challenging to switch to a competitor. Those switching costs are competitive advantages, and at a specific minimal viable scale, the company will be able to raise prices to a level that allows them to become profitable. However, the fact is that many firms place this bet, but many firms fail to reap any rewards from it. An investment in the company becomes a binary bet: either the firm will achieve minimal viable economies of scale or go bust. There’s no middle ground. Without scale, there are no profits to be had. An investor may reap rich rewards from believing in the company, but that investments may lose money. That kind of binary bet leads to manic-depressive stock price movements, which are characterized by extreme volatility. Each earnings result and each operating announcement is interpreted and overinterpreted, leading to euphoric or depressive pricing.
Aside from the volatility that arises from binary bets, there is the question of how substantial the switching costs can be. The SaaS market is rich in opportunity, and this makes it incredibly competitive. That means that rivals are cropping up, prices are kept extremely low, and competition is always a click away. The competitive landscape may be such that the competition is priced so low that the switching costs are lower than the economic savings from switching.