Business Breakdowns
· Matt Reustle
[00:00:00] S0: Yeah, it's interesting to hear for such a thematic thing to see how different companies and investor bases are approaching it. I derailed us a bit from the financial discussion. I will have to ask about the gross margin of this business, but because it's a software business, I'm sure it's absolutely outrageous. So if you could just touch quickly on gross margin, operating margin, the beautiful software model is really a miracle from a financial regard. But can you outline a bit about that and any trend lines or dynamics that you think are interesting there?
· Ben Hensman
[00:00:00] S1: Yeah. So Monday has been at scale for some time in terms of incremental costs. For a number of years they've been sitting around 90% gross margin. That's been very consistent and I think the main variable there over time will likely be AI costs and just how those input costs change versus customer usage. That may end up changing where their gross margin profile lands at a much larger scale. But at the moment both the company and in our view, there's no reason why that needs to change materially. If you look at the business over time, over the last six years or so, it's had a fairly consistent cost profile around R&D and around general administrative costs. Where the leverage has really come through in this business enabling it to be significantly profitable, particularly in cash flow terms, is in sales and marketing. So I mentioned back in 2019 this business was performance marketing driven primarily as well as product-led growth. So they were spending a very significant amount on sales and marketing. In 2019 it was 115 million US that was 150% of revenue that year. But one really interesting thing about Monday is it's always been a very cash-focused business. And so from a free cash flow perspective, I mentioned earlier, the business has been incredibly cash efficient and really focused on cash collection versus spend, as opposed to accounting revenue versus spend. And that's because they can fund that customer acquisition cost, the headcount within sales and marketing and partner solutions, and all of those folks primarily with customers paying upfront. If you cycle through the P&L today at a billion dollars or so of revenue, that's generating nearly $900 million in gross profit and about $145 million of EBITDA on a free cash flow basis, they're generating about $300 million of free cash flow. That includes some interest revenue. So without interest, it's about a 25% free cash flow margin. And that's been similar for the last couple of years and prior to that, broadly free cash flow neutral. The reason for that free cash flow dynamic is that 80% upfront billing I mentioned. And when the company is continuing to grow so fast and fairly evenly throughout the year, free cash flow is always sitting meaningfully ahead of that smooth EBITDA profile. And that gives the company a lot of valuation support.
· Ben Hensman
Given that they're generating so much cash over recent years, we've seen them start to include free cash flow in guidance as well. And so we've got a very clear view of how those margins are evolving, how that profile is evolving. They've also really effectively managed dilution in recent years. So while GAAP operating income has only recently turned positive, and there is a significant delta between GAAP operating income and non-GAAP operating income being stock compensation, that has for the last couple of years been about 13, 14% of revenue. But looking at net dilution itself, it's actually averaged about 1.8% over the last couple of years. And given the level of growth, given the level of value creation, this is a reasonably manageable level for the company to be. Incentivizing staff using stock to round all of that out. What this flows through to is the Rule of 40 or Rule of X, which while being a bit of an arbitrary term and combining two different metrics together, it does give you a sense of just how efficiently this business is growing and how fast it is growing. In the last two years it has been a rule of 60 company. So there have only been a couple of companies that have been sitting at that level. In 2024, that was at 64%. In 2023 it was at 69%, combining free cash flow, margin and top line growth. So it's an extraordinary story in terms of not just the top line growth and the drivers of that. The move to multi-product, the move to a platform, the scaling of those go-to-market functions, but the efficiency with which they've been able to do all of that and then how that's flowed through to the bottom line and free cash flow generation has been really impressive.
· Matt Reustle
[00:00:00] S0: Rule of 60 is a whole different territory, but I've seen the charts and where they show up in that upper right corner on capital allocation. One of the things that I meant to ask earlier is with a business like Salesforce, M&A became a key piece of the strategy there in terms of deepening their roots within different businesses and different offerings. Have they done anything from an M&A perspective and is that something that you would expect them to explore in the future?
· Ben Hensman
[00:00:00] S1: They haven't. So today the business has 1.4 billion on the balance sheet, no debt and that gives them a lot of optionality and to date hasn't burned a hole in their pocket in terms of their uses of cash. They've been very disciplined. It's obviously generating a lot of interest revenue right now, which is helpful. But in terms of what they can do with that cash, they really highlight three areas, none of which they've executed on in terms of uses of that cash. Their first priority of course is always investing in organic growth and that's continued to be the focus, but they haven't required additional cash for that given they're generating so much of it. The other two options are inorganic M&A and share repurchases. And on the M&A front, they haven't acquired a business to date, but they have been looking at businesses in areas that really complement the workflows and allow them to build depth in specific areas of product. And so I'll give a really specific example. We've talked about marketing ops quite a bit. This has been a really fruitful area for them to start in businesses. It's one of the verticals that they created and focused on in the early years when they were a really broad and horizontal platform and needed to help customers understand what the value prop was. Marketing ops has been an area, and so there are a number of small businesses and startups around the world that have gone in and filled different parts of specific workflows. So really niche operations. That's an example of where you might do a tuck-in acquisition to bring that capability into that specific part of the platform for marketing ops customers. They haven't chosen to do that yet, but that's where they'll focus. The other area is acqui-hires where there are businesses with really impressive talent, fantastic ideas and capabilities that they want to bring into the business. Share repurchases are the other option and that's something that they can definitely take advantage of at points when the business is not valued particularly highly.
· Matt Reustle, Ben Hensman
[00:00:00] S0: Have they ever done share repurchases in the past? [00:00:00] S1: No. [00:00:00] S0: Yeah. Pay the employees in the stock, wait for it to come back to buy back. There's some interesting options, particularly when you mentioned the dilution versus the percentage of revenue. It's an interesting delta between the two. And then I guess when I think about the business, I am sure they have high aspirations and a long runway ahead. Have they ever been targeted in M&A talks? Is that ever something that gets floated around?