CXM - Braze: A Good Q3 And A Great Market But Realistically I Now Have To Say Sell

Summary

• Marketing suite provider Braze plays in a great market with a “timeless” need.
• Management posted good, albeit not blowout, Q3 FY ‘23 results, sending shares lower in after-hours trading.
• More worryingly, management’s outlook for Q4 FY ‘23 and FY ‘24 is nothing to write home about.
• Still, analysts remain bullish on BRZE stock.
• Despite my bullishness for their market and belief that they could be a takeout candidate, I recommend investors sell Braze stock heading into 2023.

An Eternal Problem

In my last article on Braze ( BRZE ), I shared a brief story from my time selling enterprise software. I think it is worthwhile to repeat it here, along with another related story, as an opening to this analysis. When I first started in the business in the late 90s, my employer marketed an offering designed to help companies automate the processes used to design and deliver marketing content to their customers across different channels, such as the web, email, and print. In reality, the offering was vaporware. They didn’t have an off-the-shelf product per-se to attack this use case; and the concept was arguably ahead of its time and the technology of-the-day. Fast-forward to the early-2010s, and I was working for another software company focused on the integration space. They promoted their ability to help marketers connect and synthesize all their disparate systems containing data about their customers – a “360-degree customer view” to use an overhyped industry phrase. These stories from my past are separated by about 15 “real” years, but by “light-years” in terms of available technology – which is to say a comparison of the capabilities of computing technologies in the 2010s versus the late 90s is like comparing night and day. Yet, both of my employers were basically attacking the same problem despite the different “eras” they were operating in: delivering the right message, on the right channel, at the right time to customers.

The challenges associated with managing customer interactions is something of an “eternal” problem:

Companies are always going to be banging their heads against a wall trying to develop better ways to design, implement, and execute marketing campaigns more effectively; and there will be any number of technology vendors knocking on their door to help them figure it out.

I am sure the same general conversation will be happening decades from now, enriched by whatever technologies have become mainstream by then, including potentially new customer channels such as metaverse environments and augmented reality.

How does this all relate to BRZE you ask?

A Great Space

My point mentioning the stories in the prior section is simple: BRZE is in a great space. Although, you might not know it based on their year-to-date (“YTD”) performance.

Notes:

• Data as of market close December 12, 2022.

And, unfortunately, YTD performance stands a chance of trending a bit lower tomorrow with the stock down about ~(7%), in after-hours trading as I write this, following the release of Q3 FY ‘23 results . I’ll discuss the firm’s Q3 results shortly, but I think it behooves us to talk a little more about their market.

Some analysts use the term “marketing cloud” to refer to the market that BRZE and its competitors operate in. It’s a friendlier description than the “Enterprise Marketing Software Suites” (“EMSS”) nomenclature as used by Forrester. Regardless of what we call it, Forrester offers a nice definition that I reference here:

An enterprise marketing software suite (EMSS) [is] an integrated portfolio of marketing technology products that provide analytics, automation, and orchestration of insight-driven customer interactions to support inbound and outbound marketing.

One of the attractive aspects of the EMSS space is that it lends itself toward more of a solution-sell versus a point-product sell. That is, all the activities mentioned in the description above are ideally supported by a single vertically-integrated solution platform versus multiple point products that an organization must then “wire” together themselves. Hence, the deal sizes in this market can be very large and more strategic in nature. Of course, this is why software powerhouses like Adobe ( ADBE ), Oracle ( ORCL ), and Salesforce.com ( CRM ) are all players in this market with their respective suites. But, even up-and-coming providers like BRZE and Sprinklr ( CXM ) provide evidence of the deal “robustness” available in the market. For example, BRZE recorded 148 customers with annual recurring revenue (“ARR”) of $500K or more at the end of Q3 FY ‘23, with that customer bucket growing 53% year-on-year (“YoY”) and contributing 56% of the firm's total ARR. With so many tech firms spending significantly on their sales and marketing teams these days, a large deal dynamic helps to justify that spend.

As always, it’s not easy to put a box around the size of the available market; but a good number of analysts forecast the space growing into the -teens billion at a ~8% CAGR over the next ~5 years or so ( 1 , 2 ). With BRZE forecasting ~$350M in total revenue for FY ‘23, it would seem they have plenty of runway ahead despite numerous competitive threats, including the heavyweights mentioned earlier and a number of smaller players.

Notes:

• Forrester considers its Cross-Channel Campaign Management (CCCM) category as a composition of EMSS vendors and independent platform vendors like BRZE.

With an attractive market and a leadership position as seen in Figure 2, but a generally awful share performance in 2022, what are tech investors to make of BRZE heading into the new year? Well, let’s talk about the quarter…

Braze Q3 FY23 Results Post-Mortem and Outlook

BRZE posted a good Q3 performance with management beating on both lines.

Notes:

• Revenue and non-GAAP earnings estimates from Seeking Alpha .

These are obviously welcome results given the otherwise challenging year that has characterized the business. Highlights from the quarter include:

• Total revenue of $93.1M during the quarter. Revenue grew 45.6% YoY with $64M in total sales in Q3 FY ‘22. Subscription revenue in Q3 FY ‘23 was $89.0M or 95.6% of total revenue as compared to $59.3M or 92.7% of total revenue in Q3 FY ‘22.

• 43% of total sales from international customers.

• Total customers increased to 1,715 and total large customers with an ARR of $500K+ increased to 148. Total customers grew by ~38% versus 1,247 total customers in the prior period. BRZE’s large customer bucket grew by 52% as compared to 97 large customers in Q2 FY ‘23.

• Net retention rate (“NRR”) of 126% in Q3 FY ‘23; NRR for large customers with ARR of $500K+ was 129% during the quarter.

• Gross margin dipped by (130 bps) to 68.7% versus the prior period. Management noted during the earnings call that gross margins were impacted in part by higher hosting and third-party messaging costs.

• Free cash flow decreased to ($28.1M) during the quarter versus ($3.5M) in the prior period.

While Q3 results gave long BRZE investors a reprieve, management’s outlook for Q4 FY ‘23 was a bit muted calling for $95M - $96M in sales, reflecting 36% growth versus the prior period. Moreover, management sounded a cautious tone with respect to FY ‘24. They called out the 3 things that every other tech company seems to be calling out as 2022 comes to a close:

1. Macroeconomic headwinds are pushing back on the business.

2. Sales cycles are elongated with increased customer scrutiny on budgets and spending.

3. Customers are avoiding multi-year contracts in favor of shorter-term purchase agreements.

Investors don’t seem to have much to hang their hat on heading into 2023 (BRZE’s FY ‘24) despite the compelling market that they play in. Although, it is worthwhile to mention that, after calling out deficiencies in their sales organization in Q2 FY ‘23, management offered they have seen improvement in their field sales performance. Hence, they are ideally heading into the new year with revenue-generating resources that are ready-to-go in what may turn out to be a tougher selling environment.

Compelling, But Being Realistic…

I had previously recommended BRZE shares as a “hold”, speculating that the company may be a good takeout candidate. In particular, I had wondered out loud if Snowflake ( SNOW ) might be eager to acquire a firm like BRZE given that:

1. BRZE is built on top of Snowflake and therefore BRZE acts as a draw for customer data onto SNOW’s platform.

2. SNOW might consider investing in a company that pushes them a bit higher in the application stack such that they can continue evolving their customer engagements beyond traditional data warehousing.

Obviously, I was speculating; and readers disagreed with me, with one suggesting a more “integration-centric” play would make more sense for SNOW. Still, I think BRZE could be snatched up given that their platform touches so many aspects of an organization’s marketing workflow and underlying systems – I think it is an attractive opportunity in the right “hands”.

But, as I also commented in that earlier article, I don’t know exactly how to value BRZE. At market close today, the firm had a market capitalization of $2.7B, reflecting a multiple of 7.7x forecasted FY ‘23 total sales of ~$350M. In today’s market, this valuation doesn’t seem too insane. But, what if the floor does indeed fall out from the tech industry next year? What will be reasonable in that market?

With management’s cautious view on FY ‘24 and a good, but not blowout, Q3 in mind, I am altering my thesis to suggest that investors sell shares. Despite doing a lot of the right things, including more aggressive R&D hiring and new integrations allowing marketers to exploit the billions of users using WhatsApp, there is a lot of ambiguity going into the next fiscal period.

Although, expectedly, my view comes opposite to analysts.

If BRZE manages to climb up to the average analyst price of $47.20 using Figure 4 data, then shares hold a significant 60%+ upside based on today’s close of $28.90.

To reiterate, I think BRZE’s market is a compelling one for investors to look at investing in because the business case for marketing suite technologies is somewhat “timeless”. But, of course, it is a competitive space and management noted during today’s earnings call that pre-IPO vendors may be underpricing deals to win market share. If that trend continues, BRZE, which has historically positioned itself as more of a “premium” offering in the marketplace, may be pressured to reduce prices to maintain its base and/or grow. In fact, CEO Bill Magnuson, pointed out that they are seeing more customers opting to stick with shorter-term contracts at contract renewal, rather than moving from shorter-term agreements to a multi-year agreements. That dynamic does not bode well for BRZE heading into a tough economic environment where competitors are willing to undercut the company on price to gain share. With these facts in mind and management’s less-than-bullish view on Q4 FY ‘23 and the new fiscal year, I can’t see how any other recommendation other than “sell” makes sense at this point in time.

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