BRZE - Braze: Rating Downgrade As Upside Is Dependent On Multiples To Re-Rate Higher

2023-09-18 13:18:53 ET

Summary

• BRZE has reported strong financial results with substantial revenue growth and improved margins, beating expectations in the latest quarter.
• I have downgraded my rating from buy to hold.
• The catalyst for multiples appreciation may come when BRZE turns profitable, potentially around 4FQ25, according to consensus estimates.

Summary

Citing from my previous write, Braze ( BRZE ) is a leading customer engagement solution enabling brands to drive multi-channel, highly personalized, real-time engagements with their customers. Brands can attract and onboard new customers, engage existing ones, or promote greater customer retention with the help of BRZE's comprehensive platform, which allows them to engage customers in the channel of their choosing with real-time, relevant, and contextual messaging. Readers may find my previous coverage via this link . My previous rating was a buy, as I continue to be optimistic about BRZE long-term potential due to its strong execution despite the uncertain macro environment.

I am revising my rating from a buy to a hold, as the upside is now limited compared to when I first wrote about the stock in late April this year. I remain optimistic about the business; however, further upside on the stock level seems to be dependent on multiples re-rating higher. While possible, I believe it is better to wait for the catalyst (BRZE turning profitable) to be closer in sight before going long again.

Financials/Valuation

Both total revenue (34% y/y) and subscription revenue (34% y/y) accelerated from the 1Q24 to the 2Q24, bringing in $115 million and landing 6% ahead of consensus. The revenue beat also helped the company's pro forma operating margin, which came in at -6.6%, beat expectations by 750 basis points. Pro forma earnings per share came in at -0.04 thanks in part to the margin outperformance.

For my model, I updated for management's raised FY24 revenue guidance and held my growth assumption for FY25 the same as my previous model. The price target I have remains the same at $49. I first recommended a long in late April, and the stock has since risen by around 50%, a fantastic rally. Even in my previous post, I recommended a buy rating when the share price was at $43, as the upside was still okay at 13%. However, at the current share price, I think the upside is dependent on multiples rerating higher, which is possible as Adobe is trading at 11x forward revenue (which I take as the ceiling for BRZE). While BRZE is growing faster than Adobe, the latter is in a much more profitable position and, hence, should command a premium. The upside catalyst for multiples to rerate is likely when BRZE turns profitable, which, if we use consensus estimates, would be sometime around 4FQ25. Until then, I am downgrading my rating to a hold and waiting for the next opportunity to buy.

Comments

As I had anticipated, BRZE delivered a stellar 2Q24 result. I believe that, in addition to the primary P&L figures, the underlying operating metrics are displaying encouraging signs of growth and execution. Billing in 2Q24, for example, is up strongly from the previous quarter, increasing by 500 basis points (2Q24: 34%; 1Q24: 29%). Even more impressive was the 28% y/y growth in RPO, which represented an acceleration of 600 bps compared to 1Q24. My expectation is that BRZE will maintain its current rate of growth, given its current level of momentum and the fact that BRZE is continuing to hone its go-to-market [GTM] strategy. In particular, management highlighted growing momentum with channel partners. They described how BRZE's partnership with a global system integrator [GSI] helped them win over a quick-service restaurant that had been using one of the legacy marketing clouds. Since BRZE's GTM has restructured the sales team in 2Q23, the company's continued expansion will necessitate strong ties to these GSIs.

In the personnel side, we have been working there to optimize. But as I mentioned on my prepared remarks in the call, one of the further areas of leverage is executing on our cost optimized location strategy, and there are individuals or there are roles rather on that -- on the -- in the core segment whereas the organization grows, we will be able to find ways to grow into some of these costs optimized as location. Source: 2Q24 earnings.

I expect that BRZE will encounter similar opportunities in the future as the company deepens its connections with GSIs and marketing agencies of various sizes. It's important to note that although GSI implementations yield faster results, partners initially earn less revenue due to GSI's share. Conversely, having a larger customer base opens up the potential to provide additional ongoing services, thereby boosting recurring revenue. I foresee that as times passes, this GTM strategy will substantially enhance BRZE revenue, driven by the growing momentum with our channel partners.

We're investing to allow that mutually beneficial flywheel, that I've spoken about in prior quarters to continue to spin up. And I'd say we're also advancing at varying speeds, depending on the partner, but we're really excited about the overall trend line and we're seeing examples of tremendous success where we're generating really strong services revenue for those partners that are leaned into their Braze practices and our joint go-to-market motions. But the characterization of how you're a really great Braze partner is very different from the way that you may have been a great partner to the legacy marketing cloud. Source: 2Q24 earnings

Some investors might be concerned that this would depress margins, as GSI will take a cut from these at the gross margin level. I beg to differ, as the leads from GSI cost essentially nothing on the sales and marketing (S&M) line. Even if we assume the decrease in gross margin offsets the benefit from lowered S&M, it is still net positive as revenue grows.

It's almost like the old GSI Commerce model where they're going to do fulfillment all the way through the front-end e-commerce store to search marketing and all other things to bring customers to the front door and Braze is the white label engagement solution inside of that. So that costs us 0 from a sales and marketing effort perspective. And then it's -- we're supporting the partner who then is supporting all of their end customers, and we think that could be an interesting emotion for us over time. Source: Braze 2022 investor day

I'd like to circle back to the AI chance facing BRZE that I mentioned in my previous post. When I look at how far BRZE has come, I can't help but feel encouraged. The management team highlighted their machine learning-driven predictive suite, which is already generating revenue as a premium add-on for customers, during the 2Q24 call. Brands will also benefit from the AI recommendation engine's ability to promote products with which consumers are highly likely to engage in a purchase conversation, as it is fueled by a transformer model trained specifically for the brand in question. This should be another driver to growth as it becomes a standalone product in the future.

In addition to these unique features, Braze also incorporates Generative AI capabilities into its products to support content and campaign development for marketing groups. In turn, this is anticipated to raise the level of consumer engagement, the number of monthly active users, the volume of messages sent, and the amount of money made by Braze. These are new revenue streams that should continue to support growth.

Conclusion

BRZE has shown significant progress in its customer engagement solutions, but I'm revising my rating from a buy to a hold. While the company's financials, including strong revenue growth and improved margins, are impressive, the current stock price suggests limited upside unless there's a multiple re-rating higher. I remain optimistic about BRZE's long-term potential, especially with its AI-driven predictive suite and recommendation engine, along with Generative AI capabilities offering new revenue streams. However, the catalyst for further stock appreciation might hinge on BRZE turning profitable, potentially around 4FQ25, according to consensus estimates. Therefore, I recommend a hold position for now and await a more opportune moment to buy.

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