BRZE - Braze: Rating Upgrade As The Business Soldiers Through This Storm

2024-01-18 04:19:26 ET

Summary

• Braze's 3Q24 revenue grew 33.1%, beating expectations, with subscription revenue increasing 33% year-over-year.
• The company's balance sheet remains strong, with a net cash position of ~$370 million.
• The demand environment seems to be gradually turning positive, particularly in the enterprise customer segment, indicating potential for continued growth.

Summary

Readers may find my previous coverage via this link . My previous rating was a hold, as I believed any further upside for Braze ( BRZE ) would require multiples to re-rate even higher, even though I was optimistic about the business. My conclusion back then was to wait for a cheaper valuation or when there was a visible catalyst in sight before buying the stock again. I am revising my rating from hold to buy as I now believe BRZE is able to continue growing the business at >30% for the foreseeable future.

Financials / Valuation

BRZE 3Q24 revenue grew 33.1%, with subscription revenue increasing 33% Y/Y to $118.4 million. This strong 33.1% growth was ~570 bps higher than what consensus expected. The same beat was seen at the gross margin level, which saw 71.4%, beating the consensus estimate by 317 bps. The gross profit outperformance drove non-GAAP EBIT margins to -7.2%, an expansion of more than 10 points. BRZE's balance sheet remained sound after the end of the quarter, with a net cash position of ~$370 million, more than enough to last the business for the next few years assuming the same LTM cash burn rate of ~$130 million (using EBITDA loss as a benchmark).

Now that CY2023 has come to an end and FY24 is going to end soon in 2 weeks, I believe the market will shift its focus to FY26 numbers. Based on how BRZE has performed in 3Q24, I have raised my growth expectations from deceleration to 30% growth for the next 2 years. Despite the current macro conditions, 3Q24 was able to grow by 33%, with strength supported by enterprise customers—evidence that I believe indicates a possible start to a recovery. This also indicates to me that growth can only get better from here since BRZE grew by >30% in one of the worst macro conditions in recent history. With all these in mind, I believe the current 8.7x forward revenue multiple is well justified as compared to recent history, as BRZE has shown that growth of >30% is possible. Note that my growth estimate for FY25 and FY26 is above consensus, which I think is too low given how BRZE is growing in today’s condition. As BRZE shows more evidence that 30% growth is possible (e.g., if 1Q25 is >30%), there is a good chance that consensus will upgrade their estimates, which will be positive for the stock sentiment.

Comments

BRZE's recent performance was a positive surprise for me, as it led me to believe that the business can continue to grow at 30% instead of my decelerating growth expectations. Notably, BRZE's growth strength was supported by strength from enterprise customers, which I believe is an indication that the demand environment is turning for the better. The reason I say this is because large businesses are typically the first to recover in a macro-recovery because they have the financial capacity to do so. As such, while BRZE saw challenges in the SMB (small and medium businesses) segment, I am not as worried because SMBs are typically slower in terms of recovery. With enterprise leading the pack, recovery in SMB should come in due time. An interesting comment made by management led me to believe that growth can only get better from here:

Marketing budgets and team sizes are still flat or otherwise constrained. CFOs are still scrutinizing every dollar that goes out the door. And we also see many businesses still struggling to adapt to the new macro. Source: 3Q24 earnings

Despite this constraint, BRZE still managed to grow revenue by 33%. This literally tells us that in a normal environment, BRZE would have grown much higher than this. Much better. I see a possibility for BRZE growth to accelerate back to >40% at the start of the recovery cycle as businesses release their hold on marketing budgets to take advantage of a booming economy.

With a larger marketing budget, it also meant that BRZE would be able to sell additional products into the installed base, which is another growth driver. On this point regarding cross- or up-selling additional products, BRZE has certainly done a great job, which lends credence to its ability to continue doing so. As of 3Q24, BRZE has passed $500 million in committed ARR. This is an astonishing feat considering that it grew by almost 2x in over 2 years. In terms of room to continue growing ARR, based on BRZE's latest results, I don’t see much issue for them to continue as there is still substantial room within the existing base of customers to improve ARR/customer (only 189 out of their 2,011 customers are spending >$500k in ARR). Note that BRZE was growing the number of customers by more than 40% before the macro conditions got worse, and it is still growing at >20% despite current conditions. With Brze's growing agency and partner ecosystem, it should be able to accelerate customer growth when the macro situation improves, which means more room for up- and cross-selling opportunities to expand ARR.

And we're cultivating partnership, partner relationships across that whole spectrum as well, inclusive of smaller marketing and growth agencies that work through our partner-led on-boarding program to deliver to SMBs all the way up to the global systems integrators, the big marketing holding companies that or the agency holding companies that work with us in the world's largest enterprise businesses.

Speaking of that, there's also obviously the agencies and the ecosystem and the partnership side, which also will help to compound our way to $1 billion ARR and beyond. Source: 3Q24 earnings

Lastly, I think the competitive environment is also gradually turning positive for BRZE as interest and inflation rates rose. Companies that were supported by VC money have faced liquidity issues as they are now not able to “grow at all costs." Profitability has become a central focus for many of these loss-making companies. As they cut down on growth expenditures to raise cash, this is positive for BRZE as it is in a net cash position, giving it the necessary financial capacity to continue investing in growth expenditures to capture share when competitors are stepping back. I expect this dynamic to continue for the coming years, as we are unlikely to go back to the zero interest rate era, and VCs in the coming years will have stricter investment criteria given that rates are higher. This means that BRZE start-up competitors with weak balance sheet will not be able to tap into the equity market as easily as they did previously.

Risk & conclusion

Although I mentioned that there is leading evidence that the demand environment is turning, timing is extremely difficult as many things are happening every day. For instance, if the conflict between Ukraine and Russia escalates to a full-blown conflict that draws in multiple parties, the macro environment is unlikely to see a swift recovery. This could delay BRZE’s ability to accelerate growth.

In conclusion, I am upgrading BRZE from a hold to a buy rating. The unexpected strength in enterprise customer performance suggests a positive shift in the demand environment. Despite challenges in the SMB segment, I am optimistic as large enterprises often lead macro recoveries. Given that BRZE managed to grow revenue by 33% even in today’s macro environment, I see no reason why growth cannot be >30% when the macro situation recovers. BRZE's successful cross-selling efforts and a growing agency ecosystem also position it for continued growth. Additionally, a favorable competitive landscape, with BRZE in a net cash position, enhances its ability to capture market share.

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