KIND - Nextdoor: Business Stabilizing But Losses Are Still High

2023-06-19 22:32:09 ET

Summary

• Nextdoor's performance in the past quarter shows revenue resilience in certain verticals and steady user growth and engagement.
• Investment in AI could enhance the product, increase engagement, and drive revenue growth and margin expansion.
• Lack of visibility in profitability raises concerns and may keep the stock rangebound for now; maintaining a hold rating on KIND.

Investment thesis

I continue to give Nextdoor ( KIND ) a hold rating, but am seeing signs of stabilization in the recent results. For starters, KIND went through the same downturn as many other businesses that have exposure to the advertising industry when the macro economy went south. Despite the continued volatility in the ad budget environment, the 1Q earnings were better than expected as revenues came in from certain verticals showing signs of resilience. It's crucial to note that both user growth and engagement have remained steady. Management also followed through with 4Q strategy to continue optimizing its expense growth which gave me better confidence on the business path to the guided margin target. In the long run, I believe that KIND has plenty of room to expand its user base and generate more revenue. However, the lack of visibility to profitability is something that is worrying and should cause the stock to be in rangebound for the time-being. Hence, I continue to give KIND stock a hold rating as I wait for clearer catalyst for re-rating.

Stabilization

In my opinion, KIND is now in the stabilization phase, the first step toward a full recovery. Despite persistent macroeconomic uncertainty, the company's revenue and EBITDA for 1Q came in higher than expected. KIND has successfully upheld a commendable advertiser retention rate of 90% among its top 50 advertisers, while experiencing a sequential increase in WAUs by 2.4 million, accompanied by higher engagement levels. The fact that KIND has maintained its partnerships with these advertisers even during challenging periods reflects the compelling value proposition it provides. Furthermore, there has been consistent growth in WAUs in the international market as well. These positive indicators of accelerated user growth and increased engagement bode well for KIND's stock in the near term. If we look at the verticals that are still dragging down on growth: retail, financial services, and real estate, we can see that these are verticals that are largely impacted by the macro environment – that should turn around eventually. Since the demand in these markets is not there right now, I believe it is difficult for KIND to invest in its growth engines in order to capture it. Therefore, I advocate that management put their attention on sectors like technology, telecom, and healthcare that are less vulnerable to macro and have structural demand growth. As KIND continues to index toward less macro-reliant verticals, this investment should pay off over time.

Investing in AI

Management's investment in AI to enhance the product should, in my opinion, be a major factor for future outperformance and acceleration of revenue growth and margin. Internally (for the ops team) and externally (for the user), I can think of many places where adopting AI would be helpful. The first step could be to implement AI chatbot assistants for internal use, which would greatly reduce the burden of handling inquiries for customer service team - which means lesser headcount is needed. Investment in AI would be most beneficial if it were used to increase engagement by making content of higher quality. KIND can improve its value to advertisers by learning more about the preferences of its users based on their demographics with the help of AI.

Overhang on the stock

The biggest risk to the stock, in my opinion, is that KIND is still operating at a loss. In 1Q23, the company had an 80% gross margin and a -75% EBITDA margin, which means it spent $2 for every $1 spent. The worst part is that there is no clear path for EBITDA to break even in the near term. Also, no information has been provided regarding a return to prior share repurchases to counteract dilution, and stock-based compensation expense has remained high at 30-35% of revenues. While the market favored the stabilization of user metrics (stock rose to $3), I believe the stock will remain rangebound for the time being until KIND shows signs of acceleration in profitability.

Conclusion

I maintain a hold rating on KIND. Despite facing challenges in the advertising industry, KIND's 1Q earnings exceeded expectations, indicating revenue resilience in certain verticals. User growth and engagement have remained steady, and management's focus on optimizing expense growth is encouraging. Additionally, investing in AI to enhance the product and increase engagement could be a significant driver of revenue growth and margin expansion. However, I believe the lack of visibility in profitability raises concerns and may keep the stock rangebound for now. Ultimately, I await clearer catalysts for re-rating before adjusting my rating on KIND.

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