KIND - Nextdoor: No Logical Reason For Me To Invest Today

2023-12-05 10:51:53 ET

Summary

• Nextdoor's operating performance has not improved and the business is still in the red, with little visibility into its path to profitability.
• Recent results show subdued top-line growth and little improvement on an adjusted EBITDA basis, with declining key operating metrics.
• The advent of AI has significantly elevated KIND's business risk, making it difficult for smaller players like Nextdoor to compete with larger platforms.

Overview

My recommendation for Nextdoor (KIND) is a hold rating, as I don't see any positive upsides in the near term. Operating performance has not improved since my last writeup, and despite management's efforts to drive cost improvement, the business is still far in the red. The advent of AI has also significantly elevated KIND's business risk. While I think there is a path for KIND to pull through ahead, I don't see a logical reason to invest today. I remain neutral on the stock. Note that I previously rated a hold rating for KIND as there was little visibility into KIND's path to profitability and losses were tracking at very high levels back then.

Recent results & updates

It has been 6 months since my last write-up on KIND, and I think it's about time to give an update on my view after reviewing the latest quarter performance . Top line growth remained subdued at mid-single-digits, where 3Q23 saw 4% revenue growth (30bps deceleration from 2Q23) to $56.1 million. On the profitability front, KIND has made little improvement on an adjusted EBITDA basis. Adj EBITDA came in worse on both an absolute and percentage basis; 3Q23 -$19.8 million was worse than 3Q22 -$18.4 million, and the margin compressed by 100bps to -35% from -34% last year. If I were to sum up KIND's performance so far, it has been a disaster with no improvements at all. Key operating metrics like WAU (weekly active users) also declined sequentially for the second consecutive quarter to 40.4 million. While this was deliberately driven by a change in notification strategy and could deliver better long-term results (to be fair, session depth grew 30% year over year and the number of new neighbours coming to the platform organically accelerated 32% sequentially), I don't think the market fancy another element of uncertainty in the business. Making things worse, management comments and guidance have effectively put a lid on the stock performance in 4Q23. Specifically, they mentioned enterprise advertiser demand was mixed in August and September, and that softness has continued into 4Q23, with weakness in real estate, home, and financial services. The weakness led to management having a weak 4Q outlook that was below consensus expectations. Pre-results: consensus expected ~$61 million in 4Q23 revenue (positive growth), but management guided for $51 million, which was a huge delta. Management history with revenue guidance has been pretty accurate, and as such, I don't expect any surprises in 4Q23.

Although the management cost restructuring effort that is expected to drive around $60 million of annualised GAAP expense savings is commendable, I don't think this is sufficient to convince the market that KIND is going to be anywhere near profitable. Over the last 12 months, KIND generated a GAAP EBIT loss of $161 million. Even with the $60 million in savings, KIND is still losing $100 million, or -~57% GAAP EBIT margin. Moreover, KIND's stock-based compensation [SBC] expense as a percentage of revenue has reached an all-time high of 42% (the first time it has ever reached 40%). I see these as deferred cash costs, basically, and that shareholders will need to "pay" for them one way or another. So on a cash profit basis, KIND is a very deep loss.

I think the bigger picture here is that KIND's weak performance and poor profitability trajectory really highlight the weakness of being sub-scale in this industry. I believe these challenges will start to snowball at a compounding rate as the titans in the industry (Meta, Google, Amazon, etc.) continue to invest massive amounts of dollars into AI. In the past, subscale players like KIND could find a niche in this big market, carve out a base of subscribers, and attract advertising dollars (i.e., revenue). Larger players are less likely to penetrate these small niches because of the lack of visibility, the profit pool is too small to be attractive (KIND is not profitable at all), and they might simply lack the human resources to spend time figuring out how to penetrate these markets. However, this is not the case with the adoption of AI marketing . The advent of AI enables larger platforms to offer more sophisticated products, both for users and advertisers. With the same amount of human resources, players with sophisticated AI machines can run multiple simulations to figure out if a market is attractive and what the best way to blast ads to the underlying users is. In other words, with AI, players like Google could, in a much more labor- and cost-efficient way, disrupt KIND's market, significantly elevating KIND's business risk. Viewed from another angle, the advent of AI also reduces the barriers of entry for new players to disrupt KIND's market.

As such, I think a lot has to go right for this stock to work: drive topline against a much more competitive operating environment (one that will get even tougher), reach profitability while reducing headcount, address SBC without losing employees, or put the balance sheet at risk (KIND could use its cash to buy back shares). All of it is possible, but extremely tough, and I don't see a logical reason for me to invest my money at this point.

Summary

Given KIND's continuous weak performance, losses, and weak outlook, I reiterate my hold rating. Despite management's cost-saving measures, KIND's financials remain deeply negative. Moreover, I believe the industry's scale advantages and the advent of AI present substantial challenges for smaller players like KIND. Considering these concerns and the uncertain path to profitability, I maintain a neutral position on KIND until clear signs of improvement emerge.

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