XM - Qualtrics: An Acquisition Currently Offering Little Upside For Investors

2023-05-10 13:32:47 ET

Summary

• Silver Lake Partners and CPP Investments are set to acquire Qualtrics for $18.15 per share in cash.
• The transaction is expected to be completed in the second half of 2023.
• We believe this acquisition presents little opportunity for investors with a meager ~1.5% spread between the current share price and acquisition price.

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Investment Thesis

Due to the meager 1.5% upside spread between the current share price of Qualtrics (XM) and the per-share acquisition price, we give Qualtrics a Neutral rating. It is unlikely that anything interrupts or prevents the acquisition from being completed, which is reflected by the small spread between the current share price and the acquisition price.

Company Overview

Qualtrics is a customer and employee experience management software company founded in 2002. In the company's own words , "Qualtrics captures every form of customer and employee feedback, including survey responses, contact center chat interactions, social media posts, product reviews, and more. With advanced machine learning and AI, Qualtrics analyzes this data to understand the emotion, effort, and intent behind the words. Qualtrics' technology captures aggregated data, offering organizations insights to help them take the right action to improve customer experiences." The company employs over 5,600 people and has co-headquarters in Provo, Utah and Seattle, Washington.

Thesis Explainer

As of the end of 2022, Qualtrics had over 18,750 customers, including 90% of the Fortune 100. Furthermore, Qualtrics has 189 customers paying them over $1 million per year for their products and services. Such a high-ticket customer base has helped Qualtrics to fuel rapid growth over the last several years.

In January of 2023, SAP SE (SAP), the largest holder of Qualtrics at the time, announced that they were exploring a sale of their stake in the company. SAP had been struggling as of late and decided that it would be best for them to focus their efforts on their core operations, of which Qualtrics didn't belong. That day, Qualtrics' stock jumped over 32% in reaction to the news.

Less than two months later, on March 13th, Qualtrics' share price jumped another 6% after it was announced that Silver Lake Partners, a large and reputable private equity firm focused on technology investing, alongside the Canadian Pension Plan Investment Board, had come to terms to acquire the company for $12.5 billion, or $18.15 per share.

Silver Lake in particular is no stranger to deals of this size and magnitude. They are well-known in the industry for their $24.4 billion buyout of Dell (DELL) in 2014. At the time, this was the largest technology buyout ever.

Qualtrics' acquisition by Silver Lake and the CPP is expected to be completed in the second half of 2023. Markets have shown confidence in the deal going through. The current share price of $17.89 reflects a small ~1.5% upside from the acquisition price of $18.15. This small spread between the current share price and the acquisition price suggests that there is little room for significant upside in the near future as it is likely that the spread will only narrow as the acquisition nears completion.

Financials

Qualtrics is still very much in growth mode, and their financials certainly display that. The company themselves points out that the experience management software category is relatively new and rapidly changing. Due to operating in a largely undeveloped space, Qualtrics is actively trying to capture as much market share as they possibly can.

Qualtrics' FY 2022 revenue was $1.459 billion, a robust 35% increase from 2021's revenue total of $1.076 billion. Approximately 80% of those revenues came from recurring subscriptions. This large amount of recurring revenue allows Qualtrics the luxury of relatively stable and predictable cash flows. Furthermore, the company believes that there is still ample room for growth. Their 2022 annual report to shareholders estimated the value of their total addressable market ((TAM)) to be a whopping $60 billion . Even if this $60 billion TAM is a classic case of management over-optimism, it still helps to illustrate just how large Qualtrics' opportunity is.

The company also boasts impressive gross margins in excess of 70%. Couple this with net dollar retention of 120%, and things are looking pretty good. However, as I mentioned earlier, Qualtrics is in full-fledged growth mode, leading to ample expenses. EBITDA for 2022 came in at -$943 million, and net income was -$1.061 billion. It's worth noting as well that Qualtrics has spent over 2x gross profits for the last two years on operating expenses. This has been a trend throughout Qualtrics' history and could continue to be a theme in the near future, depending on how Silver Lake chooses to operate the company.

Despite taking on this high-growth approach, Qualtrics has a decently stable cash position. The company ended Q1 2023 with over $800 million in the bank, almost $100 million more than they had at the end of 2022.

One thing that stands out from Qualtrics' financial statements are the large amounts of capital that are devoted to stock based compensation, with approximately 50% of all of it going to the CEO. In the last four quarters alone, the company has awarded over $1 billion worth of stock based compensation. While stock based compensation is generally a good idea for companies in order to align incentives between management and shareholders, sometimes it can go over the line of what is necessary, and this seems like it may be one of those instances. Illustratively, during this same time period of $1 billion+ of stock based compensation being awarded, Qualtrics' stock has plummeted approximately 37%. I'm not sure if this is the type of aligned incentives that were imagined when the compensation plan was originally put into effect.

It will be interesting to see how Qualtrics' financials change throughout the years under ownership by Silver Lake and the CPP. I'd imagine that they will continue to aim to maximize growth, but also double down on a path to long-term profitability so that it can fetch a high valuation if and when they decide to exit the investment and take Qualtrics public again.

Valuation

Qualtrics is currently the largest player in the experience management space. However, there are some other companies in the space that have good traction that can serve as comparables for Qualtrics.

One such is Momentive Global (MNTV), the parent company of Survey Monkey. In mid-March of this year, it was announced that Momentive entered into an agreement to be acquired by a group led by Symphony Technology Group in an all-cash transaction that values Momentive at approximately $1.5 billion, or less than 3x TTM revenues. On the other hand, Qualtrics is currently trading for almost 7x TTM revenues. Although this is more than double the multiple at which Momentive is being acquired, it is for good reason. Qualtrics has demonstrated a much more complete, valuable, and sustainable business model than that of Momentive.

Nonetheless, by some standards, Qualtrics could be overvalued as they are more than double the sector median in many multiples, such as Price/Book, Price/Cash Flow, EV/Sales, etc. This jump in valuation multiples is likely due to the 60%+ premium that Silver Lake agreed to acquire the company for. However, at the end of the day, a company is worth what someone is willing to pay for it. And in this case, Silver Lake is willing to pay $12.5 billion for it, so Qualtrics should make sure to enjoy the premium valuation while they can.

Risks

The greatest and most prominent risk for investors at this point is linked directly to the likelihood of the deal with Silver Lake going through. Although it is incredibly unlikely that the deal fails to be completed, the effects on Qualtrics' stock could be significant if it were to happen. Such an event could cause the stock to tumble down after it will have been pegged at or near the $18.15 share price for an extended period of time.

Investors should note that this private equity deal is unique in the sense that only $1 billion of debt is being used to finance the acquisition, despite it being a large scale buyout. Silver Lake opted for this financing approach due to the current high interest rate environment. Relying on such a small portion of debt to finance the acquisition makes the deal more likely to go through as it isn't heavily reliant on massive debt commitments from a large group of lenders. This is one of the factors contributing to the small spread between the current share price and the acquisition price.

Conclusion

Qualtrics' remaining days as a public company, at least for the foreseeable future, are limited. The company has posted impressive growth as of late and looks well-poised for the future. While now may not be the optimal time to claim a stake in the emerging experience management industry by investing in Qualtrics, investors should keep an eye out for the company in years to come. Assuming Silver Lake and the CPP's investment goes well and they eventually aim to exit through another Qualtrics IPO, public markets investors will likely get another chance to buy in. And when it comes back to the public markets, it has the potential to be a mature cash cow, leaning heavily on its robust and strong enterprise customer base.

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