NOW - Qualtrics International: Changing My Stance From Neutral To Long

Summary

• Overall, XM's growth in revenue was 2% higher than expected, and the company's EBIT margin was in line with consensus.
• Management commentary echoes the same touch macro backdrop that other software companies are facing.
• New better-than-expected profit guidance has aided in a very positive valuation rerating.

Investment thesis

Based on the most recent earnings report, I am revising my recommendation to long Qualtrics International ( XM ). My argument is still valid from a business point of view. Customers and employees alike place a high value on having a positive interaction with a company, and XM was an early innovator in the field of Experience Management. The XM platform not only enables businesses to collect feedback from a wide variety of sources, but also enables customers to analyze and correlate that feedback with operational data to generate actionable insights. All in all, to sum it up, XM is a promising investment because of its alignment with secular trends like digital transformation, its consistent growth in scalable revenues, and its highly effective business model.

4Q22 earnings review

XM's revenue growth was 2% higher than expected, and 4Q22 Billings (revenue + change in deferred revenue) of ~$572 million was up 11%, while sales of cRPOs increased by 16%. However, the NRR was down 4 percentage points on a sequential basis, ending at 120%. XM also shared that its subscriber base increased by 14% to 18,750 users, with 2,262 users spending over $100,000 in ARR on the platform.

My view

XM's overall report was in line with analyst projections. While management's projection for revenue growth in 2023 was 15%, 1% lower than expected, projections for margin expansion were 10%-11%, exceeding expectations of 5%. If we convert that to a raw number, we get an EBIT of around $175 million, which is significantly higher than the consensus estimate of $95 million. On the other hand, XM reported that the macro environment remained stable from the previous quarter, with increased scrutiny on budgets and lengthening deal cycles. I don't find this surprising given how the rest of the software and tech world is doing, even Microsoft ( MSFT ) commentary wasn't great.

That said, I believe the recent revenue decline is indicative of how strong the covid normalization impact and weak macro is. As a result, I'm questioning whether or not the business is less predictable than I had assumed. While I agree that XM plays a crucial role for many clients, this may not be the case for survey-heavy contracts or brand-new clients..

Guidance

XM guidance for FY23 reflect the continued macro and more symmetrical model. I think this outlook is consistent with that of other software companies like MSFT, which has expressed similar views. However, management did note that the fourth quarter of 2022 was consistent with the second half of the year, so there is reason for cautious optimism. This also suggests a degree of steadiness. Management did mention would benefit greatly from an uptick in business when economic conditions improved. These are encouraging statements, but the timing of the economic recovery remains unclear. As a result of layoffs, hiring freezes, and other cost-cutting measures, XM is on track to exceed its FY23 operating margin guide (>20% target). With respect to free cash flow, Qualtrics anticipates that FCF margin will converge with operating margin by year's end.

Although XM's subscription revenue forecast for FY2023 is not optimistic, I think it makes sense for the company to be more conservative in guiding given the current financial and economic challenges that are anticipated to persist throughout FY2023. More importantly, the operating margin has been directed in a more favorable direction than was anticipated by management.

Overall, I have a positive impression of XM's guidance approach and tone because the company seems to be edging toward narrative stability and leaning into profitability in order to pursue a more well-rounded business model, balancing growth and profits.

Partnership with ServiceNow

An F500 energy company has signed a multimillion-dollar deal with XM, which was made possible thanks to the company's collaboration with ServiceNow ( NOW ) and the use of the XM Discover solution. I take this as a vote of confidence in XM's innovative technology, compelling value proposition, and capacity to win new business in the face of intense competition. This win reinforces my belief regarding XM long-term growth prospect as it continues to manage to close important and large deals.

Valuation

Based on the management guidance, updated consensus estimates, and the rerated valuation, I believe case for XM has shifted from fair value to 34% upside by FY24. A big part of this change comes from the increase in multiple from 3.3x to 5x which I think is due to the better than expected profit guidance.

Conclusion

Based on the most recent earnings report, I am revising my recommendation to long XM. I believe investors are happy with the new profit guidance that XM set out in the report, which has aided in a very positive valuation rerating from 3.3x to 5x.

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